Finding the right compensation structure is crucial for aligning employee and company interests. Among the options, commission pay stands out as an approach that incentivizes performance by directly tying earnings to sales results. For many sales-focused roles, commission pay enables higher income potential and provides advantages for both workers and businesses.

Throughout this article, we will provide an in-depth look at how commission pay works, its key advantages and disadvantages, scenarios where commission pay stands out as the best alternative, and strategies to optimize commission structures for maximum benefit. Both businesses and employees can gain insight into how aligning pay with sales performance through commission can be the best approach in most cases.

What is Commission Pay?

Commission pay refers to compensation for employees based on the sales they generate, rather than a fixed salary or hourly wage (though it is often combined with a salary or hourly rate). With commission-based pay, the employee earns a percentage of the total sales revenue they bring in as income.

For example, a salesperson who sells $100,000 worth of products and earns a 5% commission would make $5,000 in commission pay.

Also read: What Is CRM Software? A Complete Guide for 2023

The commission percentage varies by industry and individual employer but often ranges from 1% to 20% of net sales. Commission pay serves as an incentive for employees to maximize sales productivity and revenue. The more they sell, the more they earn. Commission pay ties earnings directly to performance.

Jobs that typically pay a commission include:

  • Sales representatives who earn commission on top of their base salary. They make a percentage of each sale.
  • Real estate agents earn commission based on home sale prices, often 3% to 6% of the total price.
  • Insurance brokers often receive a commission per every new policy sold or renewed.
  • Stockbrokers can earn a commission per trade made by their clients.
  • B2B salespeople who sell various products to other businesses can earn a percentage commission on each sale.
  • Car, furniture, electronics, and other retail salespeople.

Types of Commission Pay

how to calculate commission pay

Companies adopt different models to calculate the commissions they will be paying to their sales personnel depending on the industry they are in, the kind of incentive they would like to offer their sales representatives, and how the business model works.

These types of commission pay are vital to understand for both employees and employers at companies who use these structures.

Here is a detailed overview of 9 different types of commission pay structures.

#1 – Straight Commission

In this case, the commission for the sales representative is calculated as a percentage of the net revenue the person produces within a certain period. This payment often substitutes a base salary entirely as the higher commission rates compensate for the lack of base pay.

Which industries tend to use it?

Real estate, insurance, consulting, and financial services.

#2 – Salary Plus Commission

This structure combines a base salary with additional commission pay estimated as a fixed percentage of the amount the representative brought in during a certain period. This alternative provides a reliable income plus an extra economic incentive for top performers.

Which industries tend to use it?

Retail, technology, manufacturing, and business services.

#3 – Tiered Commission

The commission percentage in this structure increases when sales reps hit higher revenue milestones. The system is designed to reward top performers and better line up the representative’s financial goals with the company’s sales quotas.

Which industries tend to use it?

Financial services, insurance, and retail.

#4 – Residual Commission

These are ongoing commissions earned by representatives as long as clients continue to pay for a given service or renew their contracts. The system rewards client retention and sales volumes at the same time.

Which industries tend to use it?

Software, insurance, and financial services.

#5 – Performance Commission

The commission rate is determined based on performance metrics like customer satisfaction, client retention, or cross-selling/up-selling percentages rather than just sales volume. The structure rewards representatives that provide a great service, broaden the company’s revenue base, improve customer loyalty, or increase the average order size per customer, among other goals.

Which industries tend to use it?

Business services, retail, consulting, and insurance.

#6 – Draw-Against Commission

Reps get a monthly “draw” against future commissions. Unearned draws are subtracted from future commissions. New representatives benefit from this scheme as they typically receive base pay despite not making any sales for a relatively short period. The amount they withdraw during that time comes from future commissions.

Which industries tend to use it?

Financial services, real estate, and insurance.

#7 – Team Commission

Commissions are earned based on the team’s performance. The goal of this system is to incentivize collaboration between sales representatives. The commissions can be aggregated into a pot that is later on distributed equally among all reps or there can be a specific quota that the team must reach to be awarded a certain amount.

Which industries tend to use it?

Retail, restaurants, and call centers.

#8 – Territory Commission

The commission rate is determined based on sales revenue generated within a geographic territory. This rewards local market expertise and fosters teamwork. It can also be used to better align the team’s priorities and performance with the company’s geographical objectives.

Which industries tend to use it?

Retail, distribution, pharmaceutical, household services, business services, and insurance.

#9 – Hybrid Commission

This scheme combines two or more commission structures like salary plus commission and tiered rates. The goal is to maximize incentives and encourages top performers to shine.

Which industries tend to use it?

Financial services, technology, manufacturing, and retail.

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How to Calculate Your Commission Pay

Now that we have provided a description of each of these 9 types of commission pay, we will be sharing the details of how commissions can be calculated under each scheme.

#1 – Straight Commission

This is one of the most common schemes and the easiest to calculate. It ties compensation with sales directly in a pretty straightforward way.

How it is calculated?

Total Revenue x Commission Percentage

Example

A real estate agent earns a 3% commission on home sales. They sell a $500,000 home and earn $15,000 (500,000 x 0.03).

#2 – Salary Plus Commission

This method offers a combination of base pay with an additional incentive for sales reps.

How it is calculated?

Base Salary + (Revenue x Commission Percentage)

Example

A sales rep earns a $60,000 base salary plus a 4% commission pay. If the person generates $1,000,000 in revenue in a year, that would result in $100,000 in annual income broken down as follows:

$60,000 + ($1,000,000 x 0.04) = $100,000.

#3 – Tiered Commission

A scheme that rewards incremental sales.

How it is calculated?

Net revenues x Commission Percentage Assigned to Bracket.

Example

A representative can earn a 5% commission for sales of up to $100,000, 7% for sales ranging between $100,000 and $250,000, and 10% if they exceed $250,000. A rep selling $300,000 in a month would earn 5% on the first $100,000, then 7% on $150,000, and 10% on the remaining $50,000. This would result in a monthly commission pay of $20,500.

#4 – Residual Commission

A typical scheme used by companies that sell a subscription or benefit from the renewal of a contract.

How it is calculated?

The formula may vary from one company to the other. However, it typically includes the straight commission pay component (Sales x Commission Percentage) plus an added incentive (either fixed or percentage-based) to reward renewals.

Example

Let’s say an insurance broker earns a 2% commission on the premium paid by its customer every year. In addition, for every renewal, he gets a $100 bonus. In a given year, the rep generated $175,000 in premium payments and managed to renew 54 of the policies he sold. This would result in an annual commission payment of $35,000 plus a $5,400 bonus for the renewals, resulting in total commissions of $40,400.

#5 – Performance Commission

This system offers multipliers to sales representatives that are aligned with the organization’s goals.

How it is calculated?

Total Sales x Commission Percentage x Performance Multiplier

Example

A rep makes $100,000 in sales with 95% customer satisfaction, earning a 5% commission rate multiplied by a 1.2 performance multiplier, totaling $6,000 (.05 x 100,000 x 1.2).

#6 – Draw-Against Commission

New sales representatives benefit from this scheme as they can draw from their future commissions to cover their living expenses while they build a customer base and get ahold of things.

How it is calculated?

Draw Amount – Earned Commission = Payment Due

Example

A rep gets a $5,000 monthly draw but earned only $4,000 in commissions during that period. They keep the full $5,000 draw and owe $1,000 to be subtracted from future commissions.

#7 – Team Commission

This system fosters collaboration and teamwork.

How it is calculated?

(Total Team Revenue x Commission Percentage) / Number of Team Members

Example

A sales team earns a 5% commission on $500,000 in revenue. Split between 4 team members, each rep earns $6,250 ($500,000 x 0.05 / 4).

#8 – Territory Commission

How it is calculated?

Total Revenue per Territory x Assigned Commission Rate

Example

If sales in the Northwest territory exceed $1.5 million in a month, the team will get a commission rate of 3%. In February, total sales were $1.6 million. A rep who made $150,000 in sales in this territory would earn $4,500 ($150,000 x 0.03).

#9 – Hybrid Commission

A tailored scheme that allows companies to line up the sales team’s goals with those of the organization.

How it is calculated?

Hybrid models are highly diverse as companies adopt whatever fits their goals the best. One system could focus on scaling sales in a region, so it may offer a few extra percentage points to those that hit or exceed a specific amount in sales during a given period while other schemes could focus on increasing the turnover of certain products and services. To this goal, they may offer a performance multiple to the reps that manage to cross-sell or upsell customers the most.

Example

A rep earns a base salary of $1,500 plus a 3% commission on the first $100,000 sales and 5% on amounts above $100,000. With $150,000 in sales in a month, the rep would earn a salary + $3,000 (3% of $100,000) + $2,500 (5% of $50,000). This would result in a monthly commission pay of $7,000.

Also read: A Beginner’s Guide to Understanding Affiliate Marketing

Benefits of Commission Pay Structures

These are the six most relevant advantages of commission pay for both employees and employers:

  • Motivates Employees to Excel: Commission pay directly ties earnings to sales results. This incentivizes employees to do their best and go above and beyond to maximize commissions. These systems reward top performers.
  • Aligns Employee and Company Interests: Commission structures make employee earnings dependent on company revenue. This alignment of interests ensures that employees are working towards expanding the business and increasing its profitability.
  • Provides Unlimited Earning Potential: With commission pay, employees have no cap on what they can potentially earn. The harder they work; the more money they can make through commissions. This unlimited earning potential keeps employees driven.
  • Rewards Expertise and Deal-making Ability: Commission structures provide the highest pay to employees who develop sales skills and become experts in persuading and closing deals. Experienced salespeople can earn substantial incomes.
  • Lowers Fixed Labor Costs: Unlike salaries that remain static, commission pay is a variable expense that only rises when revenue is generated. This lowers a company’s fixed labor costs and reduces financial risk.
  • Easy to Administer: Commission pay is simple for companies to calculate and administer. All that’s required is tracking sales numbers and applying the commission percentage or structure. It’s an efficient compensation model.

Drawbacks of Commission Pay Structures

Here are 6 key disadvantages of commission pay:

  • Income Instability: Commission earnings fluctuate based on sales performance. During specific seasons where sales are low due to seasonality or a recessionary cycle, employees may struggle financially amid the absence of base pay.
  • Requires Persistent Motivation: Employees must consistently put in their maximum effort to achieve high commissions. Keeping them motivated can be difficult as emotional, familiar, and personal issues could be an obstacle.
  • Promotes Aggressive Sales Tactics: The pressure to earn commissions can lead some employees to use overly aggressive or unethical sales tactics – i.e. hard-selling techniques and false advertising.
  • Prioritizes Sales Over Service: With commission as the focus, employees may overlook customer service responsibilities like follow-up and reporting.
  • Causes Internal Competition: Commission structures can spur cutthroat competition between sales team members driven by self-interest.
  • Higher Turnover Rates: Underperforming employees often leave or have to be terminated because they cannot survive on commissions alone or because their ability to bring in and retain customers does not live up to the company’s expectations.

How to Maximize Your Commission Pay

how to boost commission pay practical tips 3

  • Build Strong Client Relationships: Taking time to nurture client relationships leads to increased sales. Make clients feel valued by checking in regularly, providing helpful information, and anticipating their needs. Loyal clients are more likely to make repeat purchases and refer others.
  • Prioritize Time Management: Structure your day to focus on revenue-driving activities like lead generation, presentations, and closing deals. Limit time-consuming tasks that don’t directly impact sales. Working efficiently maximizes selling time and opportunities.
  • Specialize in High-Ticket Products and Services: Develop expertise around premium offerings that carry higher commissions. Pitch these products confidently and showcase how they can solve the client’s pain points better than basic options.
  • Ask for Referrals: Satisfied clients can be a sales rep’s best source for qualified referrals. Ask happy clients if they can recommend others who would benefit from your products/services. Referred prospects convert at higher rates.
  • Negotiate Commission Rates: As you gain experience and prove your selling abilities, negotiate higher commission rates with your manager. Demonstrate how your skills merit a higher rate tied to your strong performance.
  • Pursue Cross-Selling Opportunities: Identify ways to sell additional products and services to existing clients. Clients who buy multiple offerings tend to spend more over time, earning you higher total commissions.
  • Participate in Contests/Promotions: Take advantage of sales contests and bonus spiffs to earn extra commissions. Compete to win tiered prizes and incentive trips that reward top performers.
  • Prioritize High-Value Activities: Focus your efforts on sales activities proven to drive results, like contacting qualified leads and scheduling product demos. Maximizing time on high-value tasks tends to increase sales and commissions.
  • Continue Learning: Investing in sales training and continuing education improves skills and keeps your techniques sharp and up to date with the latest trends and research. Enhanced abilities can translate directly into bigger commission checks. Stay hungry to keep getting better.

When Is Commission Pay Better for Workers?

Commission pay is not necessarily the best arrangement for all workers. Depending on their skills, their ability to build relationships and manage time, and what kind of ambitions they have personally, this compensation scheme may or may not be the best alternative for them.

In this section, we outline five scenarios that describe the type of worker that would benefit the most from commission pay.

You are an expert in persuading others.

Lead generation, convincing prospects, negotiating deals, and closing sales are the bread and butter of a sales rep. Employees who excel at persuasion and develop sharp selling skills can earn higher incomes through commissions than a fixed salary. Commissions are a good fit for those who excel at building relationships and have in-depth product knowledge.

You are a performance-driven individual

People who have great personal ambitions may prefer a commission-based compensation scheme rather than a base salary. The reason for this is that their effort and skills will be compensated accordingly and that will incentivize them to bring their A-game.

You are eager to build wealth

If you have not inherited a sizable sum from a relative, building wealth will typically require that you earn a good deal of money via your regular job or a business venture. Sales jobs are typically the most accessible opportunity in the marketplace for people with the skills to perform and execute the task at hand at a high level.

You want a flexible schedule

Commission roles tend to offer more flexibility in setting one’s schedule compared to hourly or salaried positions with set hours. For those who value autonomy over when and how much they work, commission arrangements allow them to choose optimal selling times. Commission pay provides freedom and independence.

You feel comfortable with variable pay

Some prefer commission-only pay where 100% of income varies based on sales results. For those who thrive on the direct relationship between work and reward and are comfortable without a safety net, commission pay is probably the most appealing choice as it offers an enticing risk/reward model.

When Is Commission Pay Better for Businesses?

Most companies prefer to rely on commission pay to compensate their sales team. There are several reasons why this is the case and, in this section, we explain the most common explanations.

Sales Teams with High Turnover

If a sales department has a high turnover, commission pay will allow the company to limit its fixed labor costs. Rather than paying salaries to employees who may leave quickly, companies only pay for the sales they made. Commission pay also incentivizes new hires to bring their A-game quickly. This flexible cost model works well for volatile teams.

Products and Services with High Profit Margins

When profit margins are high, companies can afford to pay larger commissions without impacting their bottom lines. Luxury products and specialty services that enjoy premium pricing ranges are well-suited for commission models as they allow companies to pay their employees much more than usual without hurting their profitability.

Industries with Proven Sales Methods

Transactional sales industries where proven sales processes are in place, like retail and insurance, lend themselves to commission pay. When clear sales methods are established, commission pay rewards employees for correctly executing these processes. Products and services that essentially “sell themselves” align well with commission pay.

Companies That Prefer to Tie Pay to Performance

For organizations seeking a tighter alignment between employee pay and company revenue, commission structures directly tie employee earnings to the positive performance of the business.

Cash-strapped Startups

When starting out, commission pay allows companies to conserve cash by only paying salespeople for the revenue they bring in. Without established revenue streams, commission pay provides startups with much-needed financial flexibility and reduces fixed overhead as the business scales.

References:

US Department of Labor – Definition of Commission Pay