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A sales commission is an incentive that an organization pays salespeople for every sale they make. Read on to know more about why you need sales commission and the different sales commission structures.
A sales commission to a salesperson is what war spoils are to an emperor – an essential factor that keeps them motivated in their field.
Admittedly, sales is a competitive line of work, so pushing and prodding your team to keep moving forward takes more than just pretty speeches. It takes understanding them, their motivations, and a well-thought-out sales commission structure.
Besides, if your goal is to grow your business, you wouldn’t want your salespeople to become comfortable with making sales at a particular sales target. This brings us to sales commissions.
In this guide, we’ll dig into the X’s and O’s of sales commissions, how they benefit your sales team, and, by extension, your overall sales plan, and which sales commission structure would suit you the best.
Sales commission is a monetary incentive that salespeople (typically) get on top of their base salary depending on the sales they’ve made. The commission often depends on the sales target or quota that a rep meets.
Before digging any further into sales commissions, let’s first look at sales targets and how it is related to sales quota.
As you might have guessed, a sales quota is a target amount of sales that a salesperson achieves in a given period, say a month or quarter. Sales managers set sales quotas to establish performance expectations, motivate salespeople to aim higher and achieve the company’s revenue goals.
But here’s the thing: only when you create a realistic sales quota, your salespeople will be able to hit it. A pie in the sky target only demotivates reps – the exact opposite of what you want.
So an important question is:
“There’s no easy answer other than to test as best you can before you ink in targets and commissions,” notes Aidan Snee, the founder, and CEO of Inside Sales Solutions.
Here are a few factors that you need to consider as you plan a realistic sales quota:
Some industries tend to be highly competitive, while others aren’t.
Enrico Parodi, the SVP Sales at Sales Xceleration, shares that he looks at the same for setting realistic sales quota: “At high level, I start from the market growth and the positioning the company has in the industry they operate. This is a top down approach.
I validate my conclusions by looking at the accounts, their backlog of orders and at potential prospects/market segments.”
In his article for Harvard Business Review, Doug J. Chung tells how territory sales quota can influence a salesperson’s morale.
He says “A rep who was hitting his quotas and making decent money would want a manager to do something about a “lazy” colleague who was earning outsize pay simply because he had a good territory. ”
A subpar territory can limit the opportunities available for a salesperson, thus bringing in lesser revenue, while those with good territories thrive.
To understand territories that are performing well, and those that have fewer opportunities, you can take a look at the territory reports in your CRM software, and set the bar accordingly.
While unrealistic targets can demotivate your team, setting the bar too low does not help them either. Without challenges, they could take the metrics for granted and can slack them off.
Ultimately, testing will help you as Aidan Snee puts it “Once you do have an understanding of what a really good performance would look like, work out what you can afford to give and give enough of it to really motivate your team!” adds Snee.
In other words, consider the average sales each employee makes and set a goal from there. You can use the data and reports from your CRM software to understand the sales by over- and under-performing salespeople and figure out the average from there.
Address how well your product beats the competition as it decides how challenging it is to make sales and meet the quota.
Factor in your growth forecast for a specified period too, based on the investment, past performance, and other factors. You can always do this manually or use a CRM to help with sales forecasting.
Longer sales cycles naturally take time to complete, which means setting a high quota is going to be unrealistic. Additionally, you’ll want to pay attention to exactly what work you demand from a salesperson.
Here’s a real-life example of how the sales team sets sales goals over at Referral Rock. Mica Longanecker from their team explains, “our commission is uncapped, so we don’t spend a ton of time thinking about quotas. We set sales targets based on historical data and look to increase this over time.”
Longanecker continues, “we have a fairly short sales cycle (30-60 days) and are more focused on providing a great buying experience instead of putting pressure on our salespeople and prospects to close by a certain date. If salespeople don’t hit their target, then we’ll work on a performance plan but we focus more on attracting the right people and coaching them to be successful.”
“A good commission structure will support or hinder your whole company’s growth,” notes Snee.
Research by the Harvard Business Review agrees. In the study, a South Asian company with a retail sales force that sold durable products was put to test. The company had a linear commissions system where salespeople earned a fixed percentage of the sales they made – no bonuses, quotas, or sales commissions were involved.
So the team introduced various bonuses and commission systems. Each time they did, they compared the results against a control group to understand how commissions impacted salespeople.
Guess what they learned?
In each setting, regardless of what the bonus was, the groups that were incentivized with commissions outsold the control group that didn’t get any incentives.
Besides motivating productivity, sales commission can help retain top-performing salespeople. 43% of the workers – that’s nearly half of them – say they’d be willing to leave their jobs for one that gives them a 10% salary increase.
On top of that, The Bridge Group highlights that an average rep’s tenure is around 1.5 years – a shocker as compared with three years of tenure in 2010.
A good way to retain talent? Offer sales commissions that benefit them as well as help grow your business.
Keep in mind “changing commission structures and removing incentives often do huge damage to a business: salespeople exit, and customers usually aren't far behind,” Snee adds.
A sales commission structure, also known as a sales commission plan, is a set of rules that define how and when a salesperson gets compensated for their sales achievement.
Generally, you need a plan that’s “a win-win for both the company and the sellers,” as Parodi puts it.
3 ground rules for a good sales commission plan:
👉 Your sales commission structure doesn’t have to be rocket science. It must be simple enough for a rep to understand what they need to do to get a commission.
👉 The commission could be fixed, completely variable, or a combination of both. Read on to find out how you can set them up.
👉 The plan should be flexible. At any given point, you should be able to tweak it. For instance, in the case of an economic downturn that leaves nothing in a salesperson’s control, but only makes it difficult for them to meet a goal. This is essential as you need to keep the quotas at a level where you can motivate reps, not otherwise.
With these out of the way, let’s walk you through nine sales commission structures.
This plan offers a sales commission on top of a fixed salary, where the former motivates and the latter offers a safety net in case a salesperson doesn’t meet the target quota for commission.
The standard base salary to commission ratio is 60:40 with 60% fixed salary and 40% variable bonus or 50:50 as Parodi recommends.
“This structure maximizes the earning potential and at the same time guarantees a salary which allows the sellers to navigate in case of fluctuations in their achievements,” Parodi outlines.
This sales commission structure doesn’t include a base salary and is purely commission based on the sales made. In this way, the reps’ income comes purely from the sales they make.
This structure suits startups with limited capital. Since reps earn commissions only, you save on hiring, benefits, taxes, and other such expenses. But, the downside is that it’s challenging to retain talent with this commission plan. It can also be demanding to fill up the positions unless you offer a strong training program that ensures success.
The tiered sales commission structure ties the commission percentages to different levels of sales made. After closing a specific number of deals, the salesperson's commission rate increases.
In other words, the higher you exceed the sales quota, the more sales commission you will get.
If you have a sales team that consistently reaches its goals but doesn’t exceed them, you’ll find tiered commissions helpful.
You could set a percentage slab for different levels of sales quota attained.
For example, if the standard sales quota for your sales team is $5,000, salespeople attaining $10,000 could get an additional sales commission of 5%, and those reaching $15,000 could receive an additional 10% of sales commission, and so on.
It is also a best practice to keep a slab on the sales commission percentage. For example, 20% could be the maximum commission you give, despite the sales quota achieved.
In this case, the sales commission depends on the sales target. However, if the target exceeds, the commission increases with it.
So, you’re basically rewarding people based on how much they sell. It’s great for motivating both underperformers and those who routinely meet their quota.
As per this structure, the commission that a salesperson earns will be a percentage of the profit made rather than the sale made as you factor in the expenses related to the product you sell.
The gross margin sales commission structure is helpful for supporting your business’s bottom line by making sure every sale contributes to it.
For example, if the investment made by the company is $10,000.
And the sales achieved is $30,000, the profit would be $20,000.
So the sales commission will be calculated from the profit of $20,000, rather than the $30,000 sales made.
According to the relative salea commission structure, the quota and commission cap is fixed.
For example, if you acheive 80% of the sales target, only 80% of the sales commission will be granted, in addition to the base salary.
Territory volume sales commission is based on territory-wide earnings in contrast with individual sale basis and is ideal for team-based businesses.
This model promotes teamwork, where top-performers and average salespeople work together to achieve a territory target and split the overall sales commission.
The base rate structure doesn’t offer a sales commission. It is based only on a fixed salary.
Since there’s nothing to incentivize agents, it’s not widely used. The model is often used by those who are focused on inbound leads than closing deals so sales agents are involved in more supportive or consulting work than selling.
The absolute commission structure takes into account all the sales activities that a salesperson performs to close deals.
For example, a commission is offered for booking meetings despite the results of the meeting. This structure is great for incentivizing underperformers, but the emphasis remains on sales activities, then on revenue.
A well-thought-through sales compensation plan can attract the best and brightest talents in the industry.
Your sales commission plan can be one of the structures above or a combination of multiple structures.
For a step-by-step guide to creating your sales commission plan [with real-life examples], head over to our article “How to create the perfect sales commission plan for your business.”
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