Sales commissions can have a tremendous impact on employees’ productivity, and learning how to calculate a sales commission scheme that best motivates your team can lead to a significant boost in revenue.
In one of our studies, we discovered that a client of ours increased sales performance by 50% just by paying sales commissions on a daily rather than quarterly basis.
This study confirms that how a company calculates and pays sales commissions can significantly affect the motivation and productivity of their employees.
In this article, we will show you how to calculate and pay sales commission in the most beneficial way to your company and its employees.
We will cover:
- Why sales commission matters
- Various sales commission schemes
- Factors to consider before choosing a sales commission scheme
- The flexible way to pay sales commissions in the UAE
[Do you want to pay sales commissions in a way that best motivates your sales team? NOW Money is a digital payroll management system that allows you to flexibly (daily, weekly, or quarterly) pay sales commissions to your employees. Learn more about how NOW Money can improve your payroll and sales bonus management.]
1. Why sales commission matters
The payment of sales commissions is one of the most common ways that businesses reward and incentivize their sales teams.
In essence, this is a strategy for compensating sales reps based on their performance rather than paying a fixed hourly rate or salary.
In this system, what a sales rep earns depends entirely on their ability to close deals and meet (and exceed) sales targets.
Benefits of sales commissions
Before considering how to calculate sales commission using the various sales commission schemes currently in use, let’s consider why companies decide to use sales commission packages instead of the fixed hourly rate or salary used for employees in other departments.
Motivation for hard work
With sales commission, there is a direct relationship between how much sales a sales rep makes and how much money they earn.
Consequently, sales people are motivated to work hard to increase sales so they can earn more. This extra motivation to work harder may be lacking for those on a fixed salary package.
When employees are motivated to work harder through more attractive compensation, their productivity can increase.
Innovation
The motivation to earn more by selling more can lead to greater innovation and creativity as well. Fixed salaries will (unfortunately) incentivize some people to only do the minimum amount of work, but sales commissions can challenge them to think outside the box to find new ways to procure sales.
Unlimited earning potential
Sales reps also like sales commissions due to the unlimited earning potential it offers. With a salary, there is a cap on earnings irrespective of productivity, hard work, or creativity. Such caps are absent in a sales commission scheme – sales reps can earn as much as they want by completing as many sales as they can.
Positive work environment
If an employee thinks another employee is unjustly earning more than them, it can create rancour and bring toxicity to the work environment.
However, when the same employee understands that the other person earns more because he/she completes more sales, there is a sense of transparency that nurtures a positive work environment.
Increase in sales
The net effect of all of the above is that sales commissions can help increase the sales of businesses.
A 2017 study by the Incentive Research Foundation, a company that researches the science of incentives, found that 90% of top-performing companies use incentive programs to reward their salesforce. They also found that properly structured sales incentives programs can increase sales performance by 44%.
In essence, the right use of sales commissions can improve the performance of sales reps, which ultimately leads to more sales for the company.
2. Various sales commission schemes
Now, let’s consider some of the common sales commission schemes that companies use and how to calculate sales commission with each one of them.
Throughout this section, we’ll be using example compensation numbers and rates, which are solely for illustrative purposes.
Straight revenue commission
In this system, the company pays sales commission based on the sales (revenue) amount of the sales rep.
For example, if Company A has a straight revenue commission rate of 5% and sales rep A sells goods worth $500,000 (the sales amount) in January, 2022, they will earn a sales commission of $25,000 for the month.
Straight gross margin commission
Margin is the difference between the sales or revenue amount and the cost of sales. In the calculation of sales commissions, gross margin is the difference between revenue and the direct cost of selling incurred by the sales rep.
Suppose that in the above example, sales rep A incurred a total cost of selling of $50,000. Given this scenario, their sales commission will be $22,500 (5% * ($500,000-$50,000)).
For straight revenue commission, the revenue amount is used as the commission base while for straight gross margin commission, it is the revenue amount minus any direct cost of selling incurred by the sales rep.
Graduated or tiered commission
As the name implies, this commission system creates a tier (or ladder) of commission rates that increase with the sales amount.
For example, sales up to $500,000 can be rewarded at 5% commission rate while sales between $500,000 and $750,000 are rewarded at 7%, and sales above $750,000 can be rewarded at 10%.
This system can also be designed with sales quotas (targets) rather than absolute sales amounts.
For example, a sales rep that meets their targets can be paid 5% of the target amount (say $500,000, in our example). If they sell 150% of their sales target ($750,000), the commission rate can increase to 7% and to 10% if they sell 200% of their sales target ($1,000,000).
Relative commission
This is another commission system that depends on the ability of sales reps to meet their sales quotas or targets.
Here, a specific commission amount (instead of rate) is attached to a specific sales target.
However, if the sales rep fails to meet the quota, the percentage of the sales quota they meet is the percentage of the specific commission amount they will earn.
For example, say Company A has attached $50,000 commission to a sales target of $500,000. If sales rep A meets this target, they will get $50,000 commission. Suppose sales rep B meets only 70% of the target ($350,000 in sales), they will get only $35,000 (70%*$50,000).
Basic pay plus commission
While sales commissions have the advantages we have highlighted in the previous section, the lack of security (no fixed salary or hourly rate) can be a challenge for some sales reps, especially when the economy is in a downturn.
Some companies decide to factor this element of security in by paying a basic salary or hourly rate. Yet, to avoid unproductivity, they add commission for meeting or exceeding quotas.
For example, sales rep A might earn a salary of $5,000 irrespective of the sales amount and then qualify to earn a commission of 5% on sales amount or gross margin (to take the first two systems as examples) when they meet the target. If they meet a target of $500,000, total payment will be $30,000 (basic pay of $5,000 plus straight revenue commission of $25,000).
Multiplier commission
This system is similar to the graduated or tiered commission system.
However, instead of a preset tier that increases based on how a sales rep meets or exceeds sales quotas, there is only a single basic rate for meeting sales quotas that will be multiplied by how much a sales rep exceeds sales target to determine the actual commission rate.
Suppose that Company A rewards sales reps with a 5% commission rate if they meet their targets and uses a multiplier system to determine rates when they exceed the target.
Consider sales rep A who did 150% (1.5) of their sales target (say $750,000 actual sales with a target of $500,000). In this case, the rate applicable for sales rep A is 7.5% (1.5* 5%). If sales rep B with the same target did 200% (2.0) of their sales target, the applicable rate will be 10% (2.0*5%).
Territory volume commission
This is a joint-compensation plan where sales reps working in the same territory share the commission due on the total sales made in that territory.
The commission rate can be determined based on all the other commission systems; the key highlight is that the commission is shared.
This system is often used to ensure collaboration and teamwork between sales reps in a particular territory.
Draw against commission system
This is another system companies use to provide a sort of security for sales reps.
There are two types of draws:
- Recoverable draw: Here, the company gives a sort of advance to a sales rep at the beginning of the sales period. The draw is then deducted from their earned commission at the end of the sales period. This system is often used to help jumpstart new sales reps or sales reps in a new territory.
Some companies also use it in times of economic uncertainty (when sales reps are not meeting targets or even generating any sales). They give sales reps an advance which they will deduct once the sales reps have started earning commissions again.
- Non-recoverable draw: With non-recoverable draws, the company does not deduct the advance from the future commissions of sales reps. This is often to encourage sales reps in times of economic uncertainty.
Residual commission
This is a commission system common among companies that sell subscription-based services (SaaS marketing software for example) or services that involve retainers (law firms for example).
Here, the salesperson will continue to earn commissions as long as the customer keeps renewing their subscription or paying their retainers.
If Company A pays 5% commission when a customer renews its $5,000 monthly subscription, salesperson A who brought the customer will keep earning $250 every month as long as the customer renews.
[If you want to learn more about how to calculate sales commissions with excel formulas, you can download some helpful excel templates here.]
3. Factors to consider before choosing a sales commission scheme
Now that we have considered how to calculate sales commission with different schemes, let’s consider some factors you should consider when deciding on a scheme.
- The company’s business model: Companies that sell goods or one-off services will use different commission systems compared to subscription or retainer-based companies that have to use some form of residual commission.
Also, companies with high cost of selling may use a straight gross margin contribution while companies with insignificant cost of selling will stick to a straight revenue commission.
Furthermore, companies with high turnover of sales reps might be more attracted to a basic pay plus commission system to give them some sense of safety net or security.
In essence, you have to consider your company’s business before deciding on a commission system.
- The company’s goals: A company trying to dominate a particular territory through teamwork rather than competition among its sales reps may consider a territory volume commission system rather than an individual-based system.
A company trying to maximise revenue may be more comfortable with a straight revenue commission while a company trying to maximise profit may be more comfortable with a straight gross margin commission.
Said simply, ensure that your company’s strategic goals guide you in deciding on a commission system.
- Employees’ motivation: If you have hyped-up sales reps that are doing great numbers, a tiered or multiplier commission can be a great way to keep them motivated and striving for more. However, if you have employees that need some measure of security or a safety net to do their best work (without being anxious about whether they will go home with any money), a basic pay plus commission or a relative commission system will be better. For this latter group, allowing some draws against commission will also be good.
Another important component here is the frequency of commission payment. You have to consider if your employees will be more motivated to get daily, weekly, monthly, or quarterly payments.
You may be surprised at how much impact on motivation a change in payment frequency can cause.
- Current economic conditions: When the economy is down and sales are slow, a recoverable or non-recoverable may be suitable. In those times, security is important. And when the economy is doing well, more motivating systems like tiered and multiplier commission may be more appropriate.
4. The flexible way to pay sales commission in the UAE
As mentioned at the top, one of our clients experienced a 50% increase in sales performance by paying more frequently (daily instead of quarterly). And we have seen how the right incentives can lead to better sales performance.
Consequently, you must be flexible enough to try new commission systems or payment frequencies in the search for the best way to motivate your employees.
To do that, you need a payroll system that is flexible enough to allow you to change your commission system (the amount you pay as commission) and the frequency with which you pay commissions (whether daily, weekly, monthly or quarterly).
This is the exact flexibility that NOW Money provides.
With NOW Money, you can change the commission you pay your sales rep as well as the frequency with which you pay. This smart, flexible, and cost-effective platform allows you to tweak your system until you have found what works best for you.
You can upload your employees’ data, create and authorise payments, and load money into your account directly from the NOW Money dashboard.
Through the “create payments” section, you can make WPS payments (for employers in the UAE) like salary, wages, and leave salary, as well as non-WPS payments like bonuses and commissions.
[Do you want to perfect your sales commission strategy? NOW Money allows you to be flexible with your commission system and the frequency at which you pay commission so you can find the best system that works for you. Learn more about how NOW Money helps your business or book a demo.]
Takeaways
- Sales commissions keep sales reps motivated. And that motivation can lead to hard work and innovation.
- A more motivated salesforce can help a company increase its sales performance.
- Common sales commission systems include straight revenue commission, straight gross margin commission, graduated or tiered commission, relative commission, basic pay plus commission, multiplier commission, territory volume commission, draw against commission, and residual commission.
- Before deciding on a commission system, you have to consider your company’s structure and goals, employees’ motivation, and current economic conditions.
- You need to keep tweaking your sales commission system until you get the one that will best motivate your employees.
Photo by LinkedIn Sales Solutions on Unsplash
