Type of Sales Commissions
Sales commissions are the variable portion of an employee’s compensation. Employees in the sales industry typically get paid in part through a commission structure.
There are two types and few additional adjustments / variations:
- Flat Commission Structure
- Tiered / Multiplier Commission Structure
Adjustments and Variations
- Draw against Commission
- Residual Commission
The Basic Commission Structures
1. Flat Commission Structure
A flat commission structure is the simplest commission structure. It is typically revenue based, but can also be volume based or gross margin based. The structure is that sales executives will receive a fixed percentage commission for every unit of revenue, volume, or gross margin sold. For example, in a revenue based model where sales executives get 5% of all revenue earned, then if they bring in $100,000, they earn $5,000.
[Unit] x [Rate] = [Commission]
2. Tiered / Multiplier Commission Structure
A tiered commission structure creates additional incentives for higher dollars sold. Tiered commission structures are almost always revenue-based. The structure involves dividing potential sales dollars into different tiers, and then associating an increasing percentage earned with each of the increasing tiers. Below is an illustrative example that typifies a tired commission structure:
If your sales executive closes $180,000 of revenue for the year, they would earn $100,000 x 4% + ($150,000 - $100,000) x 5% + ($180,000 - $150,000) x 6% = $4,000 + $2,500 + $1,800 = $8,300.
There is a variation called the multiplier commission structure, or accelerators. A multiplier and an accelerator mean the exact same thing; it means the sales executives are earning an increasing, or multiplying, or accelerating commission in different tiers. While it makes the quota percentage appear more formulaic, it serves the exact same purpose and is calculated in the same way as a normal tiered commission structure. Using the previous example:
Someone earning $180,000 under a multiplier commission structure or an accelerator system will end up with the same $8,300 in commissions. Note that in this example, $100,000 is the quota, and this base level of quota pays 4%. This might sometimes be spelled out in the commission contract. A good reason to use a multiplier or accelerator is that when there are a small number of tiers (such as 2 or 3), it might be easier to just write it out as a multiplier or accelerator instead of creating a table. If you have 4 or more tiers, there is no reason not to just go with a simple tier and spell out the exact quota percentage.
The idea of a multiplier is sometimes used as encouragement for underperforming sales executives. For instance , a new tier could be created below the quota and say that if the sales executive achieves at least 75% of her commission, she will still get to calculate at an 80% rate.
Σ [Units at different tiers] x [Rate at different tiers] = [Commission]
Adjustments and Variations
1. Draw against Commission
The idea of a draw is to prepay a sales employee regular fixed payments prior to actually earning any commissions. In the future, when actual commissions are calculated, any amounts paid in a draw will be deducted against the commission.
There are two types of draws: recoverable and non-recoverable.
- Non-recoverable: this is essentially a guaranteed payment. It is still deducted against commissions earned, but if commissions are less than the draw paid, the employee keeps the difference. For example, if management paid $1,000 in draw in period 1 and commission earned in period 2 is $3,000, then the employee receives $2,000 in commissions in month 2. If commission earned in period 2 is only $800, the employee gets $0 in commission but retains the $200 difference and does not need to pay that back to the company.
- Recoverable: management can recover any shortfall between the amount paid and the actual commissions earned. This is effectively a loan by the company that requires repayment in the form of commissions. If commissions earned are less than the amount paid, the difference is rolled over and deducted against the next period’s commissions. When looking at the previous example, where commission earned in period 2 was short by $200, that $200 was rolled over to period 3 if commission earned was $500, then the employee received only $300.
Typically, a draw is used for new sales executives who might be ramping up to provide some guaranteed income. If used in a non-recoverable format, it can even be viewed as a sweetener to temporarily shift the portion of total compensation towards guaranteed, fixed, and recurring income. It is also a tool for management to provide some level of regular income for whatever reason.
2. Residual Commission
Residual commission is used in long-term sales with recurring payments. A good example is insurance, where the customer pays a regular recurring premium, be it monthly, quarterly, or annually. Each time the customer makes a payment, the sales executive receives a commission for that payment. It creates a recurring commission stream for the sales executive, but can also introduce risk if the customer turns over due to no fault of the sales executive. Mostly, this variation uses a flat commission structure.
SPIFF stands for Sales Performance Incentive Fund (the “P” can also stand for program, or promotion, depending on who you ask). It is a tactical, short-term, incentive reward that could be financial, but can also be other rewards such as prizes, trophies, or recognition. It is intended to create a short-term incentive to achieve a specific management objective. It could be to emphasize sales on a specific product line, or achieve some sort of volume goal, or do a certain number of demos, or meet a certain number of clients. There is no limit to what can be part of a spiff.
Clawbacks are used when a customer expectation is not met, resulting in reduced revenue or churn within a certain window of time. In these situations, the company deducts the commissions previously paid to the employee in the current period in the form of a “clawback.”
The adjustments that go along with sales commissions can be challenging. Together, they provide a flexible tool allowing management to properly align the personal financial incentives of employees with the overall company objectives. If properly done, it creates a win-win compensation system that is highly synergistic. It is important to have the right tools to help you do this accurately and easily.
Finicast can give you an easy, customizable end-to-end commission calculation solution. Finicast will allow you to get started easily and calculate commissions using any of these commission structures. As your sales team grows and the commission structure becomes more complicated, Finicast allows you to easily customize your commission model and scale your commission calculation together with you, without needing experts to make big implementations. If you need to pull in data from your CRM, ERP systems, or even collect information from different individuals within your company, Finicast can easily accommodate any sort of data transfer or collection. Furthermore, you can even use Finicast for auditable approvals from each commission-receiving individual on your sales team.
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