May 5, 2022

Type of Sales Commissions

Type of Sales Commissions

Nelson Chan
May 5, 2022

Sales commission is the variable portion of an employee’s compensation.  Typically, employees engaged in sales receive part of their compensation through a commission structure.  In this blog, we will describe the standard commission structures.

There are two basic types and few additional adjustments / variations:

Basics

  1. Flat Commission Structure
  2. Tiered / Multiplier Commission Structure

Adjustments and Variations

  1. Draw against Commission
  2. Residual Commission
  3. SPIFF
  4. Clawbacks

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 executive will receive a fixed percentage commission for every unit of revenue or volume or gross margin sold.  For example, in a revenue based model where sales executive 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 is dividing potential sales dollars into different tiers, and then associating an increasing percentage earned to each of the increasing tier.  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.  Multiplier and accelerator means 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 appears more formulaic, it serves the exact same purpose and calculates 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.  A note is that in this example, this implies $100,000 is the quota, and this base level of quota pays 4%.  This might sometimes be spelled out in the commissions contract.  A good reason to use multiplier or accelerator is when there are 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 to not just go with a simple tier and spell out the exact quota percentage.  

The idea of a multiplier is sometimes use as encouragement for underperforming sales executives.  For example, 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 is less than the draw paid, the employee keeps the difference.  For example, management paid $1,000 in draw in period 1 and commission earned in period 2 is $3,000, then 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 shortfalls between draw paid and actual commissions earned.  This is effectively a loan by company that requires repayment in the form of commissions.  If commissions earned is less than draw paid, the difference is rolled over and deducted against next period’s commissions.  Looking at the previous example where commission earned in period 2 is short by $200, that $200 is rolled over and in period 3 if commission earned is $500, then employee received only $300.

Typically, a draw is used for new sales executives who might be ramping up to provide some guarantee income.  If used in an 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 lifetime 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.

3. SPIFF

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.

4. Clawbacks

Clawbacks are used when a customer expectation was not met resulting in reduced revenue or churn within a certain window in time.  In these situations, the company deduct the commissions previously paid to the employee in the current period in the form of a “clawback”.

Recap

Sales commissions and the associated adjustments can be complicated.  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.  

Contact us see Finicast in action!