Meaning of Sales Commission
Sales commission is a monetary reward awarded by companies to the sales reps who have managed to achieve their sales target. It is an incentive geared towards producing more sales and rewarding the performers while simultaneously recognizing their efforts.
A sales commission agreement is signed to agree on the terms and conditions set for eligibility to earn a commission.
- A sales commission is an incentive awarded to the employees and contractual reps for achieving sales targets.
- A sales commission agreement is signed to agree on the terms and conditions set for eligibility to earn a commission.
- Different companies have different commission structures depending on their set up.
- The average commission rate is dependent on the company. Most salaried reps will earn around 5% of their sales as commission.
Sales Commission Structure
The Sales Commission structure is an important area in the company. How sales reps are paid affects how the company retains top talent. It also helps in its profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance..
There are several options a company can consider while setting a sales commission structure. They include:
#1 – 100% Commission
Also referred to as a straight commission, the income in this type of structure comes solely from the commissions as there are no salaries involved. It usually involves independent or outsourced contractors. For example, if John sells an item at $1000, and the agreement was he gets 10% of the sales, then John will earn $100. This commission is endowed with a higher risk for the salesperson due to the absence of a salary. There is a silver lining available with the sales rep which compensates for the risk.
Sales reps have the freedom to work for extra hours to generate more business. The more business they make, the more commission they can take home. As such highly talented and experienced reps are suited for this structure. Companies using this structure have the advantage of saving money on recruiting new staff.
#2 – Base Salary Plus Commission
Base salary plus commission offers a base salary and commission. The basic salary contains a fixed amount, while the bonus earnings depend solely upon the performance of the sales rep. There are various methods to arrive at the appropriate ratio of the two. For basic pay, companies look at an hourly rate which is pegged on a rate per hour as the base. Many companies in the United States go for the 60:40 ratio of salary to commission.
The good thing about this model is both the sales rep and the company are responsible for playing their parts. The model allows you to reap two benefits. As the sales rep, you get rewarded with a salary, regardless of performance, and additional compensation for the sales.
Having a fixed salary with the possibility of making bonuses ensure motivation on the part of the reps. This sector is brimming with high performing sales reps and companies would need to spend a lot in order to retain them.
#3 – Tiered Commission
Tiered Commission works with tiers, and one can make more commission here after they’ve fulfilled a set target number. For example, earning it on 10% of all sales revenue you have generated. The contract says that once you have scored the target, your commission rates will improve.
Once you hit the milestone, the commission rate will get revised to a higher number like 20%. This keeps the sales rep amply motivated who get creative as they upsell and cross-sell to achieve higher sales.
#4 – Revenue Commission
Calculations are simple for this particular one. Whatever revenue sales rep make, the value is multiplied by the rate of commission which gives the amount of commission. It is easy in that if you sell a $2,000 product, you get 10%, which is $200.
#5 – Gross Margin Level
From the name itself, it can be estimated that the commission will be charged on an amount after some deductions. Just like revenue commission, the amount will be based on sales revenue after the expenses have been deducted.
In simple words, the gross commission is offered on the profit, which is acquired after deducting the cost incurred for the sales target from the revenue generated. Thus, selling $10,000 worth of a product with expenses worth $6,000, the earnings would be calculated from the difference, which is $4,000. In case there has been a loss, the rep will not be paid.
#6 – Commission Draw
A little complicated of the lot. Advance payment is involved here against which the commission calculations are conducted. The sales rep earns a fixed amount of pay regardless if they meet the target or not. So, if your draw is $1000 and you end up earning $700 as commission, you keep the whole amount plus the remaining $300. In case you want to earn a higher amount than the draw value, you’d need to increase your sales number.
#7 – Base Rate
Instead of earning a commission, you are paid using an hourly rate or earn a salary. Since there is no reward for motivation, productivity is low, and team members are not motivated.
Sales Commission Agreement Format
- Most sales agreements bear the company name at the beginning. They will then stipulate the profit marginsProfit MarginsProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. required for you to earn a commission.
- The next part shows when the commission is due for payment and the criteria for payment.
- The next part usually states the validity of the commission, usually 30 days. If you disagree with the amount, then you raise your concerns here.
- Finally, the sales rep signs the agreement, which means they agree with the terms and conditions stipulated.
Average Sales Commission Rates
You would want to be fair with your sales team when determining their rates. There are factors to consider before making that decision. It is important to note that where a company offers a large salary, commissions are low and vice versa. The starting point has to be estimating the expected sales amount. Based on that, think of an amount you are willing to spend on the sales rep.
In the industry, it is usually seen that the basic sales commission rates are not less than 5%, for the reps with a good salary. The average commission rate hovers between 20%-30%. Some companies offer a handsome rate ranging from 40%-50% to high performing reps who aren’t taking a salary home.
How to Calculate Sales Commission?
The commission is calculated as a percentage based on the commission rate.
Thus, Commission = Rate*Sales.
You multiply the rate with the sales after converting the rate into a decimal.
George is a motorbike salesman who receives a 10% commission for every motorbike he sells. Calculate his commission for a motorbike whose cost is $40,000.
Let C be commission and R rate.
- R=10% and as a decimal 10/100, which is 0.1.
- Thus, c=0.1*40000
- John will receive a commission of $4000
This has been a guide to What is a Sales Commission and its definition. Here we discuss its structure, rates and format along with calculations. You may also have a look at the following articles to learn more –