how to pay a salesperson

7 Types of Sales Commission Structures & Examples

In the competitive world of sales industry, recruiting and retaining skilled sales representatives is important for a successful business. It is also crucial to ensure that the sales team gets fair sales compensation, which can involve various commission schemes and types of commission structures. This approach is key to maintaining the motivation of your sales team. If you're interested in learning more about hiring for various sales roles, check out this the Ultimate Guide to Hiring for Various Sales Roles.

What is Sales Commission?

Sales commission, also called sales compensation, is a bonus given to salespeople when they meet sales goals. It is a common method of compensating sales representatives based on their performance. It is a percentage of the revenue or profit generated from their sales.

Sales commission structures vary and include things like commission plans, commission rates, bonuses for hitting targets, and incentives for good performance. Usually, it's a percentage of the money the sales representative brings in. The exact percentage can change based on what's being sold, how much is sold, and how the sales team works.

Importance of Effective Sales Commission Structure

Employers use sales commissions to motivate employees to achieve higher sales and to reward top performers. Sales commissions is one of the most effective way of compensating sales person and driving increased product or service sales. This is why most companies use commission structures as a key part of their compensation strategy.

When it comes to remunerating a salesperson, you'll find various commission types worth considering. These structures play a pivotal role in shaping your sales team's motivation and performance.

It is important to hire the right salesperson and motivate them with a suitable sales commission structure so that they can achieve sales.

7 Type of Sales Commission Structure (With Examples)

Let's explore the world of sales commission structures, where understanding the options is key to motivating and rewarding your sales team. These structures are how businesses motivate and reward their sales teams. In this guide, we'll look at 7 different commission structure for sales reps, examples, and insights to create effective commission plans that boost sales.

1. Commission Based Salary

A commission-based pay structure, also known as a salary commission-based model, is a compensation method where employees earn money based on the sales or business they generate, rather than receiving a fixed salary.

This pay-based on commission approach encourages sales representatives to work diligently, excel in their sales efforts, and contribute significantly to a company's sales. It directly rewards their hard work and has the potential to lead to higher earnings, particularly for those who work on a commission basis.

2. Salary Plus Commission

The salary plus commission structure, often referred to as the base salary plus commission structure. It stands out as the most popular commission arrangement for sales positions. In this system, salespeople receive a base salary combined with additional commission earnings for their sales achievements. Typically, the ratio between the base salary and commission hovers around 60:40, offering a balanced approach to compensation.

3. Tiered Commission

Tiered commission structures are a dynamic approach to sales compensation. Salespeople earn a commission on each sale they make, calculated as a percentage of the sale amount. However, what sets tiered commissions apart is that as salespeople reach specific revenue goals or tiers, their commission rates increase.

Here's an example of how a Tiered Commission Structure works:

  • For sales up to $10,000, the commission rate is 5%.
  • For sales between $10,001 and $20,000, the commission rate increases to 7%.
  • For sales exceeding $20,000, the commission rate further rises to 10%.

Commission rates increase as sales targets are met. Sales reps earn a percentage of each sale's value. As they hit revenue goals, their commission rates rise. This type of sales commission structure motivates salespeople to achieve targets and aim for higher sales tiers, maximizing their earnings.

4. Team-Based Commission

In sales team commission structures, a group of salespeople works together to meet their sales objectives, and they share the commission among themselves. Each team member receives a portion of the commission based on their contribution to the team's success.

For example, if the team achieves the sales target and earns RM10,000 in commission, and there are 5 team members, each salesperson will receive RM2,000.

This type of commission scheme for sales teams promotes collaboration and rewards individual efforts within the team.

5. Residual Commission

Sales representatives earn commission on recurring sales or long-term contracts. They will receive ongoing payments or a percentage of the revenue generated by repeat sales or recurring services.

When a salesperson sells a subscription service, they earn commission not just once but continuously for each payment the customer makes during the entire subscription period. It's like earning a reward repeatedly for bringing in that customer and keeping them subscribed.

Residual Commission rewards salespeople for building long-term relationships with customers and encourages them to focus on generating repeat sales, creating consistent income over time.

6. Draw Against Commission

Sales reps receive an advance or draw on their future commissions, which they repay from their future earnings. As a sales representative, the more you sell, the higher your commissions. You receive a fixed monthly salary, also known as a draw, regardless of your sales performance. You only make a profit when your total commissions surpass the draw amount you received.

For example,

Supposedly A sales rep earn RM4000 a month in commission and receives RM2000 a month in draw.

  • Scenario 1: Amount Over the Draw

If they hit their sales target of RM4000, then they will earn RM2000 more.

  • Scenario 2: Amount Under the Draw

If they did not hit the sales target and earn only RM1000, they owe the company 1000.

7. Profit-Based Commission

The sales rep's commission is calculated based on the profit generated from sales. As they sell more products or services and generate higher profits for the company, their commission earnings increase accordingly.

Suppose a sales representative is earning a commission of 5% on the profit generated from their sales. The company sells a product with a cost price of RM50 and a selling price of RM100.

  • Scenario 1: If the sales representative sells one unit of the product, the profit generated would be

Profit = Selling Price - Cost Price

Profit = RM100 - RM50

Profit = RM50

Commission earned by the sales representative:

Commission = Profit * Commission Rate

Commission = RM50 * 5% (0.05)

Commission = RM2.50

  • Scenario 2: Now, let's say the sales representative sells five units of the product in a month.

Total Revenue = Selling Price * Number of Units Sold

Total Revenue = RM100 * 5

Total Revenue = RM500

Total Cost = Cost Price * Number of Units Sold

Total Cost = RM50 * 5

Total Cost = RM250

Total Profit = Total Revenue - Total Cost

Total Profit = RM500 - RM250

Total Profit = RM250

Commission earned by the sales representative:

Commission = Total Profit * Commission Rate

Commission = RM250 * 5% (0.05)

Commission = RM12.50

How to Decide and Calculate the Sales Commission?

  • Setting the Right Commission Rates
    Establish clear commission rates that motivate your sales rep while aligning with your business goals. Create a formal sales commission agreement that outlines the terms and conditions of the commission structure. This agreement serves as a safeguard for both the salesperson and the employer.

  • Use a Commission Calculator
    Calculating commissions is straightforward and revolves around percentages. To find the total commission, use this simple formula:

    Total commission = (sale price * commission percentage)/100

Let's take an example of a wireless headphone sold for RM100. The sales people earn a commission of 20% for every sale they make. This means they receive RM20 as their commission amount for each transaction.

  • Understanding Average and Typical Sales Commission Rates

When determining commission rates, it's valuable to consider industry standards and benchmarks. Typical commission rates for sales reps can vary, but researching average sales commission rates within your sector can provide valuable insights and help you make informed decisions.

Related: How to Hire a Salesperson for a Startup: Expert Tips for Sales Hiring Success

Having a better understanding of the various types of sales commission structures is crucial, especially for those working in sales, such as account managers, salespeople, and individuals in different sales roles.

The choice of commission structure can significantly impact the earnings and motivation of sales professionals in their sales jobs.

By carefully selecting the most suitable type of commission and offering attractive incentives, businesses can effectively empower their sales teams to achieve remarkable results and foster long-term success in the competitive world of sales.

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