Commission Rate Calculator
This commission rate Calculator helps compensation administrators and managers determine the commission rate for
sales reps.
What commissions should I pay my new sales person?
Commission Rate for the sales person is the most crucial decision in designing the compensation plan.
The marketplace, in other words the companies that make up your competitors, are the
best determinants of the appropriate compensation to be paid to the sales person. If it is
possible to get that information, that should be the comparison for the compensation plan
you design. Industries tend to have similar plans but the individual firm can design their
very own compensation plans.
A simple formula to determine the commission can take the following steps:
One of the first questions to ask in deciding the compensation level, is to determine how
much additional revenue a reasonably performing sales person is expected to bring in.
This expected amount can be called Performance (P). This can be an expectation of the
sales manager or from what similar sales people achieve.
The next answer that we need to know is how much a reasonably performing sales person
should be expected to be paid in a year. This can be based on average compensation in
the region and/or from typical industry practice. This can be called Targeted
Compensation (T). The proportion of the targeted compensation that will be treated as Base
Salary can be
expressed as a percentage (S%). This can be zero if there is no salary component.
The Commission Rate (C%) to be used in the compensation plan can be calculated as
follows:
Targeted Commission Amount = T * (1 - S%)
Commission Rate (C%) = (Targeted Commission Amount / P ) * 100
To Quota or not to Quota
Quotas (or Goals) can be specified for the expected performance of a sales person. These
can be merely stated as expectations or encouraged through means of modifying the
compensation based on attainment against Quota.
In the second case the simplest way of encouraging achievement of Quota is to pay a
different commission rate for any attainment above Quota. The recommendation would
be to pay a significantly increased commission rate for performance above Quota, to
make exceeding the quota meaningful
Example:
Let us assume that the expected performance is $1,000,000. This can set as the Quota for
the sales person. Then the commission rate tiers can be set as follows:
Quota: $1,000,000
| Sales attainment against Quota |
Commission Rate |
| 0% to 100%
| 6% |
| 101% and above
| 2% |
Underachieving sales people can be incented towards higher performance by disincenting
lower level performances, such as in this example.
Example: Let us assume that the expected performance is $1,000,000. This can set as the Quota for
the sales person. Then the commission rate tiers can be set as follows:
Quota: $1,000,000
| Sales attainment against Quota |
Commission Rate |
| 0% to 50%
| 2% |
| 51% to 100%
| 10% |
| 101% and above
| 15% |
In this situation, the first 50% of performance is clearly under incented to drive people
towards more optimal performance which is above the 50% threshold
When to Commission?
The frequency of how often commissions should be paid is typical of industries.
Frequency of commission payments follow one of these standard intervals: weekly, biweekly, twice-monthly,
monthly and even quarterly.
In addition to industry practices the guidelines for determining the frequency of payment
are these:
- the closer the commission payments are to the actual sales, the better the
connection between the performance and reward
- the longer the sales cycle involved the longer the frequency interval can be.
Additional criteria for triggering commission payments would be the revenue event. The
typical revenue events are bookings, billing and collections. Other events can be used to
trigger payments as well.
Bookings based commissions focuses the sales rep on bringing in the business, but
possibly at the expense of long term customer relationships. Collections based
commissions have the benefit of making sure the sales person manages the customer
relationship to some extent but on the other hand sales people may spend valuable time
doing collections responsibilities. Billings tend to be a balance between these two
approaches.
What to Commission?
Some general commission considerations were presented in the earlier sections. But very
often companies are interested in emphasizing sales performance in certain parts of the
business. Different Companies want to make sure the emphasis is on new business,
profitability, certain product lines or certain customer segments. This is possible in a
well-crafted commission plan.
- New Business vs. Recurring business
Companies want to make sure their sales people are focused on bringing in new business
rather than working the same set of customers for additional business. There are multiple
ways of doing this. Here are some ways:
- Revenue from new customers may be commissioned at a higher rate for the first
order or for a period of time.
- Long term customer contracts may be commissioned at a higher rate in the first
year and then trail off in the subsequent years.
- There maybe a separate bonus for new customer signups.
- Year to year sales performance may be compared to determine net new business
and that may be commissioned separately or at a much higher rate.
- Have sales reps focus on new business and turn over established customers to
account executives for follow up business.
- Revenue vs. Profitability
Some companies where costs are a significant concern, or where the sales people have a
lot of leeway to change the price, maybe more concerned about the profitability of the
deal rather than on straight revenue. Here are some ways to address that concern:
- Commission directly on profitability rather than on revenue.
- Commission revenue only when certain profitability thresholds are met.
- For different tiers of profitability for a deal, use varying commission rates.
- Commission on revenue but provide a bonus on overall profitability.
- Commission sales reps on revenue but sales managers on profitability.
A couple of things to consider in using profitability are:- determining profitability in
certain businesses will be difficult; profitability is not transparent to the sales reps and
consequently could lead to some frustration for the sales reps.
- Customers
Because of differing business conditions, specific focus on customers or customer
segments maybe necessary to get optimal sales performance. Here are some of the ways
commission plans can be designed for that:
- Name customer accounts and assign them to sales people as their territory of
business.
- Name certain customer accounts and associate with them specific sales people so
they always get an override on business to those accounts.
- Identify preferred customer segments and provide higher commission rates in
those segments.
- Provide customer satisfaction based bonuses.
- Products
It is fairly common for companies to commission products or product groups differently.
This differing rates maybe due to difficulty of selling products, the age of product lines or
the profitability of certain product lines. Here are some ways:
- Pay higher commission rates for highly profitable product lines
- Pay higher commission rates for products that have to be cleared from inventory
- Pay higher commission rates when products are sold in a bundle
Draw!
A draw is fully defined as 'a draw againist future earnings'. This is when the sales person
is advanced an amount against expected future earnings. This is typically used to support
a new sales person while they are learning the ropes of your business. It is typically set at
an amount enough to cover the basic expenses of that person but not at full expected
commission. It is typically short in duration, maybe three or six months and rarely longer.
During that period, if the sales person earns less in commissions than the draw amount,
then the difference is given as an advance and a balance is maintained. When the sales person starts
performing well enough where they start exceeding the draw, then the
balance maybe settled by using the excess earnings above the draw. This is also called a
'Recoverable Draw'.
A typical draw could be: Draw of $2000 per month for the firs 3 months of employment.
Draw is typically used for employee sales people who do not have a base salary.
The variation on this is where the sales person is guaranteed a minimum amount of
compensation for a set period of time. This is appropriately called a 'Guarantee'.
Sometimes it is referred to as 'Non-recoverable Draw'.
Cap that well!
Some commission caps will cap the total amount of compensation that a sales person can
make. This does not follow the philosophy in commissioning sales performance. The
more sales a sales person brings in the better the company prospects, so the company
should incent additional sales rather than penalize them.
But there maybe situations where sales people may get windfalls due to no particular
effort on their own. In these cases it maybe reasonable to cap commissions related to an
individual deal at a fairly high limit such that true effort is still rewarded.
Now what!
After designing an effective commission plan after due consideration, the next step is to
administer the plans and communicate the commission results accurately and in timely
fashion. This is not trivial. Many customers start off by using spreadsheets and soon land
in a nightmare of calculation errors and upset sales people. So it is highly recommended
that they search for a flexible and well-support vendor software to calculate sales
commissions.
References: What commissions should I pay my new sales person? by Gopi Mattel at qcommission.com.
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