Incentive Fundamentals — When to use Commissions vs Bonuses
There are many ways to incentivise your sales staff to work harder, produce more sales and generate more revenue. Two of the most common types are commissions and bonuses, but do you know when a commission will work better than a bonus structure and vice-versa?
Let’s take a look at when and what incentives to use for the maximum results.
Commissions
A commission is usually calculated as a percentage of the sales the employee brings to your company. Each sales rep has a quota to reach, and if they hit that quota they will get a percentage of the sales revenue (eg. 5% of sales revenue). A commission can also be either a designated amount based on the number of units sold (eg. 50 photocopiers per month) or a percentage of overall profit. Many companies will employ a tiered commission structure which is best practice and is designed keep productivity high for the sales team, even after they hit their quotas. Once a sales rep has reached their sales quota, or sales goal, this percentage rate often increases to encourage over-performance (also called an accelerator).
When to use a commission
Commissions are primarily used to drive performance. Whether it be a monthly or quarterly commission, sales reps are incentivised to not only reach their quota, but surpass it for the lure of a larger payout. Using a commission will also help to ensure you understand the fixed amount of the money your business can reasonably afford to pay sales reps. Most companies will use a base salary + variable model but there are a number of other models to choose from. Here are the most commonly used commission structures for SaaS companies:
Salary-only
Using a salary-only structure is simple to administer because once you set the annual salary each salesperson will receive, it doesn’t matter how much is sold, their take-home salary does not change. This however does nothing to incentivise your sales team to sell more or even reach a quota. Because of this, this pay structure is fairly uncommon in a sales organisation.
Commission-only
If you are looking to minimise risk and cannot afford a full time resource, then a commission-only structure may suit you best. This structure pays staff based purely on performance. Meaning if they don’t sell anything, their wages for the month are zero, but if they do, they will receive a percentage of the sale as wages. Whilst this type of structure means you will only need to pay out when the salesperson makes a sale, it can be difficult to forecast your expenses accurately. You may also decide to pay certain sales roles a higher level of commission based on their level of experience and involvement in the sale itself. Anywhere between 5% to 45% is a standard commission-only rate.
Base salary + Variable
As mentioned above, this is the most common type of pay structure and gives businesses the greatest clarity in managing their expenses. This structure provides salespeople with a fixed yearly base salary as well as a variable amount (like a commission) based on meeting their quotas. Staff are able to receive both a steady income and the opportunity to increase their earnings through their own efforts. This pay structure also gives a company more opportunity to attract high-performers to the sales organisation and retain staff that are more competitive by nature.
Commission Disputes
According to US law firm Trepanier Law, ‘the number one cause of commission disputes arises from sales that are still in the pipeline when the employee leaves or is terminated.’ Both parties may agree that the employee is entitled to a commission on sales, but what is the definition of a “sale”? Your company will need to have a clear definition of when commission is payable and that may be when a contract is signed, the completion of a project, or when payment is received by the company.
Bonuses
Bonuses are payments you make to employees that are not regular payments. Instead, these payments are based on department sales goals or revenue targets that are met. They can be a percentage or fixed amount (eg. 5% of base salary or $5000).
Since a bonus is often paid for meeting certain performance requirements or goals, it could be paid monthly, quarterly, annually, or upon achievement of the goal.
When to use a bonus
Bonuses typically rely on both individual and corporate goals and how your sales team is structured. According to a Harvard Business Review study, quarterly bonuses can help to incentivise the lower performers in a sales team as more-frequent goals helped keep lower performers on track. Whereas the high performers could be effectively incentivised by a yearly quota and bonus. Certain roles may also help determine when to use a bonus. For example an Account Manager role that with a smaller sales quota may have a bonus scheme, but Business Development roles that have higher sales quotas may use a commission scheme. What you decide to use will be very dependant on what behaviour you are trying to influence and incentivise.
A bonus scheme can also be effective when the sales team is not responsible for the sale as a whole and they work together with other teams to complete the sale (eg. pre-sales, engineering, customer service).
Bonuses are also typically better suited to businesses that are more mature or are complex organisations with various selling roles and levels.
Bonus disputes
Many companies will require an employee to be employed on a certain date in order to be eligible for a bonus. However, disputes can arise when the terms of the bonus are not clear. If there is ambiguity around whether the bonus is guaranteed or based upon the goals of the individual or financial success of the company, staff can quickly be left feeling demotivated by the whole process. This is easily avoided by being up-front and transparent with the terms of the bonus.
Commissions and Bonuses in businesses
Now that you understand when to use commissions and bonuses, you can begin to consider which incentives to include in your compensation plan. In order to create the best plan for your business, you will need to consider the following questions:
- What is my overall budget?
- What level of risk am I able to take? (This will depend on what stage your business is at)
- How many reps do I have and what experience levels?
- Are my incentives competitive? (consider what your competitors are offering).
Effectively calculating incentives
Both commissions and bonuses can complicate bookkeeping and accounting as these payments are not the same every pay period. Commission percentages will change each quarter depending on what targets employees are able to meet and bonus programs could be dependant on the profitability of the company.
You can overcome this by implementing a real-time sales compensation app that will help your company to plan, track and manage your compensation process more effectively. If you are ready to automate your compensation process or you need to improve your compensation plan design, the team at motiveOS are ready to help.
