Sales commissions are a form of variable pay. They are based on the principle of “pay for performance”. Organizations with a sales incentive program believe that granting commissions encourages higher sales performance.
In reality, things are more subtle:
- What does “sales performance” really mean? Should it be based on gross revenue or profit? Should specific sales behaviors (or business goals) be encouraged more than others?
- What is the actual return on investment of commissions? Is there a point of diminishing return, after which paying more in commissions doesn’t matter? Which types of reward are more effective in terms of motivating representatives?
- How should commissions be presented to the sales force, and how will they perceive them? Could one presentation (say bonuses) motivate the sales force more than another (say percentages) – at the same cost?
Many companies struggle to structure their incentive plans because there are many options and degrees of freedom available – quotas, attainment levels, percentage of revenue, percentage of profit, cash bonuses, SPIFFs, prizes, multipliers, accelerators, etc. This said, one fundamental design choice for any incentive plan is – bonuses vs. percentages.
Business Goal and Perception
The best way to choose between bonus vs. percentages is to be clear about business objectives. Here is a simple table showing, for each incentive type, the associated business goal, and how the incentive may be perceived by the sales force.
|% of Revenue||Any growth||A payout for every large deal I close|
|% of Profit||Any profitability||A payout for every profitable deal I close|
|Revenue-Based Bonus||Target growth||A payout for attaining revenue goals|
|Profit-Based Bonus||Target profitability||A payout for attaining profitability goals|
Pros and Cons
Besides signaling a business goal (and packaging it with a perception), bonuses and percentages have unique pros and cons. Here are a few things to consider when making a decision:
- Percentage-based approaches often require caps to protect organizations from anomalies. For example, a mega deal, landed by chance, could result in an unreasonable payout if commissions are just percentages without any cap.
- Bonus-based approaches can reduce motivation because they are conditional on meeting certain objectives. There isn’t a feeling of “if I close this deal – in fact any deal, I’ll get a percentage of it”.
- Bonus-based approaches require careful thinking about offered amounts. Percentage-based approaches can just follow industry standards. On the flip side, representatives may quit because they are offered a higher percentage next door.
- Percentage-based approaches should prevent double-crediting to avoid double-taxation. On the flip side, a collective business objective (involving many employees), once met, could could trigger payment of many bonuses.
More about managing costs. Bonuses are often paid as fixed cash amounts, or as a percentage of salaries. Here are the associated underlying spend management principles behind each approach.
|Incentive||Spend Management Principle|
|% of Revenue||Pay a % of gross revenue|
|% of Profit||Pay a % of net profit|
|Fixed Cash Bonus||Pay from a money pool (fixed budget)|
|Salary-Based % Bonus||Extend the total salary mass|
Often the decision between bonuses and percentages depends on the maturity of the organization. For example, when launching a new product, you want sales representatives to be motivated to close every deal.
|Product launch||Account management|
|New roles & structures||Established roles & structure|
|Emerging business||Mature business|
So which approach is best for your organization – bonuses or percentages? It all depends on the following:
- What your true business goals are
- How you want to manage commission spend
- How your sales team will perceive offered rewards
- Which approach will best motivate your sales team
We recommend designing several incentive plans, each with different options, and testing them. You can use a software solution to design incentive plans and run various calculations to find the best option for your business.