The Pros and Cons of Different Sales Compensation Plans
With any job, a primary consideration is compensation. We all want to be paid fairly. One common perk of a career in sales is the ability to earn more based on your own hard work and selling success. With salary, commission, bonuses, and other incentives, sales professionals often have options and feel in control of the compensation they receive, which can be great for motivation and fulfillment. However, the types of sales compensation plans can be more complex than for other professions. Not all plans fit all salespeople. Below, we’ll explore the advantages and disadvantages of some of the most widely used compensation plans for sales professionals.
Without question, this is the easiest type of compensation for both sales reps and their organizations to manage. On the positive side, consider the following benefits:
- A salary-only compensation plan offers security for the employee and dramatically simplifies things for the employer.
- It can also foster a more collaborative and supportive team environment since there is no direct competition based on individual sales performance.
- With no variable costs, payroll expenses are easy to forecast and budget for.
- In some instances, salary-only sales can be positioned as a more “transparent” marketing differentiator. This might give customers the impression of a low- or no-pressure sale.
- It can also encourage sales representatives to prioritize ethical selling practices over aggressive tactics which are often applied to meet short-term targets.
However, this type of plan does have drawbacks:
- For one thing, there is less earning potential. Working regular hours, sales reps earn the same regardless of their work. As a result, there can be reduced incentive to work harder or produce more.
- Also, it can be more challenging to tie performance to goals. Without the incentive of commission or performance-based bonuses, salespeople may lack the motivation to go above and beyond in driving sales results. Sales managers will have to think of nonmonetary alternatives as motivators.
- A salary-only plan might not align as closely with the company’s revenue goals, as there’s no direct correlation between sales success and compensation.
- Finally, individual sellers who are highly motivated by financial incentives may be less inclined to join a company with a salary-only structure, potentially limiting the talent pool.
In theory, this type of compensation can be the most attractive for highly motivated reps because it offers several benefits that should directly appeal to them:
- First and foremost is high earning potential. When a sales rep’s pay is directly tied to the deals they close, many will be extra motivated to identify the best targets, make the extra calls, and work longer hours to get things done.
- Another benefit for sales reps is control. With commission-based compensation, reps earn based on what they sell. If they sell more, they earn more. In addition to the motivation, this appeals to extra-confident risk-takers who will think outside the box to find innovative solutions.
- A commission-only structure can be cost-effective for organizations as they only pay for actual sales generated. This model aligns the financial health of the sales team with the success of the business.
However, this too can present challenges for both reps and the organization:
- For example, a commission-only plan offers less security, making it risky for employees. Even the best reps can sometimes suffer from slumps or market changes beyond their control. These things can adversely affect their earning potential.
- In addition, commission-only compensation can result in higher turnover. Those sales reps who do not excel will leave when they can’t produce the income they need. As a result, employers should consider the increased onboarding costs associated with this type of plan.
- A further consequence of a commission-only plan is that it might trigger unwanted behavior to satisfy short-term goals that can cause irreparable damage to the brand.
- In addition, a make-or-break, commission-only comp plan increases the likelihood of a hostile work environment with little to no teamwork. If a sales rep’s entire compensation is directly tied to their individual effort, they could compete against each other for prospects or territories. As a result, the organization may lose the benefits of a united and collaborative sales team.
Base Salary Plus Commission
In many ways, this is the happy medium between salaried and commission plans:
- A common salary-to-commission ratio is 60:40 (60 percent fixed / 40 percent variable). This offers the security of a salary with the greater earning potential of commission. The hybrid structure aligns the interests of sales representatives with those of the company.
- The base salary can act as a buffer, allowing salespeople to weather uncertainties while still having the motivation to pursue commission-based opportunities.
While there are no real downsides to this type of plan, organizations should be mindful of several things:
- This requires a solution that benefits both employee and employer. As a result, it should be frequently revisited as market conditions change, making it work-intensive for employers.
- Base Salary Plus Commission plans need to be kept simple. If a plan grows too complex and elaborate, it can lead to a discouraged sales force, costly accounting errors, and complex administrative burdens.
- Also, this plan must be tied to company objectives and not prompt behavior that benefits only the sales rep, not the company.
Performance- or Goal-Based Commission
This plan pays reps when they reach specific goals, targets, or milestones in which output and activities are directly tied to their pay. It offers the following benefits:
- This is the ideal plan in situations when you’re trying to drive client growth, increase upsells, or boost cross-selling opportunities.
- Pay increases as deals are closed or benchmarks achieved. For example, a salesperson is paid $200 for every new customer and $300 for renewing an existing contract. This eliminates the intimidation of a hard quota.
- The emphasis is less on revenue and more on driving desired behaviors, activities, and outcomes.
However, a plan like this can have negative consequences:
- Sales reps with different titles and priorities may feel shortchanged compared to peers who chase fewer or easier short-term targets.
- You may run the risk that sales reps lose sight of your organization’s overall mission.
- The sales organization also focuses more on achieving immediate goals rather than building long-term customer relationships or engaging in activities that contribute to sustained business growth.
With these plans, teams work together within territories of prospects and clients. On the plus side:
- Once the pay period is complete, the commission is split between reps.
- This can be great for developing a team atmosphere because such a plan motivates team members to support each other, share best practices, and collectively strive for success. The emphasis is on achieving team goals and fostering a sense of unity and camaraderie.
- Team-based commission plans often strike a balance between individual and collective success. While team performance is crucial, individual contributions are still recognized.
However, on the downside:
- The success of team-based plans relies heavily on positive team dynamics. If there’s tension or lack of collaboration within the team, the effectiveness of the plan may be compromised.
- While this creates collaboration, it can also create animosity if some sales reps think they work harder than their peers.
- It can also be difficult for sales managers to measure and quantify individual contributions within a team.
Gross-Margin or Profit-Based Commission
A slightly more complicated plan that considers the true profitability of an organization. It takes into account the expenses it took to close a deal. For example, Sales Rep Jane closes a deal for $10,000, but it took around $2,000 in expenses. In this case, Jane only gets a commission for the difference ($8,000). First. the pluses:
- The advantage for the organization is obvious—it shifts focus from revenue to profit, which is a more straightforward indicator for a business.
- This strategy is often employed to reduce discounting that may hurt the company’s bottom line.
- Salespeople may adopt a more strategic approach to selling, focusing on value propositions, upselling, and cross-selling strategies that enhance profit margins.
On the downside:
- Sometimes, avoiding expenses (even discounting) can make selling a lot more challenging and possibly put your organization at a competitive disadvantage.
- Determining profit margins and calculating commissions based on these margins can be more complex than a traditional revenue-based commission structure. It may require accurate tracking of costs, discounts, and other factors influencing profitability. This also may lead to disputes or misunderstandings between the sales rep and leadership, especially if there’s ambiguity or lack of transparency in how profit margins are determined.
Residual Sales Commission
Residual sales commissions, also known as recurring commission, is a type of compensation structure in which sales representatives earn commissions on an ongoing basis for sales they have made in the past. This model is particularly common in industries where products or services involve recurring payments, subscriptions, or renewals, such as SaaS companies or consultancy firms. Here are some key advantages:
- This commission model encourages sales representatives to focus on building and maintaining long-term relationships with clients. The emphasis is on customer retention and satisfaction to ensure continued revenue streams.
- They provide salespeople with a degree of income predictability and stability, as they continue to earn commissions over time from existing customers in addition to pursuing new business opportunities.
- The commission structure aligns with the concept of customer lifetime value, recognizing the ongoing revenue potential associated with each customer beyond the initial sales.
Here are some considerations for organizations wanting to deploy residual sales commission plans:
- Calculating commissions for residual income can be complex, especially if there are various pricing tiers, discounts, or changes to subscription plans over time. Ensuring accurate and transparent calculations is essential to avoid disputes.
- Sales representatives may become less motivated to pursue new business if they are earning substantial residual commissions from existing customers. This can affect efforts to expand the customer base.
- Earnings from residual commissions often accumulate over time, leading to a delayed realization of income for new sales reps. This delay can be a disadvantage for those who prefer more immediate rewards for their efforts.
As all sellers know, there is no one-size-fits-all sales approach that works for all sales teams. Instead, there are best practices successful organizations employ to drive results. What works for one organization may not be right for another. In this way, it is incumbent on sales leaders to understand the environment and culture they wish to foster and develop a compensation plan that works for the long-term goals and objectives of their reps and organization.
Editor’s Note: This article, first published in June 2021, was revised to improve its clarity and relevance.
- Account Planning (15)
- Awards (39)
- Client Testimonial (37)
- Personal Branding (20)
- Podcast (11)
- Research (73)
- Sales Career Development (89)
- Sales Coaching (165)
- Sales Consulting (141)
- Sales Culture (182)
- Sales Enablement (379)
- Sales Leadership (105)
- Sales Management (270)
- Sales Negotiation (21)
- Sales Prospecting (132)
- Sales Role-Playing (19)
- Sales Training (244)
- Selling Strategies (283)
- Soft Skills (79)
- Talent Management (106)
- Trusted Advisor (29)
- Virtual Selling (59)
- Webinar (11)