How to Design an Effective Commission Rate
Establishing commission rates for a particular employee or job title can be tricky territory to enter. Setting a commission rate should accomplish several things:
- Create a profitable structure for the overall business
- Enable the employee to earn fair wages
- Incentivize exceptional performance by allowing the employee to earn well above standard compensation by greater performance potentially.
Instead of following the path of too many business owners, who insist that they cannot figure out a set commission rate and instead make up a “standard” number, which typically is a small commission compared to a weekly salary earned without any benchmarks or sales requirements.
There is no good reason to have a sales force on your staff being paid by salary instead of working to earn commissions. Businesses based on a predominantly salary structure typically generate low yields at incredibly high costs. The way to guarantee a profitable business and a satisfied sales force are to reward productivity through fair commission rates instead of a market salary.
Take the following items into account when setting up your commission rates and you will have numbers that work for both your bottom line and your valued employees:
Sales are inherently inconsistent. While all sales people should earn based on commission, there should also be a base pay to compensate for natural fluctuations in new business. This base pay should essentially be a bare minimum salary provided to each salesperson. Not only does the base pay re-assure salespeople that the company is invested in them, but also affirms a more typical employee/employer relationship. $18-36,000 is an excellent base salary in most cases, depending of course what the likely result is to be after commissions are paid. The base salary should be 50% or less than the final compensation.
In order to set a specific commission rate, first establish what the top performers should be able to earn. This rate should be generous enough to reward those who will go the extra mile to make an impact on your business’s bottom line as well as their own. Once you have set this amount, which could range anywhere from $75,000 to $150,000 or more, set a commission rate based on gross sales that could generate that income for an employee. For most businesses, this percentage will fall within the 3-7% range. However, it could b 10-15% just as quickly depending upon many variables.
Taking into account that commission should not be paid on shipping costs or taxes–only the net invoice. High invoice products may warrant a lower commission while low invoice products may call for commission rates to be raised. This is also profoundly affected by the likely frequency of orders and reorders and the difficulty of making a sale. Take a look at your profit percentages and pricing profitability, which should be a key indicator of where to set commission rates. Everyone should make money, but when we recall that the expanded sales revenue bring higher profits, then there is more room to share.
When to Pay
Commissions should be paid monthly at the very least to encourage productivity and to reward high achievers quickly. When a salesperson’s check is largely based on commission, it is plainly obvious to see the direct results of their efforts each month, which encourages better performance over the long run.
For job titles with no direct selling aspect, as in the case of a production worker or sales manager, set a higher base salary than for standard salespeople. Add a lower percentage commission to the position, and base the commission on some measure of productivity within that person’s department.
When in Doubt
If you have no other markers, as with salespeople, set a standard commission rate based on something measurable that is plainly visible to all workers: production, sales volume, profitability or other business ratios.
When everyone in your sales force is working on a commission based on profitability, production goals or revenue, the success of the company becomes the aim of each nonsales employee. In this way, well-designed commission rates encourage an entire team of workers to rally together in support of a common goal.
If paychecks are based on productivity instead of just the number of hours worked, every worker has the potential to earn more than industry standards thanks to their success and the overall success of their team and the business as a whole.
Switching from a traditional salary system to a commission structure is sure to cause some turmoil within your workforce, especially among long-established employees. Prepare your HR department for questions and objections well ahead of time to minimize issues during this transition period and always be open to employee suggestions.
The balancing act is to weigh the size of a typical invoice, the frequency or volume of likely sales, the degree of profitability, the result you want to achieve and then determine: the base salary and commission percentage. I highly recommend you skew commissions to be much greater for new business and much less for repeat business. It is even possible to remove commissions for repeat business all depending upon how your business is structured. These are the factors to weigh and assess in creating a valid commission structure that works for the salesperson, other employees, and the company.