There are many different ways to structure and layer sales compensation and commission plans and most are based on revenue performance, but in some sectors compensating based on profit is popular and there are situations where it may make sense for your company as well.
Compensating on Revenues
The most common form of sales compensation, involves a paying a commission on sales. This works well where sales people need to be highly focused on driving top line results and growth. It is also typical where the sales person cannot influence margins either because they are selling an offering with a non-negotiable price or because the sales rep does not get involved in delivery. The benefit is that compensation is easy to calculate and sales people are not distracted by anything other than sales.
Compensating Based on Gross Margin
Compensating based on gross margin is popular in the services business where there are no fixed costs and in other price sensitive businesses such as Value Added Resellers.
Commission based on profit or gross margin has its pros and cons.
In the pros column the sales rep’s compensation is tied to their contribution to the bottom line, something that sounds like it could have no downside. It has the effect of encouraging sales reps to chase profitable business (however this can be achieved with fixed pricing as well) and striving to maximize profit, a healthy share of which the company keeps. Compensating on gross margins also discourages discounting because even a small drop in price might have a big impact on overall margin and therefore commissions paid out.
In a services business paying on gross margin can cause the rep to be distracted from the selling effort if they are worrying about how much delivery is making on a project and consequently how much they will be getting paid. This can even cause frustration if the rep feels delivery is not performing effectively and furthermore, there may be instances where you want to offer some concessions to win an account however this will cause your rep to lose interest as they will not be rewarded for their sales effort. In both cases these issues can be mitigated by paying on forecasted gross margin rather than actual gross margin.
In the end each company’s specific goals, business model, sector and set of economic conditions will dictate which path to take, and a properly structured plan will be a win-win for the employer and sales rep regardless of whether they are paying sales commissions on revenue or gross margin.
To your success!
Eliot received his B. Comm. from Carleton University and has been honored as a Top 40 Under 40 Award winner.
He co-authored Sales Recruiting 2.0, How to Find Top Performing Sales People, Fast and provides regular insights on sales team management and hiring on the Peak Sales Recruiting Blog.
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