How do you pay commission only employee?
A friend of mine is a small business owner and is considering paying sales people on commission only basis.
I know one format is based on percentage of gross margin
Q1 How much would a sales person make?
Q2 Would a senior level person make a higher percentage
Add Q3 *** What are other ways to calculate a commission only structure? ***
I have a question on the subject of commissions. I have a new team of sales agents that I setup under my manager. My manager will get 10% of the gross revenue that these guys bring into the company. I pay the sales agent 20% and my manager 10% of the gross revenue. However 2 of these new guys needed a 2500 (spread over 5 weeks) dollar draw which I approved. Until they are making more commission than the draw amount we are providing, my manager does not get his 10% right? So lets say each employee draw is $500 per week. Lets say on week two the employee earns 200 dollars of a commission, subtracted from the 500 dollar draw, equals me paying him a $300 draw, and as far as my manager collecting 10% of the gross revenue, he should not get any commission until their draw is paid back, which is when the company can start earning any real money, meaning real revenue that I pay my manager the agreed upon 10% right? I spoke to my manager and said, if we approve this draw it will effect when we make any money, meaning it will delay when you can make money off your employee. And he agreed, but I just wanted to hear some of your expertise and feedback. We have other commission only contractors that don't need a draw, and as soon as they earn any commission my manager gets his 10% of the gross revenue, but when we give them a draw that changes the situation and nobody gets paid until the draw is paid back, or not? Please advise.
The majority of commission only companies usually offer a draw on commission. Which on a slow sales week the sales rep will receive a stipend for their efforts, which is then taken out of their pay once they reach their sales quota. For question one a sales person makes what he sells, nothing more nothing less. If your company has a product that fulfills the needs of their clients, and leads are generated through the ceiling, and the sales rep can sell ice to an eskimo his earning potential can be within six figures! In the case of a sales manager/branch manager they are usually salaried, but in some industries they make a small percentage of gross sales.
Caution. What type of "control" for each do you plan to practice?
The State criteria for "employee" is critical...each state varies.
Do you have a profile which is clear to the sales person?
Do you have a min. and max. level of expectation?
Do you have an exit strategy? What is your plan if and when the individual files for Un employment. Compensation is based upon many variables.
Yes, start from 5% - 15% and add 5% additional for anyone who achieves more.
For the team, calculate on total sales per month.
Lots of options/alternatives here. First, what you pay is a function of your pay philosophy and strategy and what's affordable. Second, how it's structured (thresholds, accelerators, linkages between products, etc) should be taken into account. Lots more on the list of considerations, more than could possibly fit into a forum like this.
Your Q2, a senior person could certainly demand greater compensation, but I don't know how you'd decide on what rates to pay to people with different experience levels on commission only without it looking like a dart game.
Finally, lots of ways to calculate commission -- 1) a percentage on bookings or revenue (dependency: when do you want the sales person to move on to the next sale?); 2) same percentage approach, from sales dollar $1; 3) same percentage approach but kick in after meeting a threshold; 4) a custom rate still volume based but paying a calculated amount based on a quota. For example, if you want to pay a commission of $100,000 on $2,000,000 in sales, the rate is (100,000/2,000,000) = .05%. Then you could kick it up for an accelerator, for example 2x the individual rate of .05% to .1% on the next $500,000 in sales.
I have designed many Sales Compensation plans through my career. Several key questions to answer in determining the right solution are: What is the length of the Sales cycle (days vs months vs years)? In my view, commission only does not work if it is a long Sales cycle. In that case, a combination of base + incentive works better. Also, which financial metric is within the Sales person's control? I would keep metrics to a minimum of 2-3. And the financial metric could be revenue, margin, price, volume, or combination of any. It really is dependent on structure of company. And as simple as it sounds, it needs to tie with Finance Team's calculation. I have had experience where gross margin was calculated differently across product lines and it can get quite complex. It needs to be simple. Typically a combination of Sales + profit makes sense (e.g.: Revenue/Margin). Finally, is the commission plan tied to annual fiscal goals? It is critical that the total Commission targets equal the business's total financial targets. General rule of thumb is that the leader of the sales team is incentivized on the sum to total of his individuals' team targets. Feel free to reach out if you need more detailed info.
Your friend needs to be careful, not all sales roles can be 100% commission, he needs to check into state statutes to ensure they're not violating labor laws. As to paying commission, different industries, different approaches.
Without knowing the industry, its difficult to say what expectations are for a sales rep to W2 out at the end of the year.
I strongly believe the only way to pay commissions is on the gross margin, otherwise, you are dipping into the cost side to compensate.
If you own a small business and really need a salesperson, commission only might seem to be the only way to go. Cash flow is everything for a small business and paying an unproven salesperson a basic salary for six months never appears to be a safe option.
If this is the case then you need to put yourself in the salespersons shoes.
How good is your product or service, how open is your market, how long does it take to sell on average, what profit margins do you expect to make and how do you measure these?
Commission only is all about big rewards for the salesperson.
He or she also needs money to live.
If you lead times are long then this will only suit a salesperson who sells for more than one business.
If you have taken everything into account when you work out your profit margins, be prepared to give a really big chunk away to the salesperson - in stages.
First you need to cover his or her overheads. This becomes the first target for the salesperson to hit. Up to this point you pay a nominal commission rate of GP say 20%
Once hit you need a monthly target to aim for so that sales are balanced. You cannot afford to be paying huge sums in months when sales are down.
If this target is hit then agree an additional rate for the added sales - say another 10% -20%on top.
Once these are hit in any month - you need to stop order holding for higher rates.
Now you can agree a quarterly target over an above all of these and agree to pay a higher commission on that.
Finally - think about paying in some form of shares or offering say 55% - 75% commission on all sales over a certain amount decided by you.
Logic says that once you have your own sums right and you find the best salesperson - then sales should take off. Now you must watch as costs rise for delivery and after care and adjust the figures accordingly, which is why partner shares might be a wise move instead of more and more commission.
Being a small business owner or startup doesn't necessarily require a commission only compensation plan. One model that is frequently overlooked is similar to the entertainment (record label) model - which essentially means that commissions accumulated are offset by payments made.
The problem with commission only adds two variables to an already complex equation of building a successful company:
1. margins are smaller due to paying more to the sales team (at a time when you are likely to be cutting your margins in order to compete) and,
2. the type of sales person to take on the role of commission only (and the interview / selection process being used may not be as solid as one looking for a salary based person) - may end up hiring someone that under normal circumstances you wouldn’t have hired if you had to pay them a base salary and they end up having a negative impact on the brand.
So a good way to minimize the costs associated to business development and sales while at the same time ensure the right people take on the job and are properly selected, is to have the business owner determine how much revenue he/she thinks a person may realistically generate; develop a (pre-payment of commissions) salary that pays the employee that amount on a regular basis.
This allows an employee to see a regular paycheck and not one check one month and another three months later (this is critical because sometimes it’s the sales cycle that hurts the frequency – not necessarily the quality of the sales team). Then all commissions that would have been paid are offset to the money already paid. Then any additional monies that the employee made over the amount paid get’s paid 75% every quarter. (not 100% since they may fail to achieve the company goal the next month and it’s good to have a buffer). Then at the end of the year, the owner would pay the outstanding amounts (if any) to the sales person plus some additional bonus money since the owner would have been able to leverage that “buffer” as financing. Of course at any quarter the employee may continue to fail to deliver based on one situation or another; then the owner would have the option to adjust the “pre-paid” amount or hire someone new, at least the owner risk is minimized (from the base salary + commission traditional model), while their benefit is maximized.
This model allows the company to pay a smaller commission rate (which will wash out due to any end of the year bonus money that the owner chooses to pay but at least it’s leveraged throughout the entire year rather than per cycle) and attract a more seasoned sales team. Because there is some risk to the owner, the selection process will be more critical and it will be something that the owner will surely focus on. Unfortunately – I’ve seen several startups say that they would be just as critical for commission only as they would salary employees; but in reality it eventually gets overlooked and then a “body” is found.
This has been a win/win solution to a difficult problem for several startups requiring a solid business development / sales team while at the same time minimize owner risk / costs.
I would suggest a percentage of sales for the "employee and Senior level person". The way your question is worded it so sounds like your Senior level person is not a manager. The percentage of sales should be based on what your competitors are paying in your industry. I do not think that should be difficult for you to find out.
You might look at your region and nationally, if that applies.
Also, the Senior level person should have the same percentage as the junior person because they should be selling more based on their experience. However, if your Senior person stays with you for a number of years (maybe three years), then it might be time to raise his/her percentage. Or if they have Junior people that report to them, they would get a higher percentage, plus over-rides.
We use a percentage pay scale. We base it on actual revenue. For example, if the sale generated $1000 of total revenue for the company, we pay as a percentage of that number. The how much requires some legwork on your end. You have to figure out the company's costs on generating that product and on housing the sales rep (electricity, phone, paper, etc.). We have a very low overhead, so our percentage is probably way more than yours would be. Without that info, you'll be blind to make a recommendation.
Our "senior" structure is based on who the rep manages. If the rep is just managing his accounts, then he gets paid on those accounts. If he is also managing other associates (hence "senior"), we pay him the normal amount on his own deals, but he gets an override on everyone he manages. You then have to figure that override into the calculation for how you are going to pay the people he manages on their deals (is the company eating it or are the managed giving up part of their percentage).