Management 101:
Compensating Salespeople - Part 2: Commissions

Last week we discussed the 'simple' parts of salesforce compensation: base salaries and quotas. This week the topic is the delicate art of setting commission rates.

by Jason Zigmont HowToSell.net [August 27, 1999]

After you have set quotas for your salespeople, the next step is to determine their commission percentage. The actual percentages should be determined by your profit margin. Also, by adjusting rates for individual products, commissions can become tools for motivating salespeople to sell certain products over others.

Playing the percentages
Two commission structures that are especially popular with ISPs are:

1. percentage of monthly recurring revenue (% of MRR) every month, and
2. one-time % of MRR.

Both have pros and cons, and we'll examine them in detail below. In practice, however, your accounting and payroll system may prove a critical factor in determining which you'll use: Many ISPs simply can't use a % of MRR every month system because their accounting software can't produce the necessary reports.

Both systems may also include a one-time percentage of any setup fees, but usually this is around 10 to 20 percent; it shouldn't be where a salesperson makes their real money. Commissions are usually paid one month behind to assure the sale is real and that the customer was added and billed.

Some companies do not pay commission until they receive payment from the customer, but in effect, this puts the salesperson in charge of accounts receivable. Personally, I'd rather have them out getting new sales then chasing money on a monthly basis.

Every-month system
In a % of MRR every month system, the salesperson is paid a percentage (usually 10 to 25 percent) of cumulative sales, every month. That is, if they had $1,000 in sales month 1, $2,000 in sales month 2, and $3,000 in month 3, then assuming a 10 percent commission rate, in month 1 they would receive 0 in commission (commissions are a month behind.), $100 in month 2 (10% of month 1), $300 in month 3 (10% of month 1 plus month 2) and so on, as the following chart illustrates.

This commission structure is nice because then the salesperson gains a personal stake in the customer, and is more likely to help the customer after a sale. While it is possible to do chargebacks with the next structure, it is much harder.

This structure tends to produce a steady, generous revenue stream for salespeople—sometimes causing what is often called the 'fat and happy syndrome'. The key is in the salesperson's quota. If they don't make their quotas, they may be fired and lose that revenue stream. The threat of loosing this very lucrative revenue stream is also an effective employee retention tool.

One-time system
In the flat-, or one-time percentage of sales system, the salesperson gets a cut, which can range from 50 to 200 percent, of the first month's sales. That is, if they had $1,000 in sales month 1, $2,000 in sales month 2, and $3,000 in month 3, then assuming a 100% pay rate, in month 1 they would receive $0 in commission (commissions are a month behind.), $1,000 in month 2 (100% of month 1), $2,000 in month 3 (100% of month 2) and so on. See the chart below:

This plan wins points for simplicity. The math is easy, and the numbers are very easy on accounting and payroll. The hard part is keeping the salesperson interested in the customer post-sale. One way to counter this syndrome is a chargeback program where the salesperson gets charged back commission but this is often more trouble then it is worth.

Chargebacks can cause an adversarial relationship, and are hard to calculate if you do not have a yearly contract. In most cases, the company ends up eating the charge backs, as it is not worth the hassle.

Whatever systems you decide to go with, you'll need to tinker in order to find exactly the right fit for your company. Also, there is one provision in every commission plan that you should include. "Employer has final say over all commissions and may change this plan at any time." Use this clause to your advantage, and change it if it is not working for you.

Your in service,
Jason Zigmont

—End

read Part 1 of this article
read other articles by Jason Zigmont