How to Simplify Your Commission Structure

Is your commission structure so complex that even you must have help understanding it—and calculating a commission on a pending bid?

Sales people are incentivized by money. They usually are able to calculate what’s in it for them before they make the final presentation and ask for the order. But what if the commission plan is so complex that even the people who should be most excited cannot understand or calculate the winning numbers?

Far too often, I come across companies with commission structures that take into account “all” the possible permutations of profit on a sale, causing everyone to wait for an accounting person to complete a cost analysis in order to find the magic number, or for a manager to rule on percentage splits for territories or products.

For those who have tried (and perhaps built) a commission structure based upon anything other than gross revenue, there are some relatively easy solutions for simplification.

First, forget the extremes in cost of goods or labor costs for the sake of ease in calculation—and for more effective motivation for the sales staff. Pick a number for the cost of sales for outside purchases of hardware or services, and assign a standard percentage to these. For example, make all outside hardware and services commissions calculated at 25% of the contract sales price, and all inside services commissioned at 50% of the billed amount (as a basis of that line item for the percentage to the sales person). Then make a rule that exceptions for commission calculations can be made only for contracts above some large trigger amount. Codify that the sales person cannot discount lower than some percentage of the stated prices, usually ten percent, without management approval—and possible commission percentage impact.

For recurring revenue, the commission should be calculated in advance for some stated number of contract months. Cancelled contracts would result in a chargeback against pre-calculated commissions, and charged against future earnings.

Many smaller companies pay commissions as cash is received. This complicates the accounting process, but importantly not the incentive to the sales people, who have long since been able to calculate the total commission on the order, and look to the extended payments as a form of deferred revenue, not as a penalty.

Company executives have come up with permutations for protection of cash flow or profitability since the dawn of commission time. But we can address the motivation and resulting follow-though by sales people as a result of these many types of permutations.

And simplification almost always leads to better sales efficiency, motivation, and more closings by those who now understand their portion of the profit from their work.