What’s it: Commission-based pay is money paid to employees based on the value involved, expressed as a percentage. How to pay commissions can vary between jobs and companies. For example, companies pay commissions to salespeople based on their sales value. Meanwhile, stockbrokers may charge a commission each time a client makes a transaction. And, for this article, let’s focus on commissions for salespeople.
This compensation system aims to encourage sales staff to sell as many products as possible. When staff can sell more products, they get paid more. On the other hand, if they sell less, they make less money.
How does commission-based pay work?
The company encourages sales staff to increase sales by incentivizing commissions. If they are successful, they earn more money, and the company books more revenue.
How to pay sales staff can vary between companies. For example, some companies pay commissions in addition to existing salaries or wages. Others may only pay commissions. Here are the variations:
- Salary plus commission. Employees receive a commission in addition to salary. They like this compensation system because their income is more secure. If they don’t generate sales, they still earn a basic income from a salary.
- Direct commission. Employees only receive a commission as their income. So, when they don’t sell products, they don’t earn any income at all. In other words, employees control how much they earn.
- Variable commission. Companies offer different commissions according to certain criteria. For example, your company pays higher commissions when your employees sell to key customers. Say, the key customers are those who buy in large quantities. So, when you can sell to them, your company can reach the revenue target faster. That’s the reason why you give a higher commission.
The commission is calculated based on the value sold. Suppose your company sells a product for $10. You offer a 3% commission for each product sold to drive sales. If an employee sells 100 products in a month, he receive $30 (= 3% x $10 x 100 products) as commission.
Say the employee earns a base salary of $400 a month. Thus, he received a total payment of $430. Then, if in the following month he sells 200 units, he gets double the commission ($60).
Commission plus salary is perfect for salespeople. In addition to their secure income, because they get a basic salary, they have the potential to earn more money. And, commissions inspire them to achieve the highest possible sales levels.
What are the advantages of commission-based pay?
Motivating factor. Employees will maximize their efforts to generate as much revenue as possible to earn higher commissions. So, they are keen to approach and acquire as many new customers as possible. In addition, they seek to build strong relationships with existing customers to encourage them to repurchase.
More effective. Commissions can be more effective than salaries when companies try to boost sales. Because the staff is motivated, they can generate as many sales as possible.
On the other hand, salary may not be effective enough to motivate salespeople to sell more. Instead, they may be more inclined to be lazy because they still earn a fixed nominal income regardless of the total sales generated.
More controlled labor costs. Commissions allow you to link employee productivity with pay to them. If they are more productive, you pay them more. And, conversely, if they are less productive, they get paid less.
Imagine if you pay employees with salaries. You may end up paying them too much and not worth their productivity. Say they sell less. As a result, you incur more labor costs per output sold because their total salary does not change.
What are the disadvantages of commission-based pay?
Poor staff quality. The quality of the sales staff determines how sustainable the company’s sales are. For example, they tend to take shortcuts to boost sales. They are very persuasive, for example, in a slightly deceptive way, to encourage consumers to buy even though they don’t really want to.
As a result, the company saw a considerable increase in sales in the short term. But, it then went down. Customers are reluctant to repurchase because they are deceived by the sweet promises of the sales staff.
Bad reputation. Poor quality sales staff can damage a company’s reputation. Customers no longer trust the company’s products. Finally, sales continue to fall in the long run.
Mental stress. The drive to achieve high sales can be a moral burden on the sales staff. If they have a bad month, they receive a low paycheck and maybe just a little over base salary.
Such pressures intensify during bad economic times. During the period, many customers reduce their purchases. As a result, fewer products can be sold.
Sales concentration. Ideally, salespeople have a spread-out coverage area and target different market locations from each other.
However, there are times when they may target customers in the same area. Such concentration can be bad for future growth because distribution channels are not widely developed.
Then, if the salesperson uses a different marketing message, the customer will be confused. So, they may be reluctant to buy.
Insecure income. Commissions can be a great method if the company offers a base salary. But, if there is none, the sales staff see their income as insecure. They may not get paid at all because no products are sold.
Cash flow problems. If the company sells products on credit, cash flow may be a problem. The company may have to pay sales staff sooner, say at the end of the month. On the other hand, customers may pay for the product longer, say more than a month.
If the company does not have effective credit collection policies and procedures, it can lead to cash flow problems. Companies must spend more cash to pay staff than they receive from customers.
What to read next
- Financial Motivation: Why It Matters and Types
- Wage: How it works and Types
- Time-Based Wage: How it Works, Pros and Cons
- Piece-rate Wage: How it Works, Advantages and Disadvantages
- Bonus: Types, Advantages, Disadvantages
- Salary: Influencing Factors, Advantages, Disadvantages
- Commission-Based Pay: How it Works, Pros, Cons
- Performance-Based Pay: How it Works, Pros, Cons
- Share-Ownership Scheme: Its Importance, Pros, and Cons
- Fringe benefits: Examples, Advantages, Disadvantages
- Profit-Sharing as a Motivator: How it Works, Advantages, Disadvantages
