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What Is Sales Commission? Formulas, Examples, and Best Practices

People shaking hands while looking at a sales commission agreement
Sales commissions create the opportunity to gain significant income beyond a base salary. [Adobe/Studio Science]

Learn the basics of strong, effective sales commission plans to attract top talent and drive business goals.

The pressure is on. 

About 69% of sales professionals say selling is more difficult now than in previous years, according to Salesforce’s State of Sales report.

Even though it’s harder to sell, reps still need to hit their numbers. And in this ultra-competitive environment, morale can quickly take a dive. To keep your sales team motivated when things are tough, you need to reward them for their victories. That’s where sales commission comes into play. Done the right way, commissions can be a powerful incentive to give your best and go beyond your comfort zone.

In my 20-plus-year career, and as founder of the Harris Consulting Group, I’ve learned some valuable lessons, tips, and best practices when it comes to structuring sales commissions. I’ll walk you through all the factors you need to consider when setting a sales commission structure for your team.

What you’ll learn:

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What is sales commission?

Sales commission is the additional money reps earn on top of a base salary for achieving specific goals. Commissions often push sellers to achieve sales goals and generate revenue.

For example, let’s say your leading rep’s base salary is $100,000. Your company offers a 10% commission for a product valued at $5,000. If they sell just one of those products, their net pay is $100,00 + (.1 x $5,000) = $100,500.

I believe commissions are a game-changer. Sales is one of the few professions where you can build the life and income you want based on the effort you put in. As Scott Leese, founder of Scott Leese Consulting, affirms: “In my experience, sales commissions add a level of excitement and positive reinforcement for sales teams.

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Benefits of sales commissions

Commissions help organizations boost sales team morale and grow organizational revenue. But they offer a lot more. Leese offers the following benefits of commissions in sales:

  • Increase earning potential: Commissions create the opportunity to gain significant income beyond a base salary. Top salespeople can earn high commissions, and this high-earning potential is often a huge motivator for many sales professionals.
  • Reward performance: Commissions are directly tied to sales results, so they reward high performers. For competitive salespeople who want their compensation to directly reflect the work they put in, commissions are appealing.
  • Provide incentives: Commissions incentivize salespeople to generate more revenue. The lure of higher commissions can motivate staff to increase sales activities and close more deals.
  • Indicate level of success: Earning substantial commissions can be a visible indicator of success in sales. Additionally, top earners get bragging rights and peer recognition.
  • Create control over earnings: With commissions, salespeople feel more in control over their income potential. As a result, they have the power to boost their earnings rather than relying solely on a fixed salary.
  • Spark competition: Salespeople are often competitive. Because of this, commissions can turn sales into a competition where reps try to outsell one another to earn more. This can generate more deals and more revenue.

Let’s dig deeper to unlock the true power of commissions.

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Why is sales commission important to understand?

Because it’s core to their salary, understanding commissions is crucial for sellers. Consequently, businesses must understand the power commissions have on their workforce.

For instance, a 2022 Gartner survey found that 90% of sellers experience burnout, which can lead to resignations. Commissions may have the power to incentivize reps to stick with your company long-term. Certainly, some types of commission structures are more attractive than others and can give your company an advantage when attracting and retaining the best sellers. Leese believes the best commission plans align the salesperson’s interests with the company’s interests.

“While commissions provide financial incentives, well-designed plans encourage salespeople to take a long-term, customer-focused approach for a mutually beneficial relationship,” he said.

To achieve that alignment, businesses must strike a delicate balance between their commission rate and structure. I like to imagine commission as the dangling carrot. The challenge: If the commissions are out of line with the company goals, the carrot becomes the stick. Certainly, nobody is going to stay at a job where they’re reprimanded for not hitting unreasonable targets.

Commissions come in different shapes and sizes. Knowing your rep commission rate, structure, and payout gives sellers financial visibility and helps you align them with business objectives. But there’s a little more to it…

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Basics of an effective commission structure

The stakes are incredibly high in sales. It’s one of the only roles where not meeting your quota will put you at risk of losing your job. Surviving in a make-or-break environment means salespeople must keep an eye out for their next employment opportunity, even if they are all-star sellers. That’s why you want to build a compensation plan that makes it impossible for someone to recruit your best seller. With the right approach, you can build commission rates and structures to promote smart behaviors and encourage retention rather than just immediate sales.

Here are a few things to be sure you include in your commission structure to ensure buy-in from your whole team:

  • Payout schedules: These can be structured to support longer-term goals. As an illustration, some payouts may be deferred or only paid on an account’s payment of their invoice(s).
  • “Clawback” provisions: These may be used to negate or recover commissions if a salesperson’s deal later causes problems, like failure to pay an invoice or contract cancellation. 
  • Ethics and conduct standards: These should align with company values, so reps don’t compromise integrity or compliance to earn commissions.
  • Training: If the expectation of the sales team is to grow revenue, then it is important for companies to heavily invest in sales training. Above all, the purpose of sales training is to ensure consistency in process, a common language, and the right ethical and consultative approach to sales.

Let’s take a look at some examples of commission types and how they’re calculated so you can see what would make the most sense for your business.

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8 types of sales commissions and formulas for calculating

Commission structures are not one size fits all. The right one for you depends on your business’s size, the products or services you offer, and your revenue goals. Below is a selection of the sales commissions I’ve encountered in my career that you could choose from.

1. Base salary + commission

Combines a guaranteed income with variable earnings for performance.

  • Formula: Base salary + commission
  • Example: Your annual salary is $40,000. You earn a 10% commission on all sales. If you sell $100,000 worth of products, your total for the year would be $40,000 + ($100,000 x 0.1) = $50,000.
  • Who’s it for? Teams or products with less predictable sales cycles
  • Pro: Provides financial stability and incentivizes overall sales while rewarding individual performance
  • Con: Can increase fixed costs without significant sales growth and high base salaries can lead to complacency

2. Commission calculated on exceeding quota

Combines a base salary with additional commission earned only on sales exceeding a set quota.

  • Formula: Base salary + (Sales exceeding quota x Commission rate)
  • Example: You have a $3,000 base salary per month and earn a 15% commission on sales exceeding your $10,000 quota. If you sell $12,000 worth of products, your total would be $3,000 + ($2,000 x 0.15) = $3,300.
  • Who’s it for? Established teams with ambitious targets
  • Pros: Motivates reps to exceed goals for increased pay; drives higher profitability
  • Con: Can create pressure and discourage collaboration if quota feels unattainable, leading to lower overall sales

3. Straight commission

Paid as a percentage of the total sales value.

  • Formula: Sales value x Commission rate (%)
  • Example: If you sell a product worth $1,000 with a 10% commission rate, your pay would be $1,000 x 0.1 = $100.
  • Who’s it for? Short sales cycles or independent salespeople with a high-risk tolerance
  • Pro: High earning potential directly tied to performance, leading to strong sales motivation
  • Con: Income instability and financial stress when sales are slow, potentially leading to unethical sales practices that prioritize individual gain over customer satisfaction. For example, reps could misrepresent a product by not disclosing its drawbacks or hidden fees just to close a sale.

4. Residual commission

Incentivizes salespeople with legacy clients and accounts.

  • Formula: Client account premium x Commission rate (%)
  • Example: Your legacy client continues to pay their $1,000 premiums each month. You receive a 5% commission or $50 each month.
  • Who’s it for? Established client bases and recurring revenue models
  • Pro: Long-term income from recurring sales incentivizes, building customer relationships and loyalty
  • Con: Might not provide immediate financial gratification, potentially demotivating some salespeople. This could lead to salespeople sitting on a book of business to collect money without feeling the need to get new business for the company.

5. Territory volume commission

Used for teams; a set rate for a defined region determines the sales team’s income.

  • Formula: (Your territory sales / total team sales) x Commission rate x Total sales revenue
  • Example: Your territory team has $50,000 in sales within your territory, the total team sales for the company are $500,000, and the commission rate is 10%. Your territory volume commission would be ($50,000/$500,000) x 0.1 x $500,000 = $5,000.
  • Who’s it for? Large sales teams managing geographically divided markets
  • Pro: Encourages local market development and ownership, aligning rep success with specific regions
  • Con: Might lead to resentment, competition, and neglect of shared opportunities if territories are poorly defined or one salesperson contributes the most and is getting paid the same as someone who contributed the least.

6. Tiered commission

Rates increase as sellers surpass sales goals, encouraging progressive effort.

  • Formula: (Tier 1 sales x Tier 1 rate) + (Tier 2 sales x Tier 2 rate) + … + (Tier n sales x Tier n rate)
  • Example: A tiered commission plan might have 5% for sales up to $5,000, 8% for sales between $5,000 and $10,000, and 12% for sales over $10,000.
  • Who’s it for? Teams dealing with complex sales with multiple touchpoints
  • Pro: Rewards high performers progressively, motivating exceptional effort for greater financial gains
  • Con: Can demotivate underachievers and create frustration if tiers feel unfair or unattainable

7. Gross margin commission

Profit from the sale determines the commission.

  • Formula: Gross margin per unit x Number of units sold x Commission rate (%)
  • Example: If a product has a $200 gross margin and a 15% commission rate, selling 10 units would earn you $200 x 10 x 0.15 = $300 in commission.
  • Who’s it for? High-margin products or situations where cost control is critical
  • Pro: Aligns sales focus with profitability, encouraging reps to sell high-margin products and services
  • Con: Can be complex to understand and calculate, potentially causing confusion and distrust

8. Draw against commission

Advance against future earnings, creating financial stability but requiring repayment through sales.

  • Formula: Commission earned – draw amount
  • Example: You receive a $2,000 draw against your commission. If you later earn $3,000 in commission, your total earnings would be $3,000 – $2,000 = $1,000.
  • Who’s it for? Salespeople in unpredictable income environments; particularly helpful for new reps or during sales dips
  • Pro: Provides financial security for new or underperforming reps while ensuring company commitment to employees
  • Con: Creates potential debt burden if sales fall short, leading to stress and decreased morale throughout the team.

Some of these seem complicated, but technology can help companies automate commission calculations and tracking. These platforms can save time and reduce errors for your sales team.

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Tips on deciding sales commission structure and rate

It’s one thing to offer commission. It takes an entirely different strategy to determine the best rate. According to Indeed, most sales commissions come within a sweet spot of 20% to 30% of gross margins, but the range stretches from 5% to 100%, depending on the setup.

In my experience, the perfect number for every industry does not exist. Commission is also not the only factor in hitting revenue targets. If there’s a sales team that gets 100% quota and its company goes out of business because they haven’t hit targets, it’s likely not the commission plan that’s the problem. I would assume the company has a whole host of issues that have nothing to do with the sales commission structure.

Instead of searching for that perfect number, choose a commission structure and rate by answering the following questions, then considering what comes next:

How are my competitors compensating their sales team?

Evaluate what your competitors are doing against each commission structure I shared above to see if it’s viable for your business. If your sales cycle tends to be longer and your sales team has a lower risk tolerance, then straight commission might not be the right choice. Certainly, don’t hesitate to ask your sales reps for their opinions.

Can I offer similar or even higher rates?

Top sales talent is hard to find and easy to lose, so you want to remain competitive. Once again, check in with your sales team. Ask them how they feel about the current rate and what it would take for them to stay loyal.

What is the size of my sales force?

You want to be able to scale your payouts so that everyone on your team is paid equitably for their duties. Review the job descriptions at your company. For example, the difference between sales reps vs. sales managers and sales enablement vs. sales partners roles. Consider the responsibilities for each position and balance that against your budget and current market rates.

Will the company remain profitable?

Don’t promise what you can’t pay. Confirm your sales budget and pay attention to sales forecasts, which can help you prepare for shifts in things like staffing, inventory, marketing budget, and sales capacity.

Can a sales rep easily understand the commission structure and payout?

Do you have a communication strategy? If not, it’s time to develop one. A communication strategy must spell out every detail of the commission structure and payment schedule so everyone can understand it and has an opportunity to ask questions.

Answering these questions helps you get a better picture of your competition and internal operations. With this knowledge, you’ll be able to set and adjust commission rates and structures for the highest benefit to your organization.

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How to put a sales commission structure in place, step by step

Implementing a successful commission compensation plan can be broken down into five steps:

1. Define your goals

The best practice for any plan is to define what success looks like. What are your ultimate sales targets? Do you want to obtain new logos (prospects), conquer new markets, defend your territory, take customers from your competitors, or grow existing customer revenue?

Identify the specific sales behaviors you want to incentivize, like closing high-value deals or nurturing long-term relationships. Ensure everyone on the sales team understands what the endgame is for total alignment.

2. Set achievable quotas

Find the balance between challenging and attainable. You want your sales reps to be motivated, but you don’t want to set them up for failure.

Use CRM data to confirm what your sales team has sold in the past. Combine that research with buyer interest, the economy, and market trends to set goals that inspire your team to exceed sales expectations alongside their quotas.

Have a few of your best reps review the plan to look for problems before the whole team sees it. Make the adjustments as needed based on their feedback.

3. Calculate commission rates and payouts

Clarity is the name of the game for both your business and sales team. Make sure your budgets are accurate. When you promise a commission rate, deliver it. It’s not only poor etiquette to under-deliver; it will be interpreted as unethical and that will cause your top talent to push back on what you communicated upfront. And in many cases, start looking for the door. 

Choose a calculation method that resonates with your team. Confirm that everyone understands the formula, why it was chosen, how reps can earn big, and how and where they can track it.

4. Communicate the plan

Build trust with your sales team by providing every resource they need to succeed. Equip them with training, materials, and clear explanations of the plan. Address any questions promptly and openly to create trust and buy-in. Your sales team should have full commission timeline transparency, including the exact date when the plan begins, when it ends, and when they will be paid.

To build trust with your sales team, they should be involved in developing the commission plan. Sales reps will be able to identify where there are holes, so you don’t miss something simple and avoidable that could affect performance. And being part of the process helps them feel like they have a say.

5. Monitor and evaluate performance

Your commission plan should never be static. Monitor its effectiveness against your goals, and don’t hesitate to adjust the course based on performance and team feedback. A flexible plan that adapts to market shifts and sales reality creates sustained sales growth and employee satisfaction.

Use tools like Sales Cloud’s Revenue Intelligence to track quota attainment, open pipelines, and deal shifts in real-time. Get total visibility of pipeline, forecasting, and rep performance, so you can quickly turn insights into action items. Once implementation is underway, it is time to cement the structure in writing with a commission agreement.

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What to include in a sales commission agreement

As noted above, transparency is key. A commission agreement template defines commission plan terms, clarifies expectations for all parties, and streamlines administrative processes. The agreement should include the following:

  • Commission rate and structure: Clearly defines earning potential and incentivizes specific sales behaviors
  • Sales goals and quotas: Sets performance expectations and fosters a transparent understanding of targets
  • Payout schedule: Establishes timing of commission payments and ensures financial predictability for salespersons
  • Deductions and exclusions: Outlines any expenses or sales categories not eligible for commission, preventing confusion and disputes
  • Termination clause: Specifies terms for ending the agreement and protects all parties’ interests
  • Dispute resolution process: Provides a clear path for addressing disagreement and maintaining a harmonious working relationship
  • Signatures and effective date: Validates the agreement and confirms commitment from the company and the salesperson

Remember, the specific contents of a sales commission agreement can vary depending on your company’s industry, size, and sales structure. It should be reviewed and approved by legal counsel before being used.

Because trust is a two-way street, I suggest that businesses consider adding addendums that outline how the business will support the sales rep. I like to see a sense of accountability from companies in that document.

For example, if I’m behind on my goals, what is the accountability of my sales manager to help me reach my quota? Does the agreement specify that my manager will set up X number of meetings and Y number of resources for sales training?

I want to see what the onboarding process looks like, how many one-on-ones I’m expected to have, and so forth. You want your sales team to know the company is setting them up for success, and this is a perfect opportunity.

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Tips for faster commission achievement

On a personal point, I recommend rewarding sales reps sooner to get to overachievement faster. For example, if you hit 50% of your goal, you get 40% of your commission. If you hit 70% of your goal, you get 65% of your commission.

I have a belief, although untested, that if my sales rep can get to 95% of their goal, I want to pay them 100%. However, the devil is in the details with this theory. It might work in some industries, but it might not work in others. You must consider the variables associated with your business, such as:

  • What are you selling? For example, hardware goods have a specific cost of goods sold (COGS) when compared to software, so commissions from these products will differ.
  • How much is your business investing in advertising? Higher advertising costs might lead to lower commission rates to maintain profit margins. By comparison, an effective brand awareness campaign could drive demand and increase sales volume. You should capitalize on that opportunity by choosing a commission structure that reaps the benefits of more qualified leads in the pipeline like a straight commission structure.
  • How long is your sales cycle? If you have an 18-month sales cycle, reps will have to wait up to a year to receive their commission. On the flip side, with a transactional sale on a 30- or 45-day sale cycle, reps can receive their commissions faster.
  • How many reps are hitting quota? If your team is not consistently hitting quota, it’s possible to overcompensate the high performers to make up for lower performers. For example, if I have a rep who hits 95% of her goal, I pay her at 100%. By the same token, if she hits 105% of her goal, pay her 110%. In the end, one is theoretically not overpaying the team as a whole.

All of these things affect commissions and must be considered before you build your plan and start payouts. Once the decision is made, it’s time to test your commission structure’s effectiveness and share the plan with your sales team.

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Accelerate business growth with an intentional sales commission structure

A successful commission structure is a win-win for your company and your sales team. While lucrative commission schemes help attract and retain reps who are motivated by earning potential, a commission structure that motivates everyone on your team is best for business. Strive to create a program that drives performance, boosts your profits, and builds a strong sales force as a result.

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