Sales commissions are one of the thorniest issues a small business can face. In my opinion, the most important rule is to create a commission structure that encourages sales people to do what you want them to do. Obviously your first goal is to get them to sell as much as possible; so there’s already a fundamental incentive built into the system. But you should think about tweaking things to maximize the results you want, while keeping the team motivated. Here are some of the issues I’ve encountered:
- The basic number: I think it’s best to have a simple system that’s easy to understand and unambiguous (e.g., 15 percent of sales). The compensation number you need to offer to get a good people will vary from industry, but your number should at least match your competitors. It’s not that hard to find out what they offer; ask around.
- Quotas: IBM, arguably the most successful company of the 20th century, and still going strong, sets its quotas so that the vast majority of its sales force succeeds. I recommend following its example. Set attainable goals and offer incentives for exceeding quota.
- Ceilings: Some small business owners get upset at the end of the year when they review how much money their top sales people made and impose a ceiling for the following year. I’m sorry, but this is the stupidest idea I’ve ever seen in business. You want them to sell as much as they can. Unless you’re making some pretty big mistakes elsewhere, the more they sell, the more the company profits.
- Gross sales vs. gross profits: There are some situations where you may want to adjust the commission structure to encourage more profitable jobs and pay based on gross profits, in other words, pay a higher percentage on a smaller number. This is OK. Sometimes it’s smart, but you need to make sure that your accounting is transparent enough so that all the players are clear about how gross profit is calculated.
- Bonuses: You can adjust commissions based on other non-numerical factors. For example, you can offer a higher commission for the first year on new customers, or customers in a specific industry sector or geographical location.
- Revenue recognition: Determining when you pay commissions can be as important as determining how much. Paying upon shipment of product or delivery of services is the most conservative approach, but for big-ticket projects that take months to complete, you’ll have to adjust. Extremely tight-fisted businesses pay commissions when the customer’s check arrives and dock their sales people if the customer pays late.
- Draws: If you offer a draw against commissions, this amounts to an interest-free loan. Again, it’s not a bad idea if you have enough experience to make a reliable estimate of the commission numbers.
- Salaries: Some companies offer a base salary plus commissions. This isn’t a bad idea, although the best sales people often prefer 100 percent commission so they can be “masters of their own destiny.”