What Is Commission Pay and How Does It Work

What is commission pay?

Commission pay is a compensation structure where employees are paid a certain sum of money based on the sales or revenue they generated for the business. Unlike fixed salary this is like an extra income which is based on a certain percentage of the sale or the value of a transaction or deal closed by the employee. This model of compensation is most often used in sales and performance driven roles.

The idea behind commission pay is to incentivize employees for contributing to the growth of the business. This mean the more revenue they generate for the company the higher the commission they will get and provide motivation to the employee to work towards achieving their sales target or other performance metrics.

How is commission calculated?

Calculating commission varies based on industry, job role and company policies. if the commission is calculated based on sales the typical formula is:

Commission Calculation Formula: $\text{Commission}=\text{Percentage Rate }\times \text{Sales or Revenue}$

Example: let say an individual commission is 10% and he closes a sale worth $10000, then the commission earned by him will be

• $10000 x 10% = $1000
• This mean the employee will be paid $1000 as a commission for the sale.

What jobs are commission based?

Commission pay is commonly given to employee who are involved in sale or revenue generation for the company. here are individuals who receive commission:

• Sales professional working in retail, business to business, travel agents receive commission pay.
• Real estate agent earns commission based on the value of the property they sell.
• Insurance agent and broker earn commission based on the policies they sell.
• Financial advisors like investment agent ear commission based on financial product they sell like investment products or funds.
• Car Salesman earn commission on every car they sell.
• Some freelance and independent contractors also earn commission based on each project.

Types of commission pay

Here are some of the different type of commission structure that employer provide to its sales people:

1. Straight Commission: this is a pay model where the compensation of the employee depends on the sale they done. here an employee receive a flat fee or percentage of the total sale they done and they are not paid any fixed salary or hourly wage. this commission is commonly used in real estate business where the agents receive commission based on the value of the property they sold.
   Straight commission work best for individual who are confident in their sales abilities and you are comfortable on either making small sale or big commission payment. Since there’s no base pay you need to plan out your finances and expenses for living a sustainable life.
2. Salary Plus Commission: As the name suggest salary plus commission provide both salary and an extra commission to the employee. Unlike straight commission here you will still receive salary if you didn’t sell anything and  the commission acts as an incentive over and above the current salary based on your sales performance.
   For example: if you salary is $100,000 per annum and you get 20% commission on the sale done by you. In 2024 you made a sale of $100,000. so now you will get a total of $120,000 as your total salary for that year.
   This type of commission structure is popular in business to business or corporate job where an individual can enjoy the financial stability of a job and earn an extra income as well from the commission.
3. Variable Commission: Here the rate of commission earned by the individual is not fixed and it depends on certain factors such as performance metrics or sales target. it can depend on the following things:
   – Performance: if an employee is able to achieve their sales target or generate higher sales then are eligible for commission
   – Product or service: some employer provides different commission for different product and services for example expensive and luxurious product generate higher commission
   – Time periods: Some employer may break down the commission structure into monthly, quarterly and yearly goals to encourage high sales.
   – Profitability: some commission are tied to the profitability of the company, the higher the profitability the higher the commission and vice versa.
4. Relative commission plan: here an employee commission is based on a certain benchmark such as individual performance, team performance and they get commission based on how close they are in reaching those benchmark. So if an employee is able to achieve 90% of their quota they will receive a 90% commission on the base pay. this plan contrast with fixed commission where the commission rate is constant around the year regardless of any factor.
5. Territory volume commission plan: a territorial commission is a type of commission which is ties an employee earning to the volume of the sale achieved by them in a specific geographical location. this plan is commonly used in sales and distribution business such as insurance, consumer goods and retail etc.
6. Residual commission: also known as residual income is a type of commission where salespeople receive commission from ongoing customer that continues to renew a product or service brought by them. The sales people will keep on receiving commission as long the client account remain active. Unlike other one-time commission this is commission structure provide a continuous stream of income overtime. Industry such as Software as a Service (SaaS). insurance membership or financial services practice residual based commission structure.

Benefits of commission pay for employees:

Commission based pay has several benefits, some of the include:

• Potential to earn higher incomes by exceeding sales target or achieving specific goals.
• Commission based pay motivate employee to work hard and succeed as it provide a greater sense of achievement and contribution to the organization.
• Commission are directly tied to an individual performance and effort so the harder they work the more the opportunities to generate higher commission, promotions and recognition.
• Commission based pay allow sales people with flexibility to manage their own time and strategies and allowing for an independent work environment.
• Employees in commission based role tend to develop valuable skills like negotiation, communication and relationship building which are crucial to the success of any individual work life.
• Commission based provide transparency in goals of the employee and help them understand how their performance directly influence their earning.
• Commission based pay attracts high performing, ambitious employees who are looking to make extra income with their sales skills.
• Employer can reduce fixed cost as compensation is a variable pay and depends on individual sales performance.

Disadvantages of commission pay:

Commission pay can be highly effective in sales-related roles, but it also comes with potential downsides that employees and employers should be aware of.

• The need to achieve sales target adds an extra burden on the mental health of the employees which can leads to burnout and stress. With continuous failure to achieve the target it can leads to job dissatisfaction and increase employee turnover.
• Since there’s no fixed source of income commission based pay increase the chances of income variability and due to market fluctuation, seasonality and changes in customer demands it can impact they income of the individual.
• Commission based pay leads to unhealthy competition among employees who prioritize sales performance rather than collaborating as a team.
• Incentive to earn immediate commission can lead the employee to focus on short term goals rather than cultivating the customer for long term relationships. This approach can impact customer loyalty and satisfaction.
• Commission based pay often leads to unethical sales practices such as over-selling, making false promises or pressuring customer to buy product which damage company reputation in the market.
• Commission based depends on external factors such as market condition, economic trends and industry regulation.

Commission pay best practices

to get maximum benefits out of your commission plan you need to carefully plan and adherence to best practice so that the structure ensure fairness, transparency and also motivate the employee to work hard. Here are some best practices to follow:

• Employer should clearly defined the commission structure like the commission rates, threshold for getting commission and any bonus attached to it and make sure this is clearly communicated to the employee.
• Employer should setup clear and achievable sales target for employee to work otherwise it leads to employee frustration, burnout and unethical practice among employees.
• Ensure regular communication with the employee regarding their sales performance, changes in commission structure or product and services. Also ensure proper feedback is provided to the employee and provide training and development if necessary.
• Ensure commission structure aligns with the goals and values of the organization. as these help create a sense of responsibility and ownership among employees to work harder.
• Other then measuring sales performance employer should incorporate metrics such as customer satisfaction, customer retention into the commission structure.
• Employer should provide additional incentives to employee for upsell or cross-sell additional products this not only increase revenue but help benefit customer by providing complimentary solution.
• Employer can also incorporate residual commission for their subscription based income. this also ensure steady flow of income for the employee.
• Employer should be flexible in commission to incorporate changes like market demand, new product launches and other business dynamics.

Can I negotiate my commission rate?

Yes, in many cases employee can negotiate with their employer for a better commission rate. here’s some tip on how to do so:

• You need to thoroughly understand the commission structure before negotiating. Understand the base pay, commission rate, tiered structure and other relevant points.
• Showcase your skill on what you bring to the table highlight your experience, skills, track record and contributions done in previous role.
• Do a market research for similar roles in the industry or region. Check what others are providing, what’s the target, how tough the competition is and reputation of the company before negotiating.
• you can also negotiate during performance review present your contribution and target met and apply for a higher rate based on this achievements.
• If you are unable to increase the commission rate try adding other relevant benefits instead extra bonus for over achieving or lucrative commission structure during increase in demand for product and services.
• if you have provided additional value to customer beyond standard sales you can leverage this as a point for negotiation.
• Choose an appropriate time for negotiation for example if you recently closed as big deal or company made a huge profit at that time the chances of increasing your commission rate is higher.

Commission vs. salary