Dear Shoestrings:
Both the “base plus bonus” and commission approaches have their uses. Generally, an organization’s sales cycle, size, and business model will affect the selection of commission vs. bonus. The following are some of the key differences between the two plan approaches.
In transactional selling environments with shorter sales cycles, where new business development is the priority, commission plans prevail. A commission plan in its simplest form is a rate of pay linked to a sales result, such as two percent of revenue or $200 per unit sold. Commissions provide clear line-of-sight to the sales person because the reward for the sales result is direct. Most companies in early stages of development use commission plans because they are simple to administer and drive new business. To ease cash flow for the rep, these early stage companies may also use a “draw” (basically, an advance) against commissions or a modest base salary.
As companies grow, this simple commission approach tends to break down. This is because sales strategies become more complex, new sales roles are introduced, and recurring customer revenue grows. In these environments, straight commission plans tend to overpay for the existing base of customer revenue, because they use the same rate for a large recurring revenue stream as for incremental new business. Commission plans also break down as territories vary in size because an individual’s earning opportunity is directly tied to territory size. The organization then begins the futile game of cutting and pasting territories to create a more equitable situation for all sales reps. The commission rate, used over time, becomes sacred and immovable. Changing the rate, to provide the necessary sales management flexibility, is typically viewed negatively. The organization becomes hamstrung by the commission plan and the sales management process starts to work backwards: companies make job and territory decisions to meet the needs of the commission plan.
At this point, many companies move to a base-plus-bonus plan. This structure allows the organization to vary the pay mix (the ratio of base salary to target incentive) according to the roles of each job. For example, account managers with a large base of existing business will have a less aggressive mix — perhaps 80 percent salary and 20 percent target incentive — than new business developers, who may have a mix of 40 percent salary and 60 percent target incentive. As this mix varies and a job carries more incentive pay at risk, as either commission or bonus, the accepted practice is to provide greater upside earning opportunity for performance above quota.
As a rule, for every dollar of incentive pay that would be earned at quota, a well-designed plan will provide the opportunity to earn one to two dollars in additional incentive pay at the excellence level of performance. So, for example, a plan that pays $20,000 at quota could provide an opportunity to earn an additional $20,000 for the top 5 percent to 10 percent of performers in the organization. The base-plus-bonus approach simply provides more flexibility to design a plan that fits each job role.
If the sales job in question is focused primarily on new business development and follows a transactional sales cycle of moderate length, a commission plan may be the way to go. To make the change from a base-plus-bonus to straight commission, you will need to consider cash flow for the rep. You may gradually lower the base or use a declining draw to smooth the transition. Also, if you add more risk to the plan by reducing the base salary, you should provide an appropriate level of new upside opportunity for the rep. You want to make the change motivational. After all, your objective with the plan should be to clearly communicate your sales priorities and to fully inspire the rep to work toward those priorities.
SOURCE: Mark A. Donnolo, consultant, Sibson Consulting, Atlanta, Georgia, Jan. 23, 2003.
LEARN MORE: ReadHow to structure sales commission targets and goals.
The information contained in this article is intended to provide useful information on the topic covered, but should not be construed as legal advice or a legal opinion. Also remember that state laws may differ from the federal law.