What Is Commission Pay and How Does It Work?
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- What Is Commission Pay?
- How Does Commission Work: Types of Performance Related Pay
- What are the Commission Based Jobs?
- Performance Related Pay Advantages And Disadvantages
- Disadvantages of Performance Related Pay
- How to Calculate Commission Pay in 6 Steps
- Can You Negotiate Commission?
- How to Survive a Commission-Based Job: Top 4 Key Tips
- Final Thoughts
Commission and commission pay are additional payments that are earned based on your performance. We can also refer to commission pay as performance related pay.
Depending on your job role, your commission may subsidize your paycheck or be dependent on it. Meaning you either have a base salary and earn extra money through bonus schemes or incentives, or you must make sales if you want to receive a paycheck at the end of the month.
All types of commission payments are taxable.
Depending on how the company runs, you might be paid this commission monthly, bi-monthly or simultaneously with your paycheck.
Regardless of your role or the company you work for, this article will help you understand your commission-based pay.
Not every commission pay structure is the same and will depend on the employer. The most common types of performance related pay are listed here:
This is the preferred commission pay type as it guarantees a minimum amount of money each month. Any commission is then added on top of that.
As an employee, base pay plus commission allows you to manage your finances better. You know that you will always have a set amount, which should cover your basic living costs.
You then know that the more commission you make, the more money you will have to save or spend.
Be aware that with this structure, employers may offer a lower amount of base pay.
The performance related pay percentage will also be lower than those roles which depend more on the commission earned.
Employers use this type of performance related pay to motivate sales representatives to achieve above their targets.
When an employee reaches a particular benchmark, such as revenue earned or sales closed, they move to a higher commission tier.
For example, all employees might start on an 8% commission on all sales up to $25,000. Once they have reached that benchmark, the commission then becomes 10%.
The same method may also be used for underperforming representatives, but in the opposite direction.
So, a sales rep may only receive 80% of their normal commission if they only achieve 80% of their targets.
A full commission plan is also referred to as straight commission or 100% commission. This type of performance related pay means your entire income would be dependent on the amount of commission you earn.
In this commission structure, because the commission is so high, the sales tend to also be of higher value, such as property sales.
Traditionally, people employed under this structure are freelance or independent contractors. They typically do not receive any employee benefits but work as many hours as they like, depending on how much money they want to make.
While the idea of 100% commission does sound appealing due to the freedom of being freelance, the reality is that not many are willing to live without a base salary due to the anxiety that comes from not knowing how much money they will have each week.
As a result, this type of commission pay is becoming less popular.
Residual commission payments are more commonly found in sectors such as insurance.
The sales representative receives a percentage of their customer’s payments until the customer decides to stop the service.
In some instances, a sales representative may continue to receive those commission pays even if they no longer work for that company.
Revenue commission usually runs alongside another commission pay structure in organizations that sell products with a set price.
It is a straightforward commission structure where the sales representative receives a percentage of their sales.
For example, you sell a product worth $5,000, and receive 5%.
It is common for employers to use this method when entering a new market or scaling their businesses. It is easy to implement and ensures the top sales representatives receive the highest commission.
Gross margin commission is similar to the structure of revenue commission. However, instead of receiving a percentage of the revenue, the sales rep gets a percentage of the profit from that sale.
For example, a product that sells for $2,000 may have overheads of $800. In this case, the sales representative will receive a percentage of the $1,200 profit.
The most desirable commission structure will depend on the cost and profit of the product or service you are selling.
For some employers, there is a massive upside to team-based incentives.
With this structure, the focus is less about commission and more about building a thriving work environment.
Employees receive hourly pay plus commission, similar to base pay plus commission; however, the whole team has to perform for the commissions to be paid.
As such, all employees are motivated to support and encourage one another.
The downside to this method is that those colleagues who do not do their part still receive an equal commission amount.
However, with the type of company culture these structures operate in, this is rarely the case.
Typically, any role that involves sales is commission-based.
These commission based jobs include:
- Retail assistants – Particularly with luxury brands
- Real estate brokers – Both commercial and private
- Sales engineers – Focus solely on the sales of new technology
- Wholesales and manufacturing sales representatives
- Financial services – Such as a stockbroker
- Insurance – Health, life, car, property
- Advertising sales agents – Sell advertising space on billboards, in publications and online
- Travel agents – Either self-employed or with an agency
However, the Internal Revenue Service (IRS) states that commission-based payments are not regarded the same as regular wages.
As such, bonuses, vacation pay, back pay and overtime are considered part of a commission structure.
This means that any person who receives bonuses or other incentives is in a commission structure.
Some examples of bonus-style commissions are:
- Social media managers who meet daily or monthly targets
- Marketing teams that exceed revenue targets per campaign
- Literary agents that receive a portion of book sales exceeding a specified limit
For an employee, the advantages of performance related pay are:
If you are a driven salesperson, there is no limit to the amount of money you can make.
Receiving commission gives you the time to build up your relationships, eventually leading to high-value sales.
If you receive a base salary, you have a guaranteed about of money every month regardless of your performance but always have the chance to increase your pay.
You will never be lacking motivation as your income depends on it.
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For an employee, the disadvantages of performance related pay are:
The base pay is sometimes lower than you would like, meaning you must earn a commission to cover your cost of living.
Everyone is out for themselves, so your work environment may not be supportive and friendly.
When the commission is so important, the integrity of the sales agent is sometimes compromised.
Depending on the job role, sales might depend on the time of year, seasons or current trends. You need to be prepared for periods of low or no commission.
If you are not a strong salesperson, you may struggle to get a commission.
Commission is calculated either by percentages or a formula.
Before beginning your calculation, you need to know:
- The period you are calculating – Commission is usually paid monthly or bi-monthly, so your period will either be four or two weeks.
- The total amount of sales you made during that period – If you receive different commission amounts for different products, write down each product's total rather than one whole amount. This is your commission base.
- The commission rate – The percentage or fixed amount you receive for each sale.
- Any overrides – Mainly if you are on a tiered commission structure.
- If commissions are to be split with other colleagues.
To calculate your commission, follow this formula:
- Only use the figures for the applicable period
- Multiply the commission base by the commission rate
- Calculate different commission rates separately
- Calculate tier figures and overrides if applicable
- Deduct any refunds (as specified by company policy) now
- If applicable, split the commission
This will give you your commission amount.
Every organization has different commission periods. Some will go by the calendar month. Others will work from a date specified by payroll – usually the middle of one month to the middle of the next (December 15th to January 14th).
Quotas are similar to a tiered commission system. As an incentive, your employee might state that anyone who reaches a specific goal or quota will earn extra commission.
Ceiling capping is not commonly used as it dissuades the sales representative from reaching their goals. However, should your employer decide, they may put a cap on the commission you earn.
During your last period, December 1st to December 31st, you sold:
- Product A @ 5% commission: Total $8,500
- Product B @ 7% commission: Total $5,000
- Product C @ 5% commission: Total $7,600
As a Christmas incentive, for any sales over $8,000, you receive an additional 2% commission.
- Product A commission: 8,500 x 0.05 = $425
- Product B commission: 5,000 x 0.07 = $350
- Product C commission: 7,600 x 0.05 = $380
Total commission = $1,155
Product A falls into a higher tier as the sales exceeded $8,000.
The excess is $500
500 x 0.2 = $10
New total commission = $1,165
Your total commission for December is $1,165
You always work one period behind, so in January, you will receive your base pay plus December commission.
Your employer may have put in a ceiling cap and say that the maximum amount of commission available is $1,000. As your total commission was $1,165, you would lose $165.
Commission is standardized across the entire company, so negotiating a raise is difficult.
It is recommended that you try to negotiate other parts of your package such as employee benefits or your basic salary.
It may not look like much on your paycheck but having a subsidized gym membership or flexible working hours/locations will positively impact you in the long term.
However, if you believe that your commission is below industry standards, or you feel you deserve more, then nothing should stop you from opening negotiations.
Before negotiating, compile a document of industry-standard commissions and salaries, as well as a breakdown of your performance.
- Calculate how much revenue you have produced
- Identify what goals you have achieved
- Do not be afraid to compare your performance to your colleagues
WikiJob has helpful guides for finding out average US salaries.
During the negotiation meeting:
- State that your priority is to improve your commission, but you are open to other options
- Be respectful and remain calm
- Emphasize the value you bring to the company
- Be honest about your salary expectations and start with the highest reasonable number
Once the negotiations start, do not delay your reply. Take no more than an hour to consider their proposal and politely reply with another counteroffer or an acceptance.
The best negotiators are prepared and know their worth.
When working in a job with no regular salary, you need to be prepared and organized to avoid stressing about money:
Before you start your job, write down a list of expected monthly expenditures for the following 12 months. Include all your living costs as well as fun ones such as vacations and Christmas gifts – this will give you your monthly financial minimums.
Next, you need to evaluate your sales pipeline. Knowing in which months you make a lot of commission and which months are slow will help you decide when to save.
Using all this information, create your yearly budget. Note how much commission you need to make each month and how much you need to save from your good months to cover your bad.
Performance related pay is not for everyone.
You also need to be highly motivated and organized. Some months you might excel at your job, others you might struggle to make your targets.
To succeed in a commission-based job:
- Create a set of goals and work on them every day
- Stay on top of your finances
- Remember to look after your health and wellness
For any issues or queries regarding your commission or employment package, speak to your manager or HR member.