Commissions vs Bonuses
December 13, 2019
When it comes to sales, there are a lot of terms used to describe money, or the act of getting paid in one form or another—commission, bonuses; incentives of any kind. All good stuff, right? We are talking about getting paid, after all. It’s like pizza. Pepperoni, Hawaiian, Sausage. No matter your tastes, do you ever really turn away pizza?
But back to compensation…
While the different ways you can get paid means you’ll get paid in some shape or fashion if you perform, those specific levers can certainly have varying levels of impact.
This brings us to commissions and bonuses. While both offer compensation in addition to traditional salary, what’s the difference between the two, and when should each be used?
Difference between commission and bonus
Commissions and bonuses are both a form of variable pay - money that is determined by sales activities in addition to the fixed (base) pay.
However, the commission is a piece of an employee’s total compensation puzzle, and is paid out when that employee makes a sale. The actual amount earned is determined by the commission rate, which is a percentage of the revenue on the sale. So for instance, a rep might earn 5% commission on a sale, and thus a $2,000 sale nets $100 in commission. As you can see, the amount of commission earned will vary from sale to sale.
The bonus, on the other hand, is different in that it’s paid out when a certain threshold is met, with that threshold commonly being something like the sales quota. The bonus in this case can be stated as a percentage, say 6% of the salesperson’s salary, or a fixed amount like $30,000.
Definition of variable pay: pay that is determined by sales performance, paid in addition to the fixed (base) pay.
Definition of commission: a piece of an employee’s total compensation puzzle paid out when that employee makes a sale; commission is a form of variable pay.
Definition of bonus: incentive compensation that is paid when a certain threshold is met, such as a sales quota.
Sales commissions explained
Depending on pay mix, a salesperson’s total target compensation will be split between salary and incentives, or more specifically in this case, commission. The more influence a salesperson has, the greater this variable incentive piece will be. From this, you can see how influential commission can be in motivating a salesperson to perform, and is especially in the case of something like a 50/50 pay mix.
With the introduction of commission comes a host of concerns and considerations. For instance, with so much of their take-home pay tied up in commission, it’s common for salespeople to keep their own records of expected payouts, known as shadow accounting, especially if there isn’t transparency around what they’re earning and why. This is where sales compensation automation comes in, offering transparency and helping build trust so salespeople can get away from their own spreadsheets, using their time for selling activities instead.
The other consideration is answering the question, “When should commission be paid?” The debate warrants an entirely separate blog post, but it boils down to paying upon the sales booking, on revenue, or even at the time of invoicing.
This decision matters—when salespeople are paid upon a deal being booked, it results in instant gratification and positive reinforcement, which encourages repeat effort. From this, you have a fast-moving sales team looking to attack subsequent deals, and an organization that is able to easily track commissionable events, which, again, reduces shadow accounting.
On the other hand, such a process introduces more risk given that deals can fall through. This not only can lead to cash flow issues, but can also be demoralizing given that the salesperson has already been paid, and who might have been better off just not being paid at all.
Commission can take a number of different forms that include:
- Flat commission rate for all sales
- Different commission rates for different types of sale (ex. Products with higher value)
- Different commission rates for renewals, depending on whether they are competitive or non-competitive
- Commission tiers e.g. different rates for up to threshold, threshold to target, above target - this requires realistic target setting
- Individual Commission Rates (ICRs): These are calculated by reference to the individual On Target Incentive (OTI) and target
For example a target OTI of $100k and a target of $1m would generate an ICR of 10%. There could then be 3 tiers i.e. 0-50% attainment – 7.5%, 50-100% - 12.5%, 100%+ - 15%
Commission is typically used for large deals as it is difficult to calculate a target. One deal lost or won can make a significant difference.
As mentioned above, the bonus can be awarded as a percentage of salary, or even a percentage of total revenue earned, or can be a fixed dollar amount based on total units sold. In fact, there are many different types of bonuses, and many different scenarios that can be dreamt up, making their application potentially less formal and more flexible than that of sales commission.
Types of bonuses may include:
- Spot bonus
- SPIF (Sales Performance Incentive Fund)
- President’s Club
- Non-monetary recognition
When to use commissions vs. bonuses
It may be confusing to consider when a commission would be more helpful for driving sales performance and when to use a bonus instead. Here are a few tips on when to consider using a commission or a bonus.
Commission is a best practice when:
- They are applied to earlier stage companies or new product introductions
- There are equal selling opportunities across all assigned territories
- The sales organization has goal setting challenges (e.g. tracking, credit allocation)
- Considering new account hunting roles
Quota-based bonus is best practice when:
- The company or market is more mature
- The company has a strong brand or a well-supported sales organizations
- There are significant differences in selling opportunities among sellers
- There are solid goal setting processes
- Considering retention or penetration roles
Using commissions and bonuses will have varying levels of impact depending on a variety of circumstances, so the tips above are not hard and fast rules. Be sure to factor in team dynamics, selling environments, and circumstances surrounding individual sales reps.
Have questions on incentive compensation plan components? Contact us for a free consultation to discuss plan design changes, challenges, and more.