Salary vs Commission: Which is the Right Compensation Model for Your Sales Engine?

One is a marathon. The other is a sprint. To win the race though, companies need to hit the hidden middle track.

Salaries and commissions are the two major ways an organization compensates its sales workers. There are other ways too - such as benefits, bonus, stock options, allowances and merit pay - but these two are the most common. And often, the topic of animated boardroom and watercooler debates. The topic of the debate is simple: “Which one should I go for?”

Given that sales are the main directly revenue generating activity of a business, it’s easy to see why the question warrants careful consideration, or why nearly everyone has a strong opinion on the subject.

Every business wants to have the best sales hands-on board and knows it must design a compensation framework that can successfully attract and retain them. To crack the riddle, though, one needs to have the fundamentals clear, so let’s begin there.  

Salary vs commission: understanding the difference

What is salary?

A salary is an agreed upon, fixed annual total amount paid consistently to an employee irrespective of the number of hours put in at work. While the calculation is not done per hour (that would, technically, be called wages), a minimum amount of time per week is usually expected.

Most salary payouts happen on a monthly basis, though there are employees who get paid quarterly, bi-monthly, fortnightly or weekly, too. The frequency of payment depends on the employment contract. Salaries can evolve over time: A promotion or discretionary management decision may increase or decrease it.

A salary structure constitutes five chief components:

• A fixed part that’s referred to as a base salary.
• A variable part that’s essentially performance-based pay and can be an incentive, bonus or commission.
• Benefits such as insurance, vacations, wellness programs, paid time off, professional development opportunities and retirement plans often supplement a salary. Benefits tend t be fixed vis-a-vis a restimulated period of time, after which they may change.      
• Allowances for specific expenses like dearness, house rent, transportation, conveyance, education, housing, tiffin or other special allowances. Like benefits, they remain fixed for a certain pre-designated timespan.   
• Deductions such as taxes or provident fund contributions that are withheld from the employee’s salary.

A company’s salary structure must match certain stipulations and mandates such as tax regulations, industry benchmarks, labor laws and so on.

Deductions and one-off adjustments aside, employers cannot tamper with the amount of a salary - regardless of the number of hours spent on the job, the quality of work, overall organizational performance, business climate downturns, etc. There are exceptions to this of course, such as misconduct, health and emergencies that are usually explicitly mentioned in the employment policy.

To ensure a more uniform or predictable level of output, some employers establish performance standards for certain types of salaried jobs. Meeting them may translate into rewards - financial or otherwise – that are meted out quarterly or annually.

The concept of a salary is closely linked to overtime pay. Salaried employees who are Non-exempt (a statutory term) must be paid for putting in labor beyond a certain pre-stipulated number of hours.

An Exempt employee does not earn overtime, but is usually compensated with a variety of incentives, benefits and allowances as briefly discussed earlier. These are all integrated within a predictable pay model and figure that’s decided basis nature of work, market trends and company policies.

Salary: the legs, to run

A salary marks a holistic approach to compensation. It addresses issues that go beyond simply money - such as job stability, social esteem, job satisfaction, cost of living, work life balance, professional growth, long term commitment and others.

A salaried compensation mode is good for jobs that have high levels of responsibility and decision-making, require specialized skills and education, or where projects and client cycles are long.

This kind of fixed - and usually competitive to high – pay component is the preferred and standard compensation mechanism in professions like engineering, finance, accounting, teaching, nursing, management, administration, research, law, consulting, state, government level roles and high-level corporate positions.

Pros of a salary model

• A salary lets employees focus on work – and delivery quality consistently - without having to stress about meeting basis living costs.
• Employers are assured of a steady quality of output every month. Variance and interruptions are kept at bay.
• Employees in salary mode tend to be motivated intrinsically. They have greater job satisfaction, may be more attached to project outcomes, or be open to learning, upskilling and exploring new horizons.
• Loyalty to organization, and commitment towards contributing to overall organizational success, can be relatively higher in salaried employees (compared to those who work for a commission).
• Without unhealthy competition and tendency to undercut one another, work culture tends to be positive and collaborative.
• A fixed base amount also helps simplify budgeting, payroll accounting and admin operations.
• The organization is able to make better planning, manpower and forecasting decisions.

Cons of a salary model

• The security and comfort of salary-based roles may come at the expense of competitiveness and blunt innovation appetite. Some theories say that the absence of direct incentive for productivity robs a worker of involvement and drive.
• A salary, when interpreted as a ‘cap’ on income, may be demotivating for employees who consistently step beyond the call of duty, give more at work, and feel they deserve more.
• Some employers may frown on the fact that their employees are paid irrespective of work quality or project completion status.
• Employees may be on leave when it’s time for an important delivery, affecting overall business performance.
• Set in predictable ways, salary driven employees and organizations may lack the agility to adapt to change, uncertainty or disruption.

What is a commission?

A commission is a type of variable compensation that’s mapped to performance and results. It is earned as a percentage or as a fixed sum on a deal generated, a sale made, or a milestone crossed. In that sense, commission earnings are always a function of organizational earnings.

Companies give away commissions against services rendered in the capacity of an employee, broker, agent, associate or intermediary. It may be disbursed monthly, quarterly or yearly.

Like any income, commission income is taxable, although it may be governed by specific laws.

From capsules to cars, practically everything can be sold on commission. Retail, real estate, insurance, automobile dealerships, luxury items (such as beauty products), direct selling companies like Amway, manufacturing, wholesale, travel, pharmaceuticals, wellness products, medical devices, software brands (such as Oracle and Salesforce, for instance), affiliate marketing and consumer packaged goods are some niches and sectors that have traditionally used the commission model aggressively.

Different businesses use different formulas to calculate their commission structures based on parameters that make sense to their balance sheets.

A commission can be capped or uncapped: The former sets a limit to the total amount someone can earn, while the latter – more in tune with the spirit of the pay model - lets one earn as much as they can sell.

During budgeting, companies running on a commission pay model leverage sales forecasting methods to calculate cost to company: Payouts for high performance are met from actual revenue earned.

Commission earnings by sales reps may be linked to claw back clauses, which guards the company against fraudulent practices and potential client defaults.

To unlock the full power of their commission compensation model, companies should ensure adequate support to their salespeople – such as upskilling and training programs, reimburses for work related expenses and proper marketing and advertising budgets.

Commission: the wings, to soar

As the simplest, most fundamental manifestation of a reward, a commission lets one earn dough on every dime. With its direct reward mechanism and quick gratification tilt, a commission is meant to drive folks to sell more and more.

While designing their commission model, companies aim to hit the sweet spot: Not too low to be unattractive, not too high to be unattainable.

For sales reps, earnings from commission can fluctuate drastically based on performance, marketing conditions, user behavior trends and company policy (which determines the stage at which the payout is made: When the deal is closed, or when the financial transaction is completed).

Commission based roles act as excellent motivators for high performance and self-driven salespeople who relish the idea of earning more by working more. It is particularly rewarding for confident professionals with well-honed skills, deep exposure to the domain and well nurtured, hi-value networks.  

Commissions come in various shapes and avatars. Some common ones are:

• Straight mode, where a predetermined cut is the only pay the sales personnel receives.
• Mixed mode, where the commission is added on top of a fixed base salary. Given the additional layer of predictable income, this is a highly popular and very common sales compensation mode.
• Bonus boost mode, where high performers are rewarded with an additional amount for outstanding performance at an individual or organizational level.     
• Variable mode, where the commission amount is directly tied to the monetary volume of the transaction. If the latter increases or decreases, so does the former.
• Revenue mode, a straightforward and popular format where sales members receive a cut every time a product or service is sold.
• Gross margin mode, where sales teams are eligible to a commission only from the profit the company makes from a sale.
• Tiered mode, where salespeople automatically qualify for higher commission rates after they cross specific, pre-ascertained mileposts like number of deals closed and revenue brought into the company coffers.
• Territory volume mode, where commissions are calculated basis the aggregate volume of sales or revenue generated in a specific territory – it is equitably distributed amongst all salespeople who are active in that territory.
• Multiplier mode, a flexible, popular but potentially complex mode where the reward element is amplified by certain indirect performance parameters related to target setting and deal closure.
• Residual commission, where a commission continues to accrue to the concerned salesperson for the entire duration of the customer’s association with the company – thereby incentivizing deeper customer relationships and long-term client retention.
• Flat rate mode, where sales folks earn a fixed amount on every product or service sold.
• Relative sales mode, where the commission is generated as a percentage on achieved quota, instead of revenue.
• Split mode, where commission on a single deal is distributed amongst multiple sales reps or departments. 
• Draw against commission, a practice where sales reps can ‘borrow’ (draw) a certain amount of their potential compensation in advance to meet expenses regardless of current deal status – the amount is adjusted once the commission becomes officially due.

Pros of a commission model

• Commissions symbolize the promise of unlimited earning potential for sales professionals, with the magnitude of the spoils limited only by the individual’s imagination and effort.
• Commissions offer greater autonomy and control over career and life - one can create and adjust one’s work schedule as per need and work only when there’s hunger. 
• Provision of an additional commission component can help salary-based employees supplement their income flexibly.
• The incentive angle nudges ambitious folks - in both salary and commission formats - to learn continuously and evolve in new directions both professionally and personally. 
• Commissions help employers reduce their fixed costs.
• Since commissions need to be paid only on the basis of positive outcomes, the risk to the business is less.  
• The commissions model recognizes value delivery, not number of days or hours worked. With such clear and objective success metrics, bias and subjectivity is effectively eliminated from the system.
• Driven by the carrot of higher earnings, the commission framework may inspire sales reps to prioritize building genuine relationships, customer satisfaction and long-term value for the organization.
• The commission route can be a win-win for both worker and employer. With skin-in-the-game, high performers end up not just maxing their earning potential, but also jet-Fuelling the brand’s journey. This is particularly advantageous for companies with short sales cycles, big ticket sizes or steep growth curves, or for teams looking to big-bang their way out of a lean phase.

Cons of a commission model

• With their unidimensional over-reliance on performance and the absence of a stable income safety net, commission-based roles can be stressful. For individuals, that can mean burnout. For organizations, that can translate into revenue slumps or employee churn.  
• The commission system Favours individual brilliance over collaboration and teamwork. That can encourage a cut-throat culture where aggressive performers corner all the glory, alienating the rest and creating bad blood within the system.
• Commissions can encourage unethical practices in members who prioritize quick money over brand and customer considerations.
• Overly aggressive approaches and high-pressure tactics, sometimes indulged in by folks running on commission pay, can drive prospects away and give the business a bad rap.
• People who rely on commission may take a blinkered, short-term approach to the game without attachment with the company’s long-term interests. They may only be interested in making money, instead of showcasing the company’s best face to the world.
• For companies, especially for agile startups in fast-track mode, cumbersome commission calculations can be frustratingly time consuming.

Strengthen the structure of your commission incentive plans and motivate sales teams and channel partners towards outstanding performances with xoxoday Compass – the AI powered productivity upscaling platform trusted by Coca-Cola, Mercedes-Benz and other organizations globally. 

Salary vs commission: which one should you go for?

Sales folks who prefer order and structure in life, are risk-averse, are incentivized by the reliability ingrained in a steady paycheck and are uncomfortable with fluctuation and ambiguity gravitate towards a salary format.

Commissions, on the other hand, are perfect for entrepreneurially inclined individuals who have an appetite for risk, relish competitive environments and are uber-confident of their sales super-powers.

Both the approaches have their merits and demerits. To harness the power of both worlds, a company should balance the two extremes.

It must place equal weightage on deal closure along with revenue generation on one hand, and stable results along with a sensitive and supportive culture on the other.

Combining a base salary with an attractive commission model to prioritize both organizational goals and worker interests could be the ideal path forward.