Understanding Sales Bonuses and Commissions: A Complete Guide
Compensation strategies are important motivators for sales teams and help make their performance align with the goals of any company. Out of various compensation methods, two have gained wide acceptance: bonus and commission. Though both seem similar, the basics of these pay structures differ in the way performance is rewarded.
This guide will outline the difference between bonuses and commissions, delineate when to use each, and pursue their relative advantages and disadvantages.
What constitutes a bonus?
A bonus is the remittance granted by the employer to the employee as a reward for the achievement of certain goals or significant milestones. As a rule, it is paid based on the results of work either by an individual or by a team or company as a whole, and differs according to a person’s position in a company or workplace and his needs. These payments are decided as a fixed percentage of an employee’s salary or a certain fixed flat amount.
Bonuses are not directly tied into sales transactions, which make them the most flexible among rewarding broader measures of performance. For instance, they may also be paid based on annual revenue achieved, delivery of major projects, or attainment of certain strategic intents. Bonuses also are commonly tied directly to strong performances for a given period or are incentives that encourage individuals to exceed their set sales levels.
Types of Rewards
- Performance-based Bonus: A reward given to the employee when he or she meets a certain criterion—such as sales quota or meeting project deadlines.
- Year-end Bonus: Given at the closing of the fiscal year, normally to those employees delivering valuable service to the company altogether.
- Spot Bonus: A spontaneous incentive to reward outstanding work or achievements during an employee’s given period.
- Retention Bonus: Incentives given to maintain the services of employees during significant organizational change or upon completion of a critical project.
What is Commission?
Commission is a variable pay clearly attached to sales output. In contrast to a bonus that can be steered, commissions are likely a fixed amount of revenue that the sale of the company’s products or services generates. The mode of commissioning drives employees to sell because their income is positively related to their sales level. Employees on commission find incentives to close deals, increase revenues, and achieve or overachieve sales targets.
Commissions often appear in industries like real estate and insurance and in retail—where the employee is dealing directly with the customer who is purchasing a product or a service. In a pure commission compensation model, the revenues of the company and the earnings of the salesperson are appropriately aligned: if sales go up, so do commissions.
Types of Commissions:
- Base-Rate Commission: Salespeople receive a fixed percentage for each sale, irrespective of the product or the size of the sale.
- Tiered Commission: The higher the sales target accomplished, the greater percentage or higher level of commission, promoting the overachievement of goals.
- Residual Commission: A sales representative earns a residual commission based on repeat customers or subscription-type accounts.
- Draw Against Commission: Sales representatives receive an advance on future commissions, leveling out compensation during a low-sales period.
When to Use Bonuses vs. Commissions
Whether you use a bonus-based or commission-based structure will depend not only on your goals but also your sales processes and the nature of the products or services you sell. In every business scenario, there is a unique advantage to either method.
When to Use Bonuses:
- Going Beyond Sales Performance: Bonuses may work to reward employees for their achievements for the organization outside the sales campaigns, where other employees may include project management, product development, or accounts servicing.
- Team or Company Goals: Bonuses are more applicable when performance is measured against the team or company level because it aligns more easily with overall organizational objectives.
- Flexible Rewards: The company has the flexibility to reward a broad spectrum of performance metrics, including customer satisfaction, product innovation, or operational efficiency.
When to Use Commissions:
- Direct Sales Positions: A commission structure would be very conducive for directing sales teams that are responsible for generating revenue, as it encourages them to close deals and hit targets.
- High-Transaction Value Sales: Big amounts involved in commissions are the best financial motivator for sales representatives to close large deals.
- Sales Volume Focus: Remuneration of salespeople on a commission basis develops an incentive for driving as much revenue as possible, especially in high-volume/low-margin business models.
Main Differences Between Bonuses and Commissions
Though both may be regarded as performance-related compensation, key differences exist between bonuses and commissions:
- Direct Link to Sales: Commissions are related to the sale and the money generated from that sale. Bonuses are somewhat independent of the money earned.
- Timing: Commissions usually come regularly based on sales activity, while bonuses are typically annual or based on achieving specific milestones.
- Consistency: Bonuses are fixed-rate supplementary compensation provided goals are achieved. Commissions are variable income tied directly to sales results.
Combining Bonuses and Commissions
Another model is a bonus-commission type: a combination of both bonus and commission. This combination helps an organization reward short-term sales through commissions, while long-term success is rewarded by bonuses. For example, salespeople can be rewarded with a commission for each deal closed and also receive an annual bonus if overall sales targets are met or surpassed, or if they contribute to other company objectives.
This hybrid model aligns short-term revenue generation with long-term strategic objectives. Flexibility from this perspective allows a company to design a more comprehensive sales compensation plan, one that drives individual and team performance effectively.
Conclusion
Understanding the differences between bonuses and commissions allows for the creation of an appropriate sales compensation strategy that effectively motivates your team to achieve business goals. While commissions are ideal for driving direct sales and rewarding individual performance, broader contributions to company success can be rewarded with bonuses.
In many cases, a hybrid model combining both bonuses and commissions can strike a balance between short-term sales and long-term success. Ultimately, the best compensation plan is the one tailored to your business needs, sales model, and strategic goals. Thoughtful planning and execution will result in a compensation strategy that drives success for both the company and its employees.