Like many of you, my fourth quarter included a lot of sales compensation design, review and revision. Given the business environment and the forecasting difficulties that many organizations are facing, some are still working - even now - to get sales incentive plans nailed down in final form. With this in mind, I thought it might be helpful to dedicate a post to the basics of sales commission calculation.
No, don't run away yet - I promise you it is clear, straightforward and relatively painless.
At its heart, sales commission calculation rests on a simple formula:
(Target Incentive Amount/Target Volume) x 100 = Commission Rate
Target incentive amount represents the amount of incentive (commission) that the sales person should receive if they achieve target sales volume. Target sales volume (which may also be expressed as a quota) is the sales production goal for the sales person, in revenue dollars, gross margin dollars, units sold - whatever metric is determined to best fit the sales job's focus and responsibilities. (Note that I am leaving the design questions aside here - although they are clearly critical - in order to focus solely on commission calculation.)
Let's say that a particular sales job has a target incentive amount of $40,000 and a target volume of $2,000,000. In other words, we have set a target or quota of $2,000,000 for the position, and we intend to pay $40,000 in commissions if the sales person achieves that target. The commission rate necessary to accomplish our objectives is calculated by applying our simple formula, as illustrated below.
($40,000/$2,000,000) x 100 = 2% Commission Rate
That's it. What you have in this 2% is a classic flat commission rate, which pays out at the same rate for every sale. On its own, a solid approach for many sales jobs. There are also multi-stepped commission rates, progressive or accelerated rates in order to provide greater upside for outstanding performance, regressive or decelerated rates in order to "tamp down" earnings beyond a certain point (typically an alternative to any kind of "cap") - even "matrixed" commission rates as a way of addressing competing sales objectives. The list is probably endless.
But I thought this basic formula might be a good place to begin, and to help my HR colleagues start gaining a solid footing in the sales incentive arena. Happy calculating all!
Image: Creative Commons Photo "Studying till the Sun Goes Down" by Jekert Gwapo
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