How Does Commission Work and What is It?

Performance-based pay, including commission payment, is a common part of many companies' compensation strategies, with 75% using it to boost performance and reward success. However, there is ongoing debate about the potential disadvantages of commission-based pay in the workplace.

Before we discuss the benefits and drawbacks, let's first explore how does commission work and what it is. This article also covers the rules of commission pay, explains how to calculate it, and answers common questions related to the topic.

What is a commission?

Commission is a payment type based on a percentage of the total sales or revenue generated. It's common in industries like real estate, sales, and insurance. So, how does commission work? It simply rewards employees for the sales they make, possibly motivating them to increase sales and meet targets since their pay depends on their job performance.

For example, a sales agent's commission on the sale price of a car is 3%. This means they get a percentage of the buyer's payment instead of a set salary. Furthermore, the standard salary-to-commission ratio is usually 60:40, but commission rates of 20%-30% are commonly seen as reasonable.

Use Compensation Planning Software to manage performance-based pay, such as bonuses and commissions, within your organization. The tool helps managers align rewards with performance ratings and individual contributions.

Who might get commission pay?

Aside from sales roles, jobs that offer commission pay include:

• Real estate agents: A real estate agent or buyer’s agent earns a variable commission based on the sale price of properties.

• Insurance agents: They get a commission payment for every policy sold.

• Stockbrokers: Their commission is based on the value of securities traded.

• Fundraisers: They earn commission on the funds they help raise.

• Travel agents: They receive commissions from airlines, hotels, and travel services.

• Freelance writers and editors: They may negotiate commissions based on the project's value.

• Artists and designers: They earn commissions when their work is sold through galleries or to clients.

• Entertainment professionals: Actors and musicians may receive a commission payment from merchandise sales or royalties.

• Sales representatives: This includes roles like car salespeople, retail associates, and telemarketers, all of whom often work with sales quotas.

• Financial advisors: They may earn a commission payment on investment products or services they sell to clients.

• Consultants: Depending on their field, consultants can negotiate commission-based rates for their services.

Whether you're managing sales reps, insurance agents, or those who can benefit from real estate commission, Compensation Planning Software ensures accurate pay in your pay structure. It automatically calculates pay after you import employee data. You can plan bonuses and long-term incentives alongside yearly salary planning or in a separate review cycle.

The rule of commission

According to the U.S. Department of Labor, a commission is money paid to an employee after completing a task, usually selling a certain amount of goods or services. It can be paid along with a salary or as the employee's only pay.

The Fair Labor Standards Act (FLSA) doesn't require employers to offer commission pay. However, if employees are paid on commission, they must still receive at least the federal minimum wage of $7.25 per hour.

Also, the FLSA requires overtime pay for employees working more than 40 hours a week, at a rate of 1.5 times their regular pay, including commissions. Some retail or service businesses may be exempt from this rule if they meet specific conditions.

Advantages and disadvantages of implementing commission pay

Commission pay has both benefits and drawbacks. A survey found that 44% of employees feel it improves job satisfaction, and 43% feel more engaged at work. However, some studies show that commission pay can also lead to overworking, higher stress, and lower job satisfaction, which might increase employee turnover.

Here are the other benefits and risks of being paid on commission payment:

Pros

• The direct link between sales and earnings can greatly increase employee motivation.

• Employees may work harder to close deals and boost sales, leading to higher productivity.

• Commission-based pay can attract top sales professionals who are confident in their skills.

• In some cases, commission pay can be cheaper than a fixed annual salary, especially for businesses with variable sales.

• Commission pay can be adjusted based on market conditions or individual performance.

Cons

• Employees might see changes in income, especially in many industries with seasonal sales or economic downturns.

• To meet more sales targets, many employees might resort to aggressive or unethical selling practices.

• Focusing on individual performance can sometimes reduce teamwork and cooperation.

• Setting the right commission percentage can be difficult, as it needs to match company goals and market standards.

Make sure you benefit from commission-based pay with Compensation Planning Software. It helps manage raises, bonuses, commissions, and long-term incentives fairly and effectively.

How is commission calculated?

Knowing how to calculate commission is important for ensuring fairness and clarity in compensation within an organization. Here's how to do it using the basic formula: Straight commission = (total sales) x (commission rate)

1. Find the total sales: Gather the sales figures for the period you're calculating commission payment for (daily, weekly, monthly, or annually).

2. Identify the commission rate: Find the agreed-upon commission rate, usually a percentage of total sales, as stated in your contract or agreement.

3. Calculate the commission: Multiply the total sales by the commission rate. For example, with $10,000 in sales and a 5% commission rate, the commission is $500.

Simplify commission calculations and avoid manual spreadsheets with Compensation Planning Software. It handles monthly and quarterly commissions easily and produces clear commission statements for better communication.

Note: Commission structures can vary widely. Some common variations include:

• Tiered commission: In this commission structure, the commission rate increases with higher sales. For example, an employee earns 5% on the first $10,000 in sales and 7% on sales above that, so $15,000 in sales would earn them $850.

• Draw against commission: The salesperson gets an advance on future commissions, which is subtracted from their earnings once they hit their sales goal. Example: A salesperson receives a $2,000 draw and earns $2,500 in commission, totaling $2,500 for the month.

• Base salary + commission payment: The salesperson earns a fixed salary plus commission payment. To give you a full understanding, here's an example: The salesperson with a $3,000 salary and 4% commission on $20,000 in sales makes $3,800.

• Commission on gross profit: Commission payment is based on the profit from the sale, not the total sales price. For example, if a salesperson earns 10% on the $2,000 profit from a $5,000 sale, they will earn $200.

FAQs

Now that you already know how does commission work and how it is calculated, let's answer some common questions about it.

What does 10 percent commission mean?

A 10% commission means that a salesperson earns 10% of the total sales they make. For example, if a salesperson sells a product for $100 and their commission rate is 10%, they will earn $10 in commission.

What is 5% commission on $10000?

A 5% commission on $10,000 equals $500. To find this, multiply $10,000 by the 5% commission rate (0.05): $10,000 x 0.05 = $500.

How to survive a commission-based job?

To succeed in a commission-based job, set realistic sales goals, keep improving your sales skills, build strong client relationships, and stay positive. Prepare for income fluctuations with a financial plan and stay motivated to hit your sales targets.

Is commission better than salary?

It depends. Commission payment can lead to higher earnings for top performers, but it also means less stable income. If you prefer steady pay, a salary might be better. Industry, company rules, and your sales skills also affect which option works best.

If you’re using commission-based pay, make sure to plan effectively. Compensation Planning Software simplifies commission planning for hundreds of employees, integrating direct compensation, sales compensation, and total rewards into one system.