The Wacky World of Commissions

Commission is absolutely the most incredulous foolery in the business world!  It’s absurd, irrational and in more simple terms – lunacy.  Some plans are so complex that even the sales reps who are the recipients don’t understand them.  Others take banks of accountants to figure out.  Many are computed manually because due to the outrageous nature of some of these plans, no computer software program can support them.  Most plans are very “custom” and change frequently because of all of the above reasons.  Yet, plan after plan the insanity continues.

Why you might ask are commissions so difficult?  What possesses intelligent business leaders to design such a bizarre “monster” of algorithms?  Who even designs these intricate bodies of work that drive deep into the soul of exasperation and frustration for everyone who has even remotely experienced the dread of calculating sales commissions?  Why?  Why?  Why?  Well, no one really knows.

The truth of the matter is that this is how it has always been.  Seems the business leaders want to make sure that sales talent is well compensated so that they gain value and stick around.  However, the minute sales talent starts getting too much of the pie, the “plan” gets changed.  Next, only the low-hanging fruit hangs around because there is no way to make money, so the plan gets changed again to attract better sales talent.  The merry-go-round continues to revolve as people get on and off and the horses keep changing color.

Commissions are a delicate balance.  Business leaders walk along a very thin line that tips to represent profit or loss.  The best place on the line is an even keeled one where the company is making money and the people that help the company make money are receiving their fair share.

Sales people are motivated by winning business and thus making money for themselves.  Take heed though of the sales rep that does not understand that the business they bring in must be profitable for the company.  After all, a business is not a vehicle for the sales rep to line their pockets while the company struggles to support the newly won business in a profitable scenario.

Let’s look a little deeper.  The sales rep sells a deal that brings in $5,000.  Yay!  That $5,000 must get split in a number of ways.  First, what is the cost of goods (COGS)?  In other words, how much does the company have to spend in order to give the customer $5,000 worth of goods and/or services?  First, the product has to get manufactured so there is overhead for office space; marketing/ads; services to implement/install the product; equipment and services that employees need to get the job done; salaries for employees; benefits for employees (insurance, 401k, PTO, etc.); office supplies; utilities; etc.

Generally, commissions are based upon gross margin (revenue – costs) and usually precipitated by customer payment.  No pay then no commission.  That’s fair but how are all of these COGS calculated?  There are hard costs that are known and then there are estimates for everything else.  After commission is paid if those estimates are way off the company will end up for the worse after the sale.  Sometimes, it would have been better if the sale were never made.  Yikes! Lots to consider. Thus, complex commission plans.

It would be simple if commissions were a % of the gross margin and just paid after the sale was made.  But the world of sales is not simple.  What if the customer does not pay or pays half or the company has to give a refund?  If commission was paid it is a bit difficult to get the money back, especially if the sales rep is no longer with the company. Again, this is why there are so many rules because the scenarios are endless.

So, what is the solution to end the madness?  No one has ever come up with one.  However, to take commissions to a manageable level, make it as simple as you possibly can.  This will mean that sometimes you will win and sometimes you will lose because you will not be covering every possible scenario, just the basics.

For example, pay a % of gross margin once the customer pays.  Forget about how long the AR has been out there, never mind if a refund has to be given 6 months later, let’s not quibble about each penny in costs.  Come up with the best actual figures for costs or even better estimate what your average cost is (based upon historical data) and just use that % for cost every time.  Throw in a simple and discernable bonus plan based on annual sales and you are done.

Reducing the time it takes to calculate commissions will give you more timely information and allow your accounting staff to focus on more profitable and functional items that can add to your bottom-line.  This will prove to add value to the organization and to profits. Sales will be happier because they can figure out easily what their commission is and then they can focus on bringing in business.  Simplified commissions = happy people.