Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.
In this lesson, we'll define sales commission. We'll also discuss three types of sales commission: percent of sales, stair step and fixed amount. You'll also learn when to utilize each type.
What Is Sales Commission?
Jan won the lottery and is finally going to live a lifelong dream of opening a car dealership. She contracts with one of the largest car manufacturers, starts construction on the dealership and begins advertising for car salesmen. She has a few interviews with experienced car salesmen, and one of them asked her how she was going to pay commission. Jan's not familiar with salespeople jargon so she asked the interviewee, 'What is sales commission?' The interviewee said, 'Commission is money paid to a person based on how much they sell.' He goes on to tell her commission is paid in three ways: percent of sales, stair step and fixed amount.
Jan thanks him for the explanation and tells him she'll touch base as soon as she speaks with her accountant. Let's listen as Jan's accountant explains the three types of commission structures and learn when to utilize which type of commission structure.
Percent of Sales Structure
A commission sales structure utilizing the percent of sales structure uses a percent to calculate commission based on sales. For example, if Jan's salesperson sold a $50,000 car and Jan agreed to pay him one percent of the sales, the salesperson would make $500.
This structure works best when the product is a want, rather than a need. A need is essential to living, while a want is a desire. If you have a business where you must convince a customer to purchase a particular product or service, then a percent of sales structure encourages your employees to sell, because otherwise they do not get paid.
Another example for using the percent of sales structure is when there are other desired substitutes on the market. Let's say there are five different car manufacturers, and Jan has only contracted with one. Her salespeople need to convince the consumer that their manufacturer is better than the other four to encourage the sale. Now, let's look at a stair step commission structure.
Stair Step Structure
A stair step structure increases the commission percentage based on an increase in sales. For example, Jan might have a commission plan that says when sales reach $200,000, the commission percentage will increase to three percent. Let's look at an example. Bob sells $50,000 in cars the first week of January. The second week he has sales of $100,000. If Bob can sell just $50,000 more before the month ends, he'll receive $6,000 in commissions rather than $2,000 on a flat commission rate. The percentage will jump even higher if he can sell $300,000 and receive five percent of his total monthly sales, $15,000.
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Again, this structure is best utilized when the product or service is a want and there are many options. Additionally, the business must be extremely profitable to pay the extra commission. Now, let's look at a fixed commission structure.
Fixed Commission Structure
After Jan's accountant explains the percent of sales and stair step structures, he mentions another option, a fixed commission structure. A fixed commission structure pays the employee a certain amount for each sale. For example, Jan might say, 'For each car you sell, I'll pay you $350.' If each car is worth $50,000, the sales person would make $1,400 in commission for $200,000 worth of sales rather than $2,000 in the percent of sales example. If the salesperson sold $300,000, they would make $2,100 rather than $15,000 in the stair step structure example. Fixed commission sales are best when the product or service is a need or when there are not many substitutes.
Commission is money paid to a person based on how much they sell. There are three types of commission structures: percent of sales structure, stair step structure and fixed commission structure. Percent of sales method essentially uses a percentage to calculate commission based on sales. This structure is best utilized when the product or service is a want and there are other substitutes. Next is a stair step structure, which increases the commission percentage based on an increase in sales. This structure is best utilized when the product or service is a want and there are many substitutes. The business must be extremely profitable to pay the extra commission. Lastly, there is a fixed commission structure, which pays the employee a certain amount for each sale. This structure is best utilized when the consumer does not necessarily have to be pressured to buy and where there are few substitutes.
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