How to Use Variable Pay in Your Small Business

  • Variable pay includes bonuses, commissions or management by objectives (MBO) that encourage your sales agents to make more sales.
  • You can use six different commission structures to determine your variable pay.
  • In addition to incentivizing employees, variable pay is useful for establishing your competitive advantage in hiring and meeting your revenue goals.
  • This article is for business owners who are interested in adding variable pay to their sales agents., Compensation.

Employees of all stripes often receive bonuses around vacation time. This extra money can be a worthwhile gesture during a period characterized by generosity and gratitude. It works a little differently with sales employees, who often earn bonuses or other types of variable pay at several points throughout the year. Read on to learn how employers can use variable pay to incentivize their sales teams and set their own pay rates initially.

What is Variable Pay?

Variable pay includes additional pay that you pay to sales employees when they hit certain performance points or make more sales. For example, if your sales agents earn a certain amount of additional pay each time they make a sale, these additional salaries are variable pay.

The term “variable” refers to the fact that sales employees rarely, if ever, earn the same amount of this salary per payroll cycle. In contrast, base pay is constant and does not vary between pay cycles. Together, an employee's base pay and variable pay are known as the employee's salary mix.

significant achievementsImportant achievements: Variable pay is the additional money that your sales agents earn on top of their basic pay for securing a certain number of performance points.

What are the Different Types of Variable Pay?

Variable pay falls into three categories: commissions, bonuses and management by objectives (MBO).

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  • Commission: Many employers reward their sales agents with a percentage of the value of each sale they make. This structure is known as commission. For example, let's say your sales agents earn a 2% commission on all their sales. Let's say a sales agent makes $6,000 in sales in this pay cycle. You would then add 2% of the $6,000, or $120, to their next paycheck. [Related: How to Print Paychecks]
  • Bonus: Where the commission varies from the value of the sale, the bonus may be independent of the sale. Sure, you'll probably give your best-performing salespeople a bigger bonus than your lowest-performing agents, but the amounts you pay aren't tied to sales prices. Instead, bonuses are single-installment payments that have only an indirect effect of personal selling. [Related: Guide to Paying Holiday Bonuses]
  • MBO: When you set up an MBO for your employees, you set them goals by a certain time frame. You can provide financial incentives to encourage your team to achieve these goals on time. When you do this, you add another type of variable pay to your payroll.

What are the Different Types of Sales Commission Structures?

Should you decide on commissions as your primary form of variable pay, you can choose from several sales commission structures.

1. Level Commission Structure

In a tiered commission structure, the percentage of variable pay earned by a seller on each sale increases as their total sales price increases. For example, let's say your agents currently earn a 3% commission on all sales. This is a great start to a highly persuasive commission program, but it can be made even more effective. After $200,000 in total sales, increasing this 3% commission to 5% can further encourage your sales team.

2. Revenue Commission Structure

When you think of commissions you probably think of the revenue commission structure. This structure simply describes the flat-rate commission for each sale – for example, the above 2% commission on a sale of $6,000. It has the easiest commission structure to implement and track, making it a great option for small or new sales teams.

3. Draw Against Commission Structure

The draw-against additional wages result against commission structures that are somewhat more predictable than other forms of variable pay. The draw-against amount describes the additional wages you pay to your sales agents even if they don't make any sales. You can also deduct that amount from future revenue commission payments. It is a good commission structure option for new reps or during periods of economic uncertainty.

4. Gross Margin Commission Structure

The gross margin commission structure functions almost identically to revenue commission structures. However, under this structure, you would calculate the commission based on the gross profit of the sale, not its income.

Let's see how this structure will affect the above 2% commission on sales of $6,000. If the expenses associated with that sale were $500, the sales profit would be $5,500. You would then calculate the commission based on this slightly smaller amount – in this example, 2% of $5,500, or $110. Gross margin structures may be better if you are looking to motivate your team and maximize your profits.

5. Multiplier Commission Structure

A multiplier commission structure combines the key features of tier and revenue structures in a more complex approach. This combined structure can help you track and build your sales pipeline. You will calculate each seller's commission based on the percentage of the sales quota they have fulfilled. Employees up to 70% of their quota can earn 1% commission, while employees solely on their quota can earn 2%.

6. Commission-Only Structure

Under a commission-only structure, a salesperson receives only variable pay and no base salary. Removing basic pay from the salary mix can motivate salespeople, but they can experience greater levels of stress when they don't have a salary, which they can hold back on. They may also need to be pushed too hard or too hard, which can potentially lead to irritation.

What is the difference between bonus and commission?

Since commissions are a percentage of a seller's total sales, they theoretically have no limit. In contrast, bonuses are flat-rate payments made to salespeople who achieve certain goals. This flat rate ensures that payments do not exceed a certain amount and can help you motivate your employees without cutting into your profits too much. You can also set aside a bonus pool and give a percentage of a specific bonus to employees who partially meet a goal.

Given these differences, bonuses may be better for larger or older sales teams. They're also great for those on your sales team who don't do direct sales. Commissions may be better for new teams composed primarily of employees who generate leads, drive sales and interact with customers.

TipTip: Bonuses are a better option for larger, older, less sales-oriented teams. Commissions are percentage-based and better for new, sales-heavy teams.

How do you implement a compensation plan?

Once you know whether a commission, bonus or MBO variable pay plan is the best fit for your small business, you need to go about implementing it. Doing so is generally an easy process, but it does require some skill and care to install evenly. There are three main things you should keep in mind while implementing your plan.

1. Your sales agent can control the incentives.

Let's say your sales team interacts directly with customers. In that case, setting up a commission structure can be easy: You'll multiply each agent's total sales by your commission rate.

However, let's say your team does mostly business-to-business (B2B) sales, but your company also does business-to-consumer (B2C) sales, mostly as a result of effective storefront placement. In that case, tying commissions to consumer purchases may fail to encourage your team. Instead, tie your commission to the B2B service of selling B2C products in bulk to retailers for resale. This way, you give your sales team a fair chance of earning variable pay.

2. Offer variable pay based on the performance of the employee (not the team).

A poorly performing team may have one or two star players. You should reward these agents with their own variable pay rather than linking their commissions and bonuses to team performance.

3. Give more variable pay to employees with more direct sales impact.

Let's say your sales team includes employees who handle each of the following: lead generation, initial calls with prospects, and deal closing. Each of these parts of the sales cycle has a different effect on sales. Lead generation is less directly tied to sales than an initial call, which in turn has less impact than closing a conversation. Each of these roles should be linked to variable pay that reflects these distinctions.

For example, let's say three people were involved in a $10,000 sale. One person generated the lead, one person initially reached out and one account executive eventually sealed the deal. You can pay 1%, 2% and 3% commission to each of these individuals respectively. This rate comes to $100, $200, and $300, or a total of $600. This is less than the $900 that would come from paying 3% commission to all three people.

4. Use payroll software.

The more sales your team makes, the more difficult it can be to track sales and commissions for each employee. Payroll software can reduce these errors while streamlining the calculation and payment of your commission.

TipTip: Visit our reviews of the best payroll software to learn how these systems allow you to include commissions in your paycheck. Read our Intuit QuickBooks Payroll review for a specific example, or see how Quickbooks stacks up against Gusto Payroll.

What are the benefits of implementing a variable pay structure?

Variable pay structures encourage your employees to work more to make more sales, but that's not the only reason they're valuable.

When you offer variable pay, you give yourself a competitive advantage over other companies that recruit sales agents. This advantage can help you when you are looking to get hired and when you already have a strong team. Your team members may be less likely to leave when their salary mix can be found elsewhere.

Variable pay can also shape how your team makes sales. If you want to propel your team in a certain direction, you can relate their variable pay to how well they achieve these goals. Variable pay shapes your ability to reach your revenue goals. A team that is performing to your goals is more likely to reach your ideal figure, making variable pay good for both your employees and you.

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