How to Use Variable Pay in Your Small Business

What is variable pay?

Variable pay comprises extra wages that you pay to sales employees when they hit certain performance marks or make more sales. For example, if your sales agents earn a certain amount of extra pay every time they make a sale, these additional wages are variable pay. 

The word “variable” reflects the fact that sales employees rarely, if ever, earn the same amount of this pay per payroll cycle. Conversely, base salaries are constant and don’t vary between pay cycles. Together, an employee’s base salary and variable pay make up what’s known as the employee’s pay mix.

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What are the different types of variable pay?

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

• Commissions: Many employers reward their sales agents with a percentage of the value of each sale they make, known as commission. For example, let’s say your sales agents earn a 2 percent commission on all their sales. Let’s also say a sales agent makes a $6,000 sale this pay cycle. You’ll then add 2 percent of $6,000, or $120, to their next paycheck. [Related: How to Print Paychecks]
  
• Bonuses: Where commissions vary by value of a sale, bonuses can be independent of sales. Sure, you’ll probably give your highest-performing salespeople larger bonuses than your lowest-performing agents, but the amounts you give aren’t necessarily tied to sales values. Instead, bonuses are single-installment payments on which individual sales have only an indirect impact. [Related: Guide to Paying Holiday Bonuses]
  
• MBOs: When you set MBOs for your employees, you assign them goals to hit by a certain deadline. You can offer financial incentives to encourage your team to achieve these goals on time. When you do so, 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. Tiered commission structure

In a tiered commission structure, the percentage of variable pay a salesperson earns on each sale increases as their total sales value increases. For example, let’s say your agents currently earn a 3 percent commission on all sales. That’s a great start for a highly motivating commission program, but tiering it can be even more effective. Increasing this 3 percent commission to 5 percent after $200,000 in total sales can further incentivize your sales team.

2. Revenue commission structure

Revenue commission structures are what you probably think of when you think of commissions. This structure simply describes flat-rate commissions for each and every sale — for example, the aforementioned 2 percent commission on a $6,000 sale. It’s the easiest commission structure to implement and track, making it a great choice for smaller or newer sales teams.

3. Draw-against commission structure

Draw-against commission structures result in extra wages that are somewhat more predictable than other forms of variable pay. A draw-against amount describes extra wages that you pay to your sales agents even if they make no sales. You can also deduct that amount from future revenue commission payments. It’s a good commission structure choice for new reps or during periods of economic uncertainty.

4. Gross margin commission structure

Gross margin commission structures function almost identically to revenue commission structures. However, under this structure, you’ll calculate commissions based on the gross profit of a sale rather than its revenue. 

Let’s look at how this structure would affect the aforementioned 2 percent commission on a $6,000 sale. If the expenses associated with that sale were $500, the sale profit would be $5,500. You’d then calculate commission based on this reduced amount — in this example, 2 percent of $5,500, or $110. Gross margin structures may be preferable if you’re looking to both motivate your team and maximize your profits.

5. Multiplier commission structure

A multiplier commission structure combines the key features of tiered and revenue structures into a more complex approach. This combined structure can aid you in tracking and building your sales pipeline. You’ll calculate each salesperson’s commission based on the percentage of their sales quota completed. Employees 70 percent toward their quota could earn a 1 percent commission, while employees fully at their quota could earn 2 percent.

6. Commission-only structure

Under a commission-only structure, a salesperson receives only variable pay and no base salary. The removal of base salaries from the pay mix can motivate salespeople, but they may experience greater levels of stress when they don’t have a salary onto which they can fall back. They may also need to work too much or too hard, potentially leading to burnout.

What’s the difference between a bonus and a commission?

Since commissions are a percentage of a salesperson’s total sales, they theoretically have no cap. In contrast, bonuses are flat-rate payments given to salespeople who achieve certain goals. This flat rate ensures payments don’t exceed a certain amount and can help you motivate your employees without cutting too deeply into your profits. You can also set aside a bonus pool and give a percentage of the typical bonus to employees who partially complete a goal. 

Given these distinctions, bonuses may be better for larger or more veteran sales teams. They’re also great for the people on your sales team who don’t directly make sales. Commissions may be better for newer teams primarily composed of employees who generate leads, make sales and interact with customers.

How do you implement variable pay?

Once you know whether a commission, bonus or MBO variable pay plan best suits your small business, you’ll need to go about implementing it. Doing so is typically an easy process, but it requires some tact and care to set up equitably. There are four key things you should keep in mind as you implement your plan.

1. Tie incentives to what your sales agents can control.

Let’s say your sales team interacts directly with customers. In that case, a commission structure might be easy to set up: You’ll just multiply each agent’s total sales by your commission rate. 

However, let’s say your team mostly makes business-to-business (B2B) sales, but your company also makes business-to-consumer (B2C) sales that mostly result from effective storefront placements. In that case, tying commissions to consumer purchases may fail to incentivize your team. Instead, tie your commissions to the B2B service of selling B2C products in bulk to retailers for resale. This way, you give your sales team a fair shot at earning variable pay.

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

A team that performs poorly might still have one or two star players. You should reward these agents with variable pay of their own instead of tying their commissions and bonuses to the team’s overall performance. 

3. Give employees with more direct sales influence greater variable pay.

Let’s say your sales team consists of employees who each handle one of the following: lead generation, early calls with prospects and deal closing. Each of these parts of the sales cycle has a different influence on the sale. Lead generation is less directly tied to sales than early calls, which in turn have less impact than closing conversations. For each role, your company should tie variable pay that reflects these distinctions.

For example, let’s say a $10,000 sale involved three people. One person generated the lead, one person initially reached out and one account executive ultimately sealed the deal. You could pay each of these people 1 percent, 2 percent and 3 percent commissions, respectively. That rate comes to $100, $200 and $300, or $600 total. That’s less than the $900 that would come from paying all three individuals 3 percent commissions.

4. Use payroll software. 

The more sales your team makes, the harder it can be to track sales and commissions for each employee. Payroll software can minimize these errors while streamlining your commission calculations and payments. 

The best payroll software for managing variable pay

Distributing variable pay can be a bit challenging without the right resources. To help, we’ve highlighted some of the best payroll services that can handle all the complexities of variable compensation.

• OnPay: With OnPay, you can easily add commissions and bonuses to employee pay, and OnPay will automatically calculate those payments and incorporate them into your payroll. OnPay also offers unlimited payroll runs, robust payroll tax management and seamless integration with popular accounting programs. To learn more about this software’s many capabilities, check out our OnPay payroll software review.
• Paychex: This payroll software excels at handling variable pay structures, making it an ideal choice for managing commissions, bonuses and other complex compensation models. With customizable dashboards and comprehensive HR services, Paychex simplifies all aspects of payroll management. It also streamlines tax filings, ensuring compliance and reducing your administrative workload. Discover how this software can improve your business’s payroll and operations in our Paychex payroll software review.
• Gusto: This software’s interface is a breeze to navigate, adding another benefit on top of its payroll processing capabilities. When it’s time to run payroll, you can enter any variable pay structures, such as commissions and bonuses. Gusto handles the rest and ensures seamless payment processing. To dive into this software’s other features and benefits, check out our Gusto payroll software review. If you want to learn how this software stacks up to another comprehensive payroll service, check out our QuickBooks vs. Gusto comparison.
• QuickBooks: As one of the most popular choices for direct deposit payments, QuickBooks also includes multiple options for adding variable pay. You can run a separate bonus-only payroll or add the variable pay to regular paychecks. See what else QuickBooks has to offer in our Intuit QuickBooks payroll software review. 

What are the benefits of implementing a variable pay structure?

Variable pay structures incentivize your employees to put in more work to make more sales, but that’s not the only reason they are valuable.

When you offer variable pay, you give yourself a competitive advantage against other companies recruiting sales agents. This advantage can help you when you’re looking to hire as well as when you already have a robust team. Your team members may be less likely to leave when their pay mix exceeds what they could find elsewhere.

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

Incentives that maximize performance and growth

With the different options available, you can find the variable pay structure that best fits your team dynamics and business size. Offering a mix of base salaries and additional incentives creates a strong compensation package that makes your company more attractive to prospective hires. It also motivates existing team members to achieve their goals and contribute to your business’s success. This way, you’re making a strategic move toward enhancing employee performance while simultaneously driving business growth.

Shayna Waltower contributed to the reporting and writing in this article.