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Updated Oct 23, 2023

How to Use Variable Pay in Your Small Business

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Max Freedman, Business Operations Insider and Senior Analyst

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

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 are known as the employee’s pay mix.

Key TakeawayKey takeaway
Variable pay is the extra money your sales agents earn atop their base salaries for hitting certain performance marks.

What are the different types of variable pay?

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

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  • Commissions: 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 also say a sales agent makes a $6,000 sale this pay cycle. You’ll then add 2% 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% 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% commission to 5% 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% 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% 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 slightly smaller amount – in this example, 2% 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 they have completed. Employees 70% toward their quota could earn a 1% commission, while employees fully at their quota could earn 2%.

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 older 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.

Bonuses are a better choice for larger, older, less sales-oriented teams. Commissions are percentage-based and better for newer, sales-heavy teams.

How do you implement a compensation plan?

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 three 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 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 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. Each of these roles should be tied to 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%, 2% and 3% 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 people 3% 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. 

Visit our reviews of the best payroll software to learn how these systems allow you to incorporate commission into paychecks. Read about how QuickBooks stacks up against Gusto Payroll.

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 and 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.

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Max Freedman, Business Operations Insider and Senior Analyst
Max Freedman has spent nearly a decade providing entrepreneurs and business operators with actionable advice they can use to launch and grow their businesses. Max has direct experience helping run a small business, performs hands-on reviews and has real-world experience with the categories he covers, such as accounting software and digital payroll solutions, as well as leading small business lenders and employee retirement providers. Max has written hundreds of articles for Business News Daily on a range of valuable topics, including small business funding, time and attendance, marketing and human resources.
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