Sales Commissions Law and Legal Definition
Paying a sales commission is a way of compensating salespeople. Under so-called "straight" commission arrangements, the salesperson receives an agreed-upon percentage of the revenue brought in by a sale that he or she makes. Companies use commission arrangements to sell products as well as services. But some employers choose to pay salespeople a straight salary instead. The most common form of sales compensation—other than in retail sales—is to combine a salary with commissions.
The chief advantage cited for straight commission is that commissions cause salespeople to work harder. Detractors contend that uncertainties surrounding such a form of compensation may drive off good salespeople. Furthermore, their complete dependence on commissions may lead them to develop bad business habits. But even detractors admit that pure commissions incen-tivize and move people to try harder. As a consequence the majority of businesses that employ a sales force use some combination of base pay and commission—also known as incentive pay—to compensate their salespeople. Sales clerks, however, tend to be paid salaries or wages.
BASIC COMPENSATION PLANS
Under straight commission arrangements, the seller gets a percentage of the sales price. The percentage may vary from product to product. Observers of the sales function estimate or guess that fewer than 15 percent of American firms pay their salespeople a straight commission—but those that do are satisfied with it: it motivates people to work hard enough to get the sales such companies need. Salespeople prosper in good times but are not a cost in during a downturn.
The straight salary route has its disadvantages as well. Some very able salespeople may also be lazy: they may work hard until they have what they need and then tend to sit back. They cherry-pick what they sell, moving high-commission product at the neglect of other lines. They by-pass difficult-to-reach customers when traveling or favor large buyers over small. Other, highly motivated salespeople view straight-commission selling as demeaning and cannot be attracted. Others view themselves as independents and move at frequent intervals, able to secure new jobs relatively easily. Pure commission salespeople tend not to develop high loyalties to the company that employs them: the company, after all, is not sharing the risk of the downside with them. Thus many also resist doing necessary work that is in the non-selling category, such as, for instance, attendance at trade fairs, participation in promotional visits, and providing follow-up work or technical assistance. A good deal of the sales management effort in companies that use straight-commission forces is devoted to get around problems of this type by a succession of tinkerings with incentives, supervision, and attempts at motivation. In such organizations the sales function is also often in a permanent recruiting mode.
The most frequent criticism of compensation plans that pay sales representatives a straight salary is that they eliminate the employees' incentive to perform. But such criticism is rarely heard in situations where, for instance, the sales function in performed by principals or executives—common in consulting, engineering, and service operations—or in organizations where professional level individuals are engaged in selling, the sales activity itself has significant technical complexity, and the sales function is valued and well compensated.
Salary Plus Commission or Other Incentives
This arrangement is by far the most common employed by organizations that use salespeople. Proponents tout several meaningful advantages associated with compensation plans that combine base salaries with commissions:
- Motivates sales force to expend greater effort.
- Provides company with a way to extend additional rewards to its best sales performers.
- Closely ties compensation to performance (though not to the same degree as straight commission arrangements).
- Generally easy to administer.
- Depending on the arrangement, the bestowal of increased security to employees may allow the company to take a greater percentage of sales profits.
Criticisms of compensation plans that combine salary with commissions or other incentives are usually framed not as rebukes of its philosophical underpinnings but as laments concerning its execution. For example, some companies may offer only token commissions, which do little to foster aggressive salesmanship.
In addition to commissions, some companies choose to provide non-salary compensation to their sales force through expense accounts, automobile leasing, advances against future earnings (usually commission), or sales contests.
Expense accounts are common features in many industries. Indeed, salespeople in a wide range of industry sectors depend a great deal on business lunches, etc. to close deals. Moreover, salespeople are often responsible for large territories, which makes long hours of travel a fundamental element of their job description. Organizations that do not compensate such individuals with expense accounts—or free use of leased automobiles—are likely to have considerable difficulty finding and retaining gifted salespeople. Indeed, most prospective hires will view refusal to take care of expenses as a sure sign of company stinginess and an indication that the company's ownership may not be cognizant of basic business realities.
Sales contests are another popular tool used by business owners to encourage sales activities. Under these programs, sales personnel who meet certain sales goals are rewarded with cash bonuses, paid vacations, etc. But business experts contend that sales contests can have unintended consequences for organizations if they are poorly defined or structured so that only a small segment of the sales force is rewarded. Indeed, some organizations provide incentives only to a certain percentage of top-level performers. Such programs—whether commissions or sales contests—are usually implemented in hopes of creating a competitive environment, but all too often they have the opposite effect. After all, if 25 people participate in a contest that only one person can win, 24 must also lose. In order to counteract the negative characteristics associated with traditional sales contests, sales consultants recommend that businesses instead institute so-called "open-ended" incentive programs. Such programs are designed so that participants compete against their own past performances rather than their fellow salespeople.
Open-ended programs can be shaped in two-tiered fashion so that a business's very best sales performers receive some extra recognition. For example, salespeople who increase their sales by 10 percent might receive a nice prize, while those that increase their sales by 20 percent would receive an even better one. Two objections are commonly raised to open-ended sales incentives. The first is that such initiatives cast greater uncertainty on sales budgeting efforts. After all, companies that offer an open program cannot know how many prizes to budget for. In addition, some observers contend that open programs can actually detract from the performance of a business's top salespeople—who might reach a goal too early and therefore slack off. But the impact of both of these negative attributes can be neutralized by careful planning (such as studying multi-tiered programs) and continuous monitoring.
THE FUTURE IS THE PAST
The sales function in any organization is a perpetual focus of concern. Sales are rarely overwhelming—and when they are they become a major problem of production, fulfillment, service, and the potential of losing the customer's good will. Selling is almost invariable beset by uncertainties, stresses, and the occasional (short-lived) triumph: every success is followed, not too soon after, by the question that haunts all those engaged in making or managing sales: "What have you done for me lately?" Not surprisingly, continuous examination of the sales function is a perennial preoccupation of business, has been so in the past, and is likely to be there in the future as well. In the future mix, whether the sales are predominantly direct, business-to-business, business-to-consumer, by electronic means, face to face, or take place in some other manner, finding the right mix of compensating salespeople will be a business concern, be that operation big or small. Commission sales will no doubt be one of the tools the small business owner will be using in certain circumstances.
SEE ALSO Multilevel Marketing; Personal Selling
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updated by Magee, ECDI