Here at Sales Cookie, many of our customers ask us what a reasonable revenue-based sales commission percentage should look like. They are trying to determine which exact percentage of gross revenue should be assigned to sales commissions in order to create a sales incentive program. Should it be 7%, 8%, 9%? Understandably, they are trying to control the total cost of their sales commission program.
However, it’s often a bad approach to start with a percentage of revenue to define a sales commission program (the same way you should not price something based on cost of goods, but rather on perceived value). Instead of choosing a percent of revenue, and then a commission program, it’s best to first define sales rep compensation, and then backtrack to a percent of revenue.
The best way to do this is define a base salary, plus a (base vs. variable) pay mix depending on the sales role. Together, these two components define the “expected” total target compensation – ex: 60K base + 0-40K commissions = 100K on target compensation. So, instead of controlling sales commission costs using a percent of gross revenue, you essentially control it by defining labor costs. You can still compare labor costs to total revenue or profit.
Once you’ve defined the variable pay component, you must decide which sales results must be obtained to earn it in full (ex: $1 million in revenue), and calculate the percent of revenue required to pay for commissions! This backtracking approach also explains why there is no “standard percent of revenue paid in commissions” – except in very specific industries such as real-estate.
The other benefit of using a target total compensation approach (and backtracking to a percent of revenue) is that it ensures your business remains competitive. Just assigning an arbitrary percentage of revenue to commission payouts does NOT help you ensure you will be able to hire or retain good reps. Defining pay mixes, on the opposite, helps you do this.
Most businesses want to provide special incentives for attaining higher levels of sales performance. This means using tiered commission models, which makes the total payout somewhat unpredictable. In other words, it’s hard to enforce an exact percentage of revenue using a performance-based commission model – regardless of which way you started.