Sales Commissions and Its Models

Sales commission is portion of a company’s sales revenue that is paid to the salespeople who are responsible in selling the products or services of the company. In most cases, company that implements commission-based system also provides fixed salary for their salespeople. This constant amount of salary is used as compensation for the worst case scenario when the salespeople don’t make any sales. The main purpose of this system is to reduce the company’s fixed expenses and allowances paid to the salespeople based on their salary (e.g: THR, bonus, etc). In addition, salespeople will be more motivated in selling the products or services since they are paid based on their sales activities.

According to Sessoms (n.d.), there are two types of commission payment model, Net Revenue Model and Gross Margin Model. In the Net Revenue Model, commissions are calculated based on the percentage of net revenue from a sale. This model is usually used when the salespeople don’t have any control over product pricing, and when various commission percentages are based on product price ranges. There are some advantages of using this model. First, commission expenses can be estimated and product prices can be adjusted. Second, the information about the profit margins of the company can be kept confidential. Third, it allows quick responses to profitability issues that might immediately affect the business's cash flow.

The Gross Margin Model is used when the company allows salespeople to negotiate product prices. In this model, the commissions paid to the sales people is based on the gross profit margin, which is determined before making additional adjustments for administrative and sales expenses. Less complex gross margin model may be suitable for small businesses that have few employees and no sales department.   

    

Outside from these two models, Garrison (2012) stated that commissions based on sales dollars can lead to lower profits. For example, when a company offers two products with different selling price, the salespeople will put an extra effort in selling the product with higher selling price because they will get larger commissions. On the other hand, higher selling price doesn’t mean greater contribution margin. It is possible that the product with higher selling price has lower contribution margin compared to the cheaper product. Company tries to maximize their profit by increasing the sales of product that has greater contribution margin, but salespeople don’t care about the company’s profit since they’re paid based on the selling price of the products. To eliminate this problem, Garrison suggested that company pays the commissions based on contribution margin rather than on selling price. By doing this, the benefit between the company and the salespeople will be maximized.

In conclusion, the commission-based system can benefit both the company and the salespeople. Product pricing can affect a company whether to use the Net Revenue Model or the Gross Margin Model. The only difference between these two models is on the percentage basis. The Net Revenue Model based on the net revenue from sale, and the Gross Margin Model based on the gross profit margin.

Source:

Gail Sessoms. (n.d.). Sales Commissions With the Net Revenue Model Vs. Gross Margin Model. Chron. Retrieved  from http://smallbusiness.chron.com/sales-commissions-net-revenue-model-vs-gross-margin-model-38255.html

Garrison R.H, Brewer P.C., Noreen E.W., Cheng N.S., Yuen K.C.K. (2012). Managerial Accounting: An Asian Perspective. New York: McGrawHill