What is commission? (With types and FAQs)

What's important to you when choosing your line of work? Some people decide based on financial security. Some people decide based on what they enjoy or what they are passionate about. Others choose a job in a field where they excel. And many people focus on financial security.  

If you are looking for a job that pays well, roles with commission-based pay are a good option. Commission pay is a form of compensation that rewards you for your performance. This payment scheme is common in the sales industry, and many real estate and recruitment roles also use it.  

If you want to understand the concept of commissions better, you are in the right place. Here, we explore the practicalities of this form of income. We'll cover the following topics in this guide: 

• What is commission pay?
• Types of commission pay
• Advantages of commission pay
• Disadvantages of commission pay
• How to calculate commission
• Conclusion
• FAQs 

What is commission pay? 

A commission is a payment that employees receive based on their performance. This performance-based salary structure incentivises employees to achieve specific goals or targets, often tied to their productivity or the success of their work. Unlike fixed salaries or wages, commission pay fluctuates depending on the level of performance or results achieved. It is typically part of their compensation package. 

The commission amount is typically a percentage of the revenue the employee brings in through selling a product or service over a set period.  The fee paid depends on the agreement between the company and the employee. Regardless of the commission percentage, their earning potential increases with higher sales or value generation. 

In general, companies in the business of selling products or providing services include commission as a form of compensation. These include real estate companies, recruitment and insurance agencies, retail stores, and investment firms. It's a win-win situation; both employers and employees have a shared interest in increasing the company's revenue. 

Types of commission pay 

When you hear the word "commission," you may think of payment on top of a person's salary. There are several different types of commission. Here's a breakdown of some of them: 

 1. Straight commission 

Straight commission is a payment model where earnings are a percentage of the total revenue generated for the company. A person working on this type of commission does not receive a base salary. Instead, they get a predetermined percentage of the total revenue they bring in for the company. This high-risk, high-reward structure typically offers a higher commission rate to incentivise sales performance.  

2. Base plus commission 

The base plus commission is a model in which employees receive a base salary plus a percentage of the income they generate for the business. This provides them with a level of financial stability through the base salary. While the commission rate is typically lower than in straight commission, it still offers the opportunity to earn additional income based on their performance.  

3. Bonus commission 

A bonus commission is an incentive given to an employee – usually in top management – for exceptional performance. This is given on top of the regular salary and is separate from any other commissions the employee earns.  

4. Residual commission 

This commission model is common in insurance sales. The agent regularly earns a percentage from clients' paid premiums. If a client ends their policy, the agent loses this commission. 

5. Gross margin commission 

The gross margin commission model calculates commission as a percentage of the gross margin of the product or service. This is the sale amount minus the cost of production.  

A great salesperson can maximise their profit when they sell the product or service at higher prices, leading to larger commissions. This model is in contrast with other commission structures, that consider the net income a sale generates.  

6. Territory volume commission 

This type of commission depends on the volume of sales a group of agents makes. If the group sells enough to meet its quota, each agent earns the same commission. Even if an agent sells just one product or service, they can still earn a commission equal to the others working in the same territory.  

7. Tiered commission 

Tiered commission structures provide increasing commission rates as sales targets are met. This model encourages agents to strive for higher sales as higher performance results in greater incentives.  

8. Milestone commission  

Milestone commission is a type of incentive structure where sales representatives earn commissions based on reaching specific milestones. Instead of getting paid for selling, they earn bonuses for meeting key milestones, like hitting sales quotas or closing deals on time. This setup motivates reps to focus on important goals and helps companies achieve their targets more effectively.  

9. Single rate commission  

A single rate commission is a simple payment system where salespeople earn a set percentage of the total sales they make. There is just one commission rate, and it is applied to all sales equally. This model offers clarity, making it easy for salespeople to know how much they will earn for each sale.  

10. Multiple rate commission  

Multiple rate commission is when salespeople earn different commission rates based on different factors, like the amount or type of sales. Instead of one fixed rate, there are several rates applied to different sales categories. This system allows companies to customise commissions to specific sales goals and strategies. It motivates reps to focus on important targets. 

Advantages of commission pay 

There are many benefits to working in a commission-based environment. These include:

• Ability to control your income: In many commission models, the amount you sell determines the level of income you receive. The better you perform, the more you earn. This gives you direct control over your earnings.
• Higher earning potential: A commission-driven job allows you to increase your income significantly with more sales. These roles offer dynamic income growth based on performance. This is unlike traditional salaried roles, where earnings remain constant.
• Ability to work more independently: Many roles with commission-based earnings give you the freedom to set your schedule. You get more independence. This flexibility contrasts with the structured nature of a traditional job.
• Opportunity to develop skills: In commission-driven roles, you often develop valuable skills such as communication, negotiation, salesmanship, and time management. These skills are transferable and can be applied effectively across various job sectors.   

Disadvantages of commission pay 

There are also some disadvantages to working on a commission basis. These include:

• Impact on team dynamics: In commission-paying roles, the competitive nature of the environment may lead to a lack of teamwork among team members. This competitiveness can foster a toxic culture where team members don't support each other.
• Income fluctuations: During periods of reduced sales activity, known as lean selling periods, income may decrease significantly, posing financial challenges. This fluctuation can lead to financial stress, which may impact your health and relationships.
• Lack of structure: Traditional workplaces provide clear guidelines, responsibilities and routines. Commission-driven work, on the other hand, often lacks a defined structure, placing the responsibility for productivity and motivation fully on the salespersons. 

How to calculate commission 

Commission rates can differ between companies and industries. Some businesses offer higher rates than others. For example, property agents can earn anywhere from 1% to 4% in commission on the sale price. Factors such as market demand and competitive landscape often influence these variations.  

Performance-based commission structures vary too. Some companies implement tiered systems where commission rates increase as sales goals are met. Others may opt for different models that combine base salaries with performance incentives.  

Let's look at the different methods used to calculate a commission with examples:  

1. Straight commission  

The formula for the straight commission is:  

• Commission = Total Sales × Commission Rate  

Example: If an employee makes $5,000 in sales and the commission rate is 10%, the commission earned would be $500 ($5000 × 0.1). 

2. Base plus commission 

You can calculate base plus commission as follows:  

• Total Compensation = Base Salary + (Total Sales × Commission Rate)  

Example: If an employee has a base salary of $1,500, the commission rate is 10%, and the sales total for the period is $20,000. Using the formula, the commission for services rendered is $2,000 ($20,000 x 0.1). The agent's total compensation is $3,500.   

3. Bonus commission  

This is how you can compute bonus commission:  

• Bonus Commission = Bonus Rate × Base Salary  

Example: Suppose a top manager has a base salary of $5,000, and the bonus commission rate is 5%. Using the formula, the bonus commission would be $250 ($5,000 × 0.05).  

4. Residual commission  

You can compute this commission as follows:  

• Residual Commission = (Percentage of Premium) × (Premium Paid by Client)  

Example: In an insurance sales scenario, an agent earns a residual commission of 2% from clients' paid premiums. If a client pays a premium of $10,000, the agent's residual commission would be $200 (2% of $10,000).  

5. Gross margin commission 

Gross margin commission can be derived as follows:  

• Gross Margin Commission = Commission Rate × (Sale Amount - Cost of Production)  

Example: Consider a salesperson with a gross margin commission rate of 15%. They sell a product for $10,000, and the cost of production is $5,000. Using the formula, the gross margin commission earned would be $750 (15% of $5,000).  

6. Territory volume commission 

You can calculate territory volume commission as follows:  

• Territory Volume Commission = Total Sales Volume × Commission Rate / Number of Agents  

Example: Suppose the quarterly sales target for a region is $120,000, and there are three employees in the territory. The commission for reaching the target is 20%. Two of them make sales worth $50,000 each, while the third manages to bring in $20,000.  

Because they have reached their goal, the group receives 20% of the $20,000. The three agents share this equally. This means each one gets $8,000 regardless of their contributions to the sales target.  

7. Tiered commission 

Tiered commission can be calculated as follows:  

• Tiered Commission = (Commission Rate 1 × Sales Amount 1) + (Commission Rate 2 × Sales Amount 2) + ... + (Commission Rate n × Sales Amount n)  

Example:  Consider a tiered commission structure with the following rates and sales amounts:

• 3% for sales up to $2,000
• 5% between $2,001 and $5,000
• 7% between $5,001 and $10,000
• 10% above $10,001. 

If an agent makes $20,00 in sales, the calculation would be:  

($2,000 x 3%) + ($3,000 x 5%) + ($5,000 x 7%) + ($10,000 x 10%) = $60 + $150 + $350 + $1,000 = $1,560 in commissions 

8. Milestone commission  

This can be calculated as follows:  

• Total Commission = Bonus Amount × Number of Milestones Achieved  

Example: Let's say a sales representative has achieved two milestones during a sales period, and the bonus amount for each milestone is $500. Hence, the sales representative would earn a total commission of $1,000 for reaching two milestones. 

9. Single rate commission  

You can find this using the same formula used for straight commission, as both structures involve calculating the commission based on the total sales multiplied by the commission rate. 

• Total Commission = Total Sales × Commission Rate  

Example: Let's say a salesperson's total sales for the month are $3,000, and the commission rate is 8%. So, the total commission earned is $240 ($3,000 × 0.08). 

10. Multiple rate commission  

You can calculate this using:  

• Multiple Rate Commission: Total Commission = (Sales at Rate 1 × Commission Rate 1) + (Sales at Rate 2 × Commission Rate 2) + ... + (Sales at Rate n × Commission Rate n)  

Example: Let's say a salesperson makes the following sales: 

• Sales at Rate 1 (up to $10,000): $6,000
• Sales at Rate 2 (from $10,001 to $20,000): $3,000
• Commission Rate 1: 5%
• Commission Rate 2: 7% 

This means he earns a total commission of $510 [($6,000 × 0.05) + ($3,000 × 0.07)] = ($300 + $210) 

Conclusion 

Commissions are a popular form of compensation in many industries because they provide incentives for staff to generate revenue and increase profit. They are a percentage of the money the employee makes for the company within a set period.  

Working on commission gives you flexibility, control, and independence in terms of your income and workload. But there are also some challenges, including income fluctuations and the lack of a structured workplace.  

Before accepting a commission-based role, ask yourself if the benefits outweigh the risks. You also need to think about what type of commission works best for you. 

FAQs 

Here are the answers to some of the most common questions about commissions: 

1. What types of jobs use commission pay? 
   ⁠Jobs that include a commission mostly involve sales, marketing, and recruitment. Real estate agents, insurance brokers, and recruiters are examples of jobs where you earn commissions depending on your performance. 
2. Can I negotiate my commission rate? 
   ⁠Yes, you can negotiate your commission rate. Make sure you research the typical rates in your industry before negotiating. Showcase the revenue you bring into the company while remaining open to compromise. 
3. What are some common misconceptions about commission pay? 
   ⁠These are a few of the incorrect assumptions people have about commissions and the jobs that use them:
   ⁠Jobs with a commission are only for salespeople. If you provide services to customers, you may also receive a commission.
   ⁠People working on commission always make a lot of money. There are lean seasons when it's more challenging to make a sale. This means your income won't always be as high as you would like it to be.
   ⁠Individuals with commission jobs don't receive a salary. This depends on the business' compensation model and your contract. Your company may offer a fixed base salary. 
4. Is commission taxable income? 
   ⁠Yes, commission is taxable income. If you receive the commission from your employer, it will be taxed as employment income. If you receive the commission as a self-employed individual, it will be taxed as trade income.