Please note that the information contained in this article is limited in scope and is only intended as a high-level overview of the topics discussed. The information is current as of the publication date only, and the laws (and associated agency and/or judicial interpretations) on the topics discussed could change at any point in the future. Block, Inc. (including its affiliates, subsidiaries, employees, officers, directors, attorneys, and tax advisors) undertakes no obligation to update this article for future changes in the law. In addition, laws vary by jurisdiction, and this article does not attempt to address all jurisdictions — for example, states, counties, or cities often have requirements that differ from federal law. Nothing in this article is or should be used as tax or legal advice. In particular, this article cannot be relied upon for the purposes of avoiding taxes, penalties, or other obligations under applicable law. For guidance or advice specific to your business, you should consult with a qualified tax and/or legal professional.
When employees are well compensated for their work, they are better motivated and perform more efficiently, which can in turn lead to increased sales. And as the retail industry recovers from the initial shocks of the pandemic, increasing sales is a priority.
You need to offer competitive pay to attract committed salespeople. A popular way to do this is to offer sales representatives a commission based on their performance or the amount of sales they bring in to your company. A study of over 13,000 employees in more than 1,200 private-sector workplaces found that employees who receive performance-related pay tend to have higher levels of job satisfaction, organizational commitment, and trust in management. If you’re considering paying your retail employees based on commission, here’s what you need to know about making it work for your business.
What is commission-based pay?
A commission is a payment made to employees based on the sales they bring to your business. With commission-based pay, employees are paid a percentage of sales attributed to them. The commissions may be calculated based on gross profit, quota, or revenue. For example, if you run a retail clothing store, you may pay sales representatives 5% of their total sales value as commission in addition to their base salary. The total amount earned is paid monthly or at other regular agreed-upon intervals.
Commission rates vary depending on the industry, product type, pricing and level of skill required to close the sale. For example, commission rates for high-ticket items, such as cars and expensive jewelry, are usually higher than those for fashion or household products. Additionally, sometimes basing commissions off of sales isn’t the right metric for your business. Other metrics to measure commission include adding new customers, increasing the average order size, improving customer retention and loyalty, and selling products that make your business more money.
Benefits of commission-based pay for your retail business
Commissions are popular for a reason: they work. But remember, the goals set for employees have to be attainable and encourage healthy challenges to employees — not bring added stress to their lives. Here are some of the benefits of paying employees on commission.
Commissions encourage employees to be more self-motivated to sell to customers and increase their own earnings, as well as aid in the growth of the business. When employees are fairly compensated for their efforts and are rewarded for bringing in more business, they feel more invested in helping increase sales.
Attract skilled salespeople
Paying based on commission helps you attract high-performing salespeople who love a challenge and can prioritize results. Since generally commission-based pay provides a higher earning potential, you can attract top performers in your industry and have a wider pool of candidates that are skilled and self-motivated.
Flexibility for workers
Some workers may prefer the flexibility that comes with commission-based pay, especially if there is no cap on commissions. Flexibility and ownership over schedules can also lead to happier employees, which aids in employee satisfaction and retention.
Downsides of commission-based pay
Commission-based pay is not without flaws. Here are some of the drawbacks.
Focus on commissions
Workers may become overly focused on earning commissions and employ aggressive sales tactics to win customers. It’s important to take the time to train employees and strike a balance of establishing a culture that puts customer needs first while rewarding employees.
Employee demotivation due to poor sales
Employees may also be demotivated if they do not meet targets regularly, especially when business is slow. This may lead to higher employee churn. To mitigate this, consider a commission structure that guarantees workers a base income during slow months or times of uncertainty.
Complicated payroll calculations
One of the biggest challenges of commission-based pay is the layer of complexity it adds to payroll calculation. You need to track items sold by each team member and calculate due commissions based on prescribed percentages. If you opt for a tiered commission structure, the calculations are even further complicated.
Tools like Square Payroll make it easy to calculate payroll when paying workers a commission. Square Payroll’s commission tracking feature allows you to set flat or tiered commission rates for employees and automatically calculate earnings based on those rates. You can track the commissions earned per item or transaction and view detailed reports.
Is commission-based pay right for your business?
You may consider paying commissions if you need to meet specific sales targets. Tying pay to performance may also help you reduce payroll costs if you need to improve the financial situation of your business. Before deciding on commission-based pay, it’s important to carefully consider your estimated revenue and profit margins.
Types of commission pay structures and when to use them
Commission pay structures vary from simple to complex. Before choosing a model, it’s a good idea to find out what’s popular in your line of business and develop your structure based on that.Please note that there may be regulatory constraints regarding this pay structure, so be sure to review the requirements that apply to your business.
Base salary plus commission
This is the most popular commission pay structure. In this model, employees earn a fixed base salary as well as a commission for sales made. The standard salary to commission ratio is 60:40, where 60% is the base salary and 40% is the variable wage that’s based on commission.
This model is helpful if you want to incentivize employees who already earn a salary, because they are guaranteed a livable wage but know they can earn more depending on their performance.
In this structure, commission rates increase progressively as employees hit specific sales milestones. For example, instead of paying a flat commission rate, employees may earn 5% for sales up to $50,000. The rate might increase to 7.5% once they surpass that and further increase when they surpass the next milestone.
This structure works well if you are trying to scale your business, because it encourages workers to outperform their targets.
Draw against commission
This is another popular commission structure, commonly used with new salespeople. Here, you pay the employee a “draw,” which is a pay advance against their future earnings. This draw may be recoverable or non-recoverable.
Here’s an example: Suppose you pay a new sales rep a draw of $500 in their first month. The rep sells nothing in the first month but earns $1500 in commissions in the next month. If the draw is recoverable, the rep will be paid $1000 in the second month because of the draw from the first month. If the draw is non-recoverable, they receive the full $1500.
Draws against commission serve as stipends, similar in some ways to a base salary, so reps are guaranteed an income during uncertain times. Consider using this commission structure when working with new sales reps to help them find their feet, or during periods of uncertainty.
Tips for paying your employees based on commission
Cover legal bases
There are various federal and state laws regarding commission-based pay in different industries. These regulations stipulate things like the records you must keep as an employer who pays commissions, how to calculate commissions and overtime compensation for eligible employees, as well as timeframes for paying commissions.
For example, the Fair Labor Standards Act (FLSA) stipulates that employers must pay employees whose earnings are based on commission a rate that is at least the federal minimum wage, currently $7.25 per hour. To avoid penalties or complications, it’s crucial that you receive proper legal guidance and ensure you thoroughly understand the rules and regulations that apply to your business.
Automate payroll calculations
Complicated payroll calculations are a challenge when you pay employees based on commission. An automation tool, such as Square Payroll, can help automatically calculate commission-based wages. This helps you save time and reduce errors from manual calculations.
Commission-based pay is a great way to motivate employees and increase sales. Ultimately, the goal when paying employees based on commission is to ensure that they are motivated to reach their sales targets. Therefore, it’s important to continuously assess and improve your commission pay plan based on employee feedback.