Long ago, we wrote about the importance of a compensation plan in an organization. I thought we’d follow up on that post by exploring the six different types of compensation plans in depth. In many companies, basics plus bonus-based compensation plans are used as a way to motivate employees. Finding what compensation plan works best for the company, involves accessing its strengths and weaknesses, making a decision based on the long-term goals, and carefully negotiating the contract with the employee in a way that it works best for the company and its needs. We’ve picked the most common and most rewarding forms of compensation plans and highlighted their benefits and downsides, so you can decide which one works best for your business needs.
Types of compensation plans for compensating employees beyond commissions:
1. Straight Salary Compensation
Straight salary refers to the basic salaries and wage given to the worker. In most companies, the base pay is determined by the worker’s job title and job role. The company sets a minimum and maximum range that can increase, decrease or remain the same, depending on the worker’s performance.
- Salespeople are usually paid on a straight salary compensation, in which there is no opportunity to earn incentives.
- Straight salary plan can help promote a sense of equality among sales people who work as teams or small groups, for everyone is paid equally and the contribution of each team member is also expected to be equal.
- A straight salary can greatly benefit someone who is transferring to a new territory. Once the person has established himself in the area, the company can switch to performance-based salary.
2. Salary plus Commission
This is one of the most reliable types of compensation plans. An employee who agrees to this type of compensation will receive a base salary along with an additional bonus if performance hits or exceeds earning goals.
- In most companies, the bonus is usually tied to a budget or other target that has little significance to the employee.
- Employees earning salary plus commission will have higher income tax rates than a self-employed agent.
- Employees are guaranteed to receive at least base salary to pay the bills, even during a time period when their sales are low.
3. Commission Only
This is a primary method for compensating independent sales agents. It is a highly attractive model, especially to start-ups who are seeking to penetrate a specific territory.
- In commission only jobs, companies offer a safety net in the form of “draw against commission.” The company pays its salespeople a set amount known as a “pre-determined draw” at the beginning of each pay period. At the end of the pay period, this prepayment is drawn from how much the salesperson earned in commissions. If a salesperson earns more commissions than he was paid, he keeps the extra money. If he earns less in commissions, he must pay the remainder back to the company.
- If an employee makes no sales during a month, he doesn’t get paid. However, successful salespeople tend to make a lot of money with commission than with a salary plus commission job.
4. Territory Volume Compensation Plans
This type of compensation is well-suited for employees who work in a team-based culture. The compensation is usually calculated by finding out territory volume. The sales numbers are added up and all commissions are split equally among all sales professionals.
- This type of compensation plan puts less pressure on individuals and fosters team-building.
- The only downside with territory volume compensation plan is that it can lead to hostility between co-workers if certain members feel that effort isn’t equally divided.
5. Profit Margin/Revenue Based Compensation Plans
Profit margin is one of the most popular types of compensation used by start-up companies. Under this plan, companies compensate its employees entirely on the profits made by the business. Due to the complexity and compliance issues involved, very few companies offer equity or stock.
- Startup companies using profit margin/revenue based compensation plan can also incorporate long-term incentives such as stock to build loyalty and a valuable sales base.
6. Residual Commission
This type of compensation plan is every salesperson’s dream. In this, salespeople continue to receive a commission as long as their accounts are generating revenue for the employer. Sadly, employers are usually reluctant to offer a residual commission deal to employees.
- Good salespeople can continue to receive residual commission ever after they leave the company through negotiation.
What’s right for you?
No two compensation plans are alike. Usually, the type of compensation plan an organization chooses, and the type that an individual accepts, depends on the market conditions and the goals of those involved.