How Sales Commission Works: Flat, Tiered and Marginal Rates

The flat rate

commission = sales × commission rateThe rate stays the same however much you sell.

At a flat 5%, sales of 80,000 earn 80,000 × 0.05 = 4,000. It is easy to understand and to forecast, but it gives no extra reward for stronger results unless the rate itself changes.

Check what the rate applies to. Commission can be paid on revenue, on gross profit, or on cash actually collected, and the same rate gives very different pay depending on which base is used. If the 80,000 of sales carry a 40% gross margin, the gross profit is 32,000. A rate of 5% on revenue pays 4,000, and the same pay on gross profit needs a rate of 4,000 ÷ 32,000 = 12.5%.

Some plans add a draw, which is an advance paid regularly against future commission. Find out whether it is repaid from later commission, and what happens if you earn less than you drew.

Marginal tiers: each rate applies to its own band

In a marginal plan, higher rates apply only to the sales that fall inside each band, in the same way income tax brackets work. Suppose the plan is:

• 4% on the first 50,000 of sales
• 6% on sales from 50,000 up to 100,000
• 8% on sales from 100,000 upward

Worked example, sales of 120,000: the first band pays 50,000 × 0.04 = 2,000. The second pays 50,000 × 0.06 = 3,000. The remaining 20,000 pays 20,000 × 0.08 = 1,600. The total is 6,600.

The effective rate is the total commission divided by total sales: 6,600 ÷ 120,000 = 5.5%. It always sits between the lowest and highest rates in a marginal plan, because only the top slice earns the top rate.

Whole-amount (retroactive) tiers

In a whole-amount plan, the rate for the tier you reach is applied to all your sales. Using the same bands with sales of 120,000, you reach the 8% tier, so commission is 120,000 × 0.08 = 9,600. That is 3,000 more than the marginal plan on identical sales.

Plans like this create a cliff at each threshold. At sales of 99,999 the 6% rate applies and pay is 99,999 × 0.06 = 5,999.94. One more sale takes you to 100,000, which moves everything to 8%, and pay becomes 8,000, a jump of about 2,000 for a single extra unit. The cliff can motivate people near a threshold, but it can also encourage pulling deals forward or delaying them into another period.

Questions to ask about any plan

• Is the rate applied to the whole amount or only the band? Ask for a worked example with your expected sales.
• What counts as a sale: signed orders, delivered goods or collected payment?
• Are returns, cancellations and discounts deducted, and can earned commission be clawed back later?
• Is the base revenue or profit? A rate on profit applies to a smaller number, so compare the final pay, not the percentage.
• Is there a base salary, a draw against future commission, or a cap on total earnings?
• Do the tiers reset monthly, quarterly or yearly?

If you are comparing two offers, work out the pay under each plan at three sales levels: a poor year, an expected year and a strong one. The plan that looks better at your expected level is not always the better one at the extremes. For the employer, commission is also a cost ratio. At 6,600 on 120,000 of sales, it is 5.5% of revenue, which should be set against the product margin. If the margin is thin, a generous top tier can eat most of the profit. A commission calculator handles the basic calculation, and the percentage calculator is useful for checking effective rates.

This article is general education about how plans are calculated, not legal, tax or employment advice. Read your own contract and ask a qualified professional about your situation.