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What is the difference between a commission and a bonus?
In the context of sales compensation, WorldatWork defines a “bonus” in contrast to a “commission.” The difference is that the “commission” is communicated as a “piece of the action” (e.g., 2% of revenue, $5 per unit, 6% of margin dollars); whereas a “bonus” is a fixed incentive amount offered for achieving a specific objective, often with less offered for lower achievement levels and more for higher levels.
Most of the time, the amount of the commission at goal (or “quota”) is higher if the quota is higher – so if one sales person has a $1M quota and another has a $1.5M quota, then one has a target commission that is 150% that of the other. Whereas in a “bonus” world, the target incentive is fixed for the role (e.g., $40k per year) and is paid for hitting quota, which may vary from one person to the next.
Some people hear the word “bonus” and mistakenly conclude that the payout outcome will be binary (all or nothing). While that’s possible, it’s rarely advisable. A typical sales compensation bonus plan will include payout rates to pay additional compensation for every increment of additional performance. The most straightforward approach here is to pay 1% of the target payout for every 1% of the quota achieved. So if the target payout is $40,000 and the quota is $1,000,000 then for every $10,000 in sales (1% of $1M), $400 is paid (1% of $40,000). It is also usually advisable to pay at a higher rate once the quota is achieved. So in our example, the payout for every additional 1% of quota over 100% (every $10,000 over $1M) might be 2% of the target incentive ($800).
Of course there are myriad nuances and variations, including the possibility of “personal commission rates” which communicate a “bonus” as if it were a “commission,” etc.
In deciding whether your compensation plan should be quota-based or commission-based, the key question is one of your business’ philosophical starting place about variable pay for sales people.
- Do you start with a fixed amount you know you can afford to pay to get your offering sold (e.g., 5% of revenue), and design the plan to manage to that value?
- Do you start with the idea that the sales job has a market value, and that those who meet the goals assigned based on the sales organization and roles you have put together should earn that market value?
If your starting place is #1, a commission is likely a better fit for your business. If your starting place is #2, a bonus type incentive could be a better approach. Commissions are more typical and appropriate in earlier stage businesses, new business roles, product launches, and certain industries; and bonuses are more typical and appropriate in more mature businesses, complex selling organizations, and account management roles.
Of course, both the cost of the sales compensation compared to the sales team’s productivity and the compensation delivered to the sales people as it relates to their job prospects outside the company must both work in order to have a successful business model.