Commission vs Bonus: What’s the Difference?

On Target Earnings (OTE) for the average American sales representative is $115,000. US organizations spend more than $800B per year managing sales employees, and more than 25% ($200B+) of that is spent on sales incentive compensation.

Properly structured incentive programs can increase employee performance by 44%. Understanding how to use incentives to get the best out of your salespeople is critical, and that starts with knowing the basics.

What is a sales incentive?

Sales incentives are financial and non-financial incentives provided to drive and increase revenue. 42% of employees consider rewards and recognition opportunities when they search for employment. 90% of top-performing companies use incentive programs to reward their sales employees. Commission, bonuses, stock options, gift cards are various forms of sales incentives provided to sales employees.

What is a bonus incentive?

A bonus is a lump sum provided to employees based on their individual performance, their department's performance, or the company's performance. This bonus amount may vary, and management typically decides the amount based on KPI and target attainment. Bonuses may be paid out quarterly or annually.

According to Harvard Business Review, quarterly bonuses will incentivize poor salespeople, while an annual reward will better incentivize high-performers.

Use a bonus if:

• You want to motivate and incentivize non-sales employees.
• Your organization has a large and established business and revenue stream.
• Your sales employees have to perform administrative responsibilities. Only 37% of a sales representatives’ time is spent on revenue-generating activities.

What is a sales commission incentive?

Sales commission is a portion of revenue given to the employee or employees who generated it. Depending on their commission rate, an employee may be entitled to receive 10% of the sales revenue they generate for their employer.

Employers provide commissions to encourage employees to deliver better results. A fixed salary doesn't give the same incentive level because an above-average performance has no impact on income.

Commission correlates performance with income. Employees can quantify the value they add to their employer. Commission might also help employers decide which employees are worth paying more to retain.

Commission incentives also provide financial flexibility. Commissions are paid out only after the employee has generated revenue. The cost of commission is incurred only if the employee generates the revenue for the employer that will pay for it.

Employers are not required to have the financial resources ready to pay commission in advance. Also, employers don’t have to pay a commission if employees don’t achieve superior performance.

Use commission payments if:

• You want to motivate and reward sales employees for better performance.
• You have a complex sales process that requires consultation, lead generation, onboarding and account management and wants to reward those employees for bringing on or growing accounts.

Commission vs Bonus Tax Implications

Regardless of the compensation structure you adopt, understand your jurisdiction's relevant tax and employment laws and how those laws affect employee remuneration. For example, the Internal Review Service (IRS) views bonuses and commissions as supplemental wages.

In some jurisdictions, if your commission is less than $1M per year, your employer has two options to withhold taxes. A flat tax rate of 25% might be applied to your commission or bonus. Alternatively, your income and commission/bonus might be taxed aggregately.

Should you offer bonuses or commission incentives?

Companies which have an incentive program are more likely to achieve their sales goals. Providing bonuses might be an effective way to compensate administrative employees who are not directly involved in generating revenue.

Providing commissions might be an effective way to increase revenue and motivate sales employees. You can always offer a combination of commission and bonus incentives to encourage employees at all levels. As business needs may vary, you can experiment to learn which compensation plans are suitable for your business.

According to McKinsey research, “smart revisions of compensation models have been found to have a 50 percent higher impact on sales than changes in advertising investments.”

If commission and bonuses are suitable for you, use this knowledge and reap the rewards.