Why do we pay sales commissions?

January 4th, 2012 by Dan Ostlund

Among our many cherished verities and assumed assumptions is the widespread belief—nearly universal practice actually—that salespeople are to be paid commissions. It’s the way things are done. Stop signs are red. Salespeople get commissions.

But why?

This is a practice so deeply ingrained that almost everyone assumes that commissions are an unalloyed good, and that salespeople won’t work without them. I’ll return to that notion about work shortly, but it’s somewhat amazing that commissions are so widely lauded when they come laden with so many recurring problems. These issues pop up with distressing regularity.

There are all kinds of problems with commissions, for example, high turnover as salespeople shop jobs to get a slightly more lucrative commission system. Always attempting to maximize personal benefit which results in system gaming like making fake phone calls to hit call numbers, sandbagging deals into the next quarter, sniping new leads, and so on (the list here is actually endless).

The problems include infighting over who gets credit for accounts and sales. They include constantly comparing territories and account value to determine fairness between salespeople. They include an enormous amount of overhead as each salesperson sedulously tracks every transaction no matter how minute to make sure they get paid on it (by the way, they hate having to do this, and it’s a staggering waste of time. It’s also a place where weak salespeople like to hide out).

All of this is organizational dysfunction, and it’s a recipe for resentment and distrust among your team.

Management then tries to correct for these problems. They constantly drop or add ballast. They have to carefully structure the pay plan, the territories, the lead assignments. They have to referee disputes, tweak the various systems, and try to keep everyone happy. It’s like a spinning top and every time it starts to wobble, management has to try to nudge it back. It’s a large amount of effort spent propping up a system that we have all just assumed is necessary.

But it gets even worse.

In research by Dan Ariely and others it appears that higher incentives, actually reduce performance. That’s a perverse and counter-intuitive result, but in several different kinds of experiments, groups that were promised the largest amount of money as a reward for doing a task performed that task more slowly, and completed the tasks less often.

And yet the paladins defending commissions are everywhere.

They say that commission-based pay maximizes autonomy. Assume there are ten “units” of pay which, of course, can be divided up in all kinds of ways; eight units of salary and two units of commission, or one unit of salary and nine units of commission. How best to do this is the source of several different kinds of holy war.

This means, they say, that for every unit of base salary that gets added to the pay mixture in place of commission there is an increase in employer control, or put the other way round, a reduction in autonomy. More salary in the mix destroys the space for independence and kills the morale of the worker. It turns motivated independent free-agent sales people into wage slaves.

But it gets even worse, according to the defenders of commissions, and here is the crux of their argument.

They say that without the potential to make extra money for your efforts—that is without a one-for-one relationship between a piece of work and the resultant money—that there is no real motivation to work, or, god forbid, to do any extra work. How do you keep salespeople hungry if you don’t pay them commissions? This is the great inscrutable puzzle in sales pay. Too much salary and not only do salespeople lose their independence they become slugs on top of it.

But hang on a second. Isn’t all this deeply insulting to salespeople? Doesn’t it presuppose that salespeople are lazy and greedy and unethical and that it is only the sweet smell of more lucre that gets them to shed their pajamas each morning?

According to this view sales people are only motivated by a specific type of pay—the commission, and the magic is in finding, like Goldilocks, that place that’s just so perfectly just right.  Because of this we regard all the pathologies commissions create as just part of the price.

But could it be possible that we’ve got cause and effect reversed here? Is it possible that the stereotype of the slimy salesperson, and the derangement of the culture they so often get blamed for, are actually the result of the way they are paid instead of the kind of people they are? Could commissions, rather than the people, be the primary cause of dysfunctional sales cultures?

Think for a second: we don’t insist that other kinds of workers be paid on commissions. Only an amazing idiot pays a programmer by lines of code. We don’t assume that programmers will dog it if they are paid only salary. Actually, we think just the opposite; they will work hard because they care about the work they’re doing, and they won’t need lashings, or thumbscrews, or other popular forms of motivation. We assume they are internally motivated. This is one of the hallmarks of the enlightened software industry. Development isn’t (usually) conveyor belt work. It doesn’t (usually) suck the soul out of you. It’s creative, it’s mind work and it operates on an entirely different rhythm from traditional kinds of labor, so heavy external control tends to be counter-productive.

And this is true of other workers today—designers and writers and interaction experts, for example. They work on this different rhythm, and are trusted to do so, not coerced by the style of pay they receive, and in good work places, not too often by a manager either. A writer may impose a rigid schedule on herself, but any manager who attempts to impose a similar sort of external authoritarian control is suffering from a kind of insanity given how out of synch such management is with the demands of a lot of today’s work. And so it is with attempts to control with pay.

The different pay systems, then, leave us with two kinds of workers; the lazy salesperson who needs to be coerced with direct rewards, and programmers who can be trusted to go about their day and get good work done. It’s just weird when you think about it.

But, these are actually two different views of workers, not necessarily two kinds of workers.

The tension between these views of workers was described in the 1960s by Douglas MacGregor in his book The Human Side of Enterprise. He suggested that managers had two views of motivation, and that a manager’s theory of motivation determined company culture. The first view he called Theory X which assumes that people are lazy, want to avoid work and need to be controlled, coerced, punished, and lavishly rewarded in order to perform. Sounds like some sort of S&M dungeon to me. Theory X demands a lot of managerial control and tends to demotivate, generate hostility, and generally make people into sour pusses.

The second he called Theory Y which assumes that people are self-motivated, derive satisfaction from their work, are creative, and thrive when given autonomy.

With these two views in hand, we now have a way to describe why sales commissions create so much dysfunction. Commissions assume a Theory X world. It assumes salespeople are lazy. They need external motivation to shake off the moss. If you pay them on salary, they just won’t get things done. The commissions view then makes the mistake of presuming that this can be fixed with either larger overall commissions or a greater percentage of total pay coming from commissions.

But if Theory X doesn’t fit and is a degrading way to treat employees, then doing more of it gets you nothing but more degradation and misery, right?

The Theory X way of doing sales compensation, I now think, has habituated us into accepting deranged and dysfunctional sales behavior as if it’s just the cost of doing business.

We Get Rid of Commissions

So we got rid of commissions.

We thought about for a long time before we did it, but we finally switched about a year ago.

We did it because we were having a lot of the problems with commissions described above even though all of our salespeople are ethical and decent. Commissions just encourage certain kinds of behavior; dysfunction is built into the logic of the system.

The different kinds of  pay created divisions at Fog Creek. It was the fundamental thing that separated sales from everyone else. Divisions like that can be exceptionally corrosive to morale, and that’s something Joel and Michael (the founders) specifically set out to avoid when they designed the Fog Creek compensation system. Fairness was one of their main concerns, just as it was in the newer StackExchange comp system, and they felt that commissions just didn’t fit.

I’ll admit that I was skeptical about ending commissions mainly because commissions are such an established way of paying salespeople. I worried that we wouldn’t be able to hire anyone. I worried that some of our sales people might quit. I worried, good Theory Y votary that I was notwithstanding, that the salespeople would coast. I worried when my friends in sales management said this would never work.

To my great surprise, our salespeople really liked the idea. They especially liked being on the same salary plan as the rest of the company.

So we did it, and no catastrophes struck us. No earthquakes. No plagues, and no one quit. In the year since we dropped the commission system our sales have gone up. In fact, four of the last five months have been record months. We can’t reasonably say that our record sales were caused by this change, but we can reasonably say it didn’t hurt, and that’s worth having a hard think about in your own company. There is no guarantee that this will work for everyone, but it’s unlikely to be a disaster either.

Our salespeople all estimated that they were spending about 20% of their time just keeping track of what money was due them. There was constant horse trading. And, most worrying, we created a heavy disincentive to do all the service stuff that makes customer service shine. Why would you want a system that sets up after-sales service as competition against new sales, especially if you have a small sales team? Reputation and retention, after all, are both paths to revenue.

Removing commissions has changed the sales team. It has taken their focus off their compensation. They have all that administration time back for more useful things. They take a longer view of the value of a prospect, and are less worried about who is going to buy right now. They feel less stress about taking vacation. They don’t quibble among themselves over accounts. And best of all, they feel more integrated with the company.

As John, one of our salespeople said, “It’s made the team better. It’s removed the ‘me, me, me’ mentality. Now I want to share information with everyone on the team, and everyone is willing to pitch in because it doesn’t hurt me to help my colleagues.”

Getting rid of commissions lets us forget about policing the wobble. Now, it is not necessarily the case that commissions are always bad, or always fail, or are wrong for you. It’s just that they come with real problems, and you need to carefully weigh both your desired company culture, and the costs of policing your commissions system against the expected increase in performance, which is a very hard calculation to make.

For us, it’s been a great success, and at least from that perspective it might be time we punch the Theory X, commissions-based sales culture right in the nose. Real redemption might lie in removing the source of the derangement and treating sales people like we treat programmers and other workers that we implicitly trust.