Commission is a payment made to employees based on the value of sales achieved. It can form all or part of a pay package. Commission is, therefore, a form of ÔÇ£incentive pay ÔÇ? (see also performance-related pay, bonuses).
Commission, like piece-rate, is a reward for the quantity or value of work achieved. In most cases, the employee is paid a flat percentage of the value of the good or service that is sold.
The rate of commission depends on the selling price and the amount of effort required in making the sale.
For example, commission rates could range from 5% where the product sells easily (e.g. household goods sold door-to-door) to 30% where the effort is substantial.
Advantages of Commission
The main advantage of commission from an employeeÔÇÖs point-of-view is that it enables high performing sales people to earn huge amounts.
The main advantage to the employer is that the payroll cost is related to the value of business achieved rather than just the amount produced. After all, businesses exist to sell goods and services for profit ÔÇô not just to make things (piece rates simply reward amounts produced, not sold).
Disadvantages of Commission
There are several drawbacks with using commission payments:
ÔÇó Sales people may cut corners to make sales (e.g. not explain the product or service in enough detail to potential customers). This was a major problem in the recent pensions mis-selling scandal in the UK
ÔÇó High commission earnings enjoyed by some of the sales team may be resented elsewhere in the business ÔÇô particularly if the sales actually depend on a team effort
ÔÇó It is difficult to change what proves to be an over-generous commission structure without upsetting and demoralising the sales team
ÔÇó Once commission payments have been made, the sales force may lose some motivation until they begin to focus on the next payment (which might be up to 12 months away)
As a result of the above disadvantages, most businesses that use commission as an incentive payment method offer a basic pay plus a moderate commission level. In this way, if sales and profits justify the change, the commission rate can always be increased slightly.
Recent research suggests that the use of commission is reducing in comparison with the growth of other incentive payment methods.
Performance Related Pay
Performance-related pay is a financial reward to employees whose work is:
ÔÇó Considered to have reached a required standard, and/or
ÔÇó Is above average
Performance related pay is generally used where employee performance cannot be appropriately measured in terms of output produced or sales achieved. Like piece rates and commission, performance related pay is a form of incentive pay.
Whilst the detail of performance-related schemes varies from business to business, there are several common features:
ÔÇó Individual performance is reviewed regularly (usually once per year) against agreed objectives or performance standards. This is the performance appraisal .
ÔÇó At the end of the appraisal, employees are categorised into performance groups ÔÇô which determine what the reward will be (if any)
ÔÇó The method of reward will vary, but traditionally it involves a cash bonus and/or increase in wage rate or salary.
Performance-related pay has grown widely in recent years ÔÇô particularly in the public sector. This is part of a movement towards rewarding individual performance which reflects individual circumstances.
According the Equal Opportunities Commission, a well-designed performance-related pay scheme would have the following elements:
ÔÇó Objective setting
ÔÇó Communication and understanding of objectives
ÔÇó Consideration of performance against objectives
ÔÇó Translation of evaluation into performance rating
ÔÇó A link between ratings and the determination of pay
ÔÇó A separate appeals procedure
Disadvantages of Performance Related Pay
There are several problems with performance-related pay:
ÔÇó There may be disputes about how performance is measured and whether an employee has done enough to be rewarded
ÔÇó Rewarding employees individually does very little to encourage teamwork
ÔÇó It may encourage unhealthy rivalry between managers
ÔÇó There is much doubt about whether performance-related pay actually does anything to motivate employees. This may be because the performance element is usually only a small percentage of total pay.
Piece Rate Pay
Piece-rate pay gives a payment for each item produced ÔÇô it is therefore the easiest way for a business to ensure that employees are paid for the amount of work they do. Piece-rate pay is also sometimes referred to as a ÔÇ£payment by results systemÔÇ?.
Piece-rate pay encourages effort, but, it is argued, often at the expense of quality. From the employeeÔÇÖs perspective, there are some problems. What happens if production machinery breaks down? What happens if there is a problem with the delivery of raw materials that slows production? These factors are outside of the employeeÔÇÖs control ÔÇô but could potentially affect their pay.
The answer to these problems is that piece-rate pay systems tend, in reality, to have two elements:
ÔÇó A basic pay element ÔÇô this is fixed (time-based)
ÔÇó An output-related element (piece-rate). Often the piece-rate element is only triggered by the business exceeding a target output in a defined period of time
Case study: Piece-rate pay in practice in the UK ÔÇô Home-based workers
In the UK many thousands of people engage in what is known as ÔÇ£home-based workÔÇ?. This refers to work:
ÔÇó In the home, or near the home in premises that are not those of an employer
ÔÇó For a cash income (i.e. not unpaid household work)
Whilst there are many successful business people and well-paid professionals working from home, the use of piece-rate pay is focused is on those at the other end of the scale ÔÇô home-based workers, mainly women, who earn only a subsistence level income.
Subsistence level home-based workers fall into two broad categories:
ÔÇó Those who work for an employer, intermediary or subcontractor for a piece-rate , who are not responsible for designing or marketing the product, but simply contribute their labour. These workers are often called subcontracted or dependent home-workers
ÔÇó Workers who design and market their own products, but who cannot be considered to be running small businesses - known as own-account workers.
The majority of home-based workers are women who do home based work in order to combine earning cash with other responsibilities, such as child-care and household management. Many earn well below the local minimum wage or average earnings. Most dependent workers work informally, without a proper employment contract. They are rarely organised or supported by formal trade unions.
Home-based work is found in most sectors of the economy, both modern and traditional industries. Good examples include:
ÔÇó Production of garments and shoes
ÔÇó Assembly of electronic, plastic and metal components
ÔÇó Many kinds of packing work
ÔÇó Weaving and dyeing of textiles in the traditional sectors
ÔÇó Handicraft work
ÔÇó Sewing and knitting garments
ÔÇó Assembling toys
It used to be thought that home-based work was an old-fashioned form of employment that would die out with the rise of modern industry. However, over the last 20 years much large-scale industry has reorganised its production, subcontracting work to smaller companies, often in other countries. At the end of the chain there are often informal workshops and home-based workers.
Subcontracted homework is a form of production which allows companies to reduce their costs by:
ÔÇó Outsourcing production to lower-paid workers, usually without formal contracts, employment and social protection or even a regular supply of work
ÔÇó Passing on some of the costs of heating, lighting and storage to the workers themselves
ÔÇó Avoiding responsibility for health and safety for these workers
ÔÇó Using home-based workers as a source of flexible labour
Some of the problems faced by home-based workers include:
ÔÇó Irregular work ÔÇô and therefore irregular income
ÔÇó Earnings well below average
ÔÇó No economic or social security for sickness, maternity or old age
ÔÇó Long working hours
ÔÇó Potential health problems caused by repetitive processes and inadequate health and safety
Time Rate Pay
Time rates are used when employees are paid for the amount of time they spend at work. This is the most common method of payment in the UK.
The usual form of time rate is the weekly wage or monthly salary. Usually the time rate is fixed in relation to a standard working week (e.g. 35 hours per week).
The employment contract for a time-rate employee will also stipulate the amount of paid leave that the employee can take each year (e.g. 5 weeks paid holiday).
Time worked over this standard is known as overtime . Overtime is generally paid at a higher rate than the standard time-rate ÔÇô reflecting the element of sacrifice by an employee. However, many employees who are paid a monthly salary do not get paid overtime. This is usually the case for managerial positions where it is generally accepted that the hours worked need to be sufficient to fulfil the role required.
The main advantages of time-rate pay are:
ÔÇó Time rates are simple for a business to calculate and administer
ÔÇó They are suitable for businesses that wish to employ staff to provide general roles (e.g. financial management, administration, maintenance) where employee productivity is not easy to measure
ÔÇó It is easy to understand from an employeeÔÇÖs perspective
ÔÇó The employee can budget personal finance with some certainty
ÔÇó Makes it easier for the employer to plan and budget for employee costs (e.g. payroll costs will be a function of overall headcount rather than estimated output)
The main disadvantages of time-rate pay are:
ÔÇó Does little to encourage greater productivity ÔÇô there is no incentive to achieve greater output
ÔÇó Time-rate payroll costs have a tendency to creep upwards (e.g. due to inflation-related pay rises and employee promotion.