A tiered commission structure is an incentive compensation system in which the earnings calculation changes at different performance levels.

Let’s explore some examples to illustrate how different sales compensation models work.

Basic Commission Structure Example

We’ll start with a basic commission structure.

Let’s assume that we have two sales reps — Jim and Dwight — who are on a quarterly compensation plan with annual variable compensation of $100K for 100% attainment (on-target earnings or OTE) — or $25K per quarter. The quarterly quota is $250K in bookings, with bookings defined as the 12-month contract value of the deals closed, based on the effective date of the contract.

With no tiers, the quarterly variable comp would simply be:

($ bookings ÷ $250K) × $25K payout

You can think of this as a 10% commission, since $25K is 10% of $250K.

In this example, let’s say that Jim closed $200K in bookings in Q1. His bookings divided by $250K is 80%, so he would receive 80% of $25K— $20K — in variable compensation for Q1. Another way to look at it would be 10% × $200K = $20K.

Dwight exceeded the target, closing $275K in bookings in Q1, so his variable compensation would be $275K x 10% = $27.5K.

But not all commission structures are this basic. Some include tiers that increase commission for reps who overachieve their quota.

Tiered Commission Structure with Accelerators

Some comp plans have accelerators, which is the simplest form of a tier. Accelerators usually apply after a rep hits their base quota for the quarter as a reward for exceeding targets. An accelerator model might look like this:

Tier 1: 10% of bookings up to quota of $250K
Tier 2: 15% of bookings over quota of $250K

Under this plan, Jim would still earn 80% ($20K) — but Dwight’s payout would be different. His calculation would look like this:

$250K × 10% = $25K
$25K (the amount over quota) × 15% = $3,750
Total = $28,750

For 110% attainment, he’s paid out $28,750 ÷ $25,000 = 115%

Tiered Commission Structure with Additional Tiers

Now let’s spice it up a little bit more and add another tier:

Tier 1: $0 to $250K = 10%
Tier 2: $250K to $300K = 15%
Tier 3: > $300K = 20%

Under this plan, Jim and Dwight would earn the same commission as in the previous plan for their $200K and $275K of bookings for the quarter.

But let’s consider another salesperson, Phyllis. She is at the top of the leaderboard and closed $325K!

With no tiers, she’d make:

$325K × 10% = $32,500

With the two tier plan, she’d make

Tier 1: $250K × 10% = $25K
Tier 2: ($325K – $250K) × 15% = $11,250
Total = $36,250, or $36,250 ÷ $25,000 = 145%

And with the three-tier plan, Phyllis would take home:

Tier 1: $250K × 10% = $25,000
Tier 2: $50K × 15% = $7,500
Tier 3: $25K × 20% = $5,000

Total: $37,500, or $37,500 ÷ $25,000 = 150%

Comparing Payouts for Different Plans

Let’s do one more example. Imagine Stanley had a record-breaking quarter and closed $500K worth of business. Depending on the plan in place, he would receive significantly different payouts.If we do each calculation for him, he’d earn:

Plan A (1 tier): $500K × 10% = $50K
Plan B (2 tiers): ($250K × 10%) + ($250K × 15%) = $62.5K
Plan C (3 tiers): ($250K × 10%) + ($50K × 15%) + ($200K × 20%) = $72.5K

Under this plan, for closing 200% of quota, Stanley would earn $72.5K ÷ $25K = 290%

Advantages and Disadvantages of Tiered Commission Structures

We’ve covered the “what” of tiered commission structures. But what about the “why”?

Why bother to set up these tiers? What are the advantages and disadvantages of tiered commission structures or comp plans?

Disadvantages

First let’s start with the disadvantages. The primary disadvantage of a tiered commission structure is that it’s more complicated than a straight commission structure with no tiers.

For some reps — especially less experienced reps — it might be more difficult for them to calculate their expected commissions. When this happens, many of the motivational advantages of a tiered plan are lost. To combat this, a good sales leader will make sure to provide a worksheet like this one that reps can reference to easily see what their commission would be at different levels of attainment.

Advantages

Tiered commission structures also have many benefits, to both sales executives as well as to sales leadership and the organization.

For the sales rep, the most obvious advantage is that reps who exceed quota can earn significantly more money. And great reps expect to earn great compensation!

Plus, at most sales orgs the top reps consistently bring in a disproportionate amount of the team’s bookings. Tiered plans ensure that they are handsomely rewarded for their efforts. Top reps will almost always be heavily sought after and recruited by other organizations. Aggressively tiered compensation structures can help to reduce the changes that top reps will leave for a different company.

At many companies, top earners can exceed $1 million a year! It’s common that these outsized commission checks are based on a tiered comp structure.

Lastly, tiered compensation plans help to align the incentives of the company with the incentives of the sales rep — especially when it comes to pulling in as many deals as possible, as soon as possible.

If a rep can close another deal after they’ve already hit quota, they are more likely to reach high comp tiers, which means that they’ll earn more on that deal than if they let it slip into the next quarter. Because of this effect, tiered compensation plans are one of the best ways to prevent reps from “sandbagging” deals, or letting a deal that could have closed in one quarter slip to the next one.

What kind of compensation plan is right for your sales org?

Typically, a smaller or younger sales team is best served by a simple compensation plan. The clear bookings target works best for those sales orgs.

However, once a company grows and the sales team grows in size, it’s definitely worth considering the benefits of a tiered structure. While there is certainly more complexity, larger sales teams will often decide that the benefits are worth the costs.