The Rise in Variable Compensation in Small Businesses

variable compensation

Small businesses have changed how they compensate employees over the past 40 years. That’s not surprising given all the changes in the economy and society that have occurred since the mid-1980s.

I have written about many of these shifts before:

  • While big companies have always paid more than small businesses, the wage gap between large and small companies has been rising in recent years.
  • Sole proprietors are increasingly replacing employees with contract workers, following the pattern set by larger businesses.
  • Benefits, like the cost of employee health insurance, are comprising a larger portion of small business labor costs than they did 30 years ago.

In my previous columns, I haven’t commented on another long-run trend in small business employee compensation, the rising use of variable compensation.

Internal Revenue Service (IRS) data on the roughly three-quarters of U.S. businesses that operate as sole proprietorships shows that commissions account for a higher percentage of labor costs now than they used to, making up 45.2 percent of those labor costs in 2011, the latest year data are available, as compared with 25.3 percent in 1975.

The shift to commissions occurred primarily in the late 1980s and early 1990s, as the figure above shows. The fraction of sole proprietors’ labor costs that take the form of commissions has fluctuated between the 40 and 50 percent mark since the mid-1990s and is currently well below the peak of 55.5 percent achieved in 1992.

But, between 1975 and 1990, the fraction of labor costs that took the form of commissions increased from 25.3 percent to 38.9 percent.

Image source: Created from data from the Internal Revenue Service

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Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

3 Reactions
  1. Over the span of a long enough and successful career in sales & marketing, in which I have consistently been compensated almost solely by commissions, I note two observations regarding commission based compensation.

    If one is able to negotiate a commission compensation program in which excellent production will deliver excellent compensation, beware the danger of success. I can recall at three instances in which my employers became resentful of the level of compensation they were obliged to fund, despite the obvious fact, that if they owed me more, they were making more. I believe that the translation of this, is that employers like commission based compensation programs, when it means that they will likely pay less than or equal to what they might have to pay under a commission arrangement. But, top producers should expect that resentment factor when they bring in sufficient sales to result in their earning 125% or 150% or more, of what might be construed as typical compensation.

    It is extremely challenging in some industries to come to grips with the peaks and valleys of commissioned sales. Once when I was in my 30’s with plenty of obligations on my plate, and following a previous exceptional earning year, my earnings one year were about 40% of what they were that previous year. Ouch! No way was I prepared for that. For sure, one or two good years of commission earnings, do not guarantee the next.

  2. As long as the commissions are aligning employee incentives with company goals, I think this is a great trend. However, I’ve seen a lot of poorly conceived incentive models that make messy relationships.

  3. Well the variable needs to be adjusted, so that any negative feel or disloyalty towards the company can be averted. As getting compensated for exact need, does helps in making business flow.