Direct Sales, MLM and Affiliate Compensation Plans Explained

Besides having a solid product and professional corporate management, company compensation plans are the key to company longevity and representative success.

Some industry terms make the compensation plans seem more complicated than they are. On the other hand, an overly complicated compensation plan with a series of pay blocks and hurdles should be an immediate red flag.

Comp plan terms such as unilevel, binary, matrix, breakaway, recurring commission and revenue share each describe a basic method for determining who is paid, what activity generates compensation and which requirements must be met before a commission is earned.

Some plans primarily reward personal sales. Others add commissions based on the sales activity of a team or downline. Affiliate programs generally compensate participants for referring customers or generating a defined action without requiring the affiliate to carry inventory or build a sales organization.

No compensation structure guarantees that participants will earn money. The plan explains how compensation is calculated, not whether a viable business exists. Actual results depend on customer demand, product pricing, operating expenses, qualification requirements and the participant's ability to generate profitable sales.

Retail Profit

Retail profit is one of the simplest forms of direct-sales compensation.

A representative purchases a product from the company at a discounted or wholesale price and sells it to a customer at a higher retail price. The difference is the representative's gross retail profit.

For example, if a representative purchases a product for $30 and sells it for $45, the gross retail profit is $15.

That does not necessarily mean the representative earned $15 in net profit. Shipping, samples, payment-processing fees, advertising costs and unsold inventory can reduce the actual return.

Some direct-sales companies no longer require representatives to purchase and resell products themselves. Instead, the company processes the customer order and pays the representative a retail commission.

Personal Sales Commission

Under a personal sales commission plan, the representative earns a percentage of the sales generated directly through their efforts.

If the commission rate is 20% and the representative produces a $100 customer order, the commission would be $20 before expenses, returns and other adjustments.

Commission rates may increase when the representative reaches specified monthly sales thresholds. A company might pay 20% at the first sales level, 25% after a higher threshold and 30% after another.

This type of arrangement is common in traditional direct sales, affiliate programs and independent sales-agent relationships.

The important question is whether the commission is based on genuine customer sales or on purchases made by the representative.

Party Plan Compensation

A party plan is primarily a sales method rather than a distinct mathematical compensation structure, but it has historically been one of the most recognizable forms of direct selling.

A representative conducts an in-person or online event where products are demonstrated and sold. The representative earns retail profit or commissions from orders placed through the event.

The host may receive free products, discounts or other rewards based on total event sales.

Some party-plan companies also allow representatives to recruit additional sellers and earn commissions from their team activity.

Unilevel Compensation Plan

A unilevel plan allows each representative to personally recruit as many people as the company permits on the first level of the organization.

Those recruited by the first level appear on the second level. Their recruits appear on the third level, and the structure continues downward.

A simplified unilevel organization might look like this:

The representative may earn a percentage of qualifying sales volume produced across several levels.

The percentage often declines at deeper levels. A company might pay a higher percentage on the first level and progressively smaller percentages on subsequent levels.

Unilevel plans are relatively easy to understand because there is generally no fixed limit on the number of people who can be placed directly beneath one distributor.

Binary Compensation Plan

A binary plan places two sales-team legs beneath each distributor: a left leg and a right leg.

New recruits are placed somewhere within one of those two legs. Each leg can continue expanding through the recruiting and sales activity of multiple participants.

Commissions are commonly based on sales volume produced in both legs. The company may calculate payment according to the weaker or lower-volume leg, sometimes referred to as the pay leg.

For example, if one leg produces 10,000 points of qualifying volume and the other produces 6,000 points, the commission calculation may be based on the 6,000-point leg.

Binary plans encourage distributors to develop both sides of the organization rather than relying on a single large team.

They can also become more difficult to evaluate because unpaid volume may carry forward, reset or expire depending on the company's rules.

Matrix Compensation Plan

A matrix plan limits both the width and depth of the organization used for certain commission calculations.

A 3-by-5 matrix, for example, may allow three positions on the first level and pay through five levels.

Once the first level is full, additional recruits may be placed beneath other distributors in the matrix. This is sometimes promoted as spillover because a distributor may receive participants placed into the organization by someone above them.

Spillover does not guarantee commissions.

The people placed into the matrix still need to generate qualifying activity, and the distributor may need to satisfy personal sales, recruiting or volume requirements.

Matrix plans can encourage cooperation within a sales organization, but their fixed structure can also limit where new recruits are placed and how quickly certain positions are filled.

Stairstep Breakaway Plan

A stairstep breakaway plan allows representatives to advance through a series of sales and leadership ranks.

As a representative's group reaches higher sales thresholds, the representative may qualify for a larger commission percentage.

Eventually, a successful distributor or team may reach a rank at which it "breaks away" from the original group for certain commission calculations.

The original sponsor may then receive a smaller leadership or override commission on the breakaway group rather than the same percentage previously earned.

This structure was historically common among large, established network-marketing companies.

It can reward the development of independent leaders, but it is generally more difficult to explain than a straightforward retail or unilevel plan.

Generation Compensation Plan

A generation plan commonly divides a downline into leadership groups known as generations.

A generation may begin with one distributor and continue downward until another distributor reaches a specified leadership rank. That newly qualified leader begins the next generation.

The person above may earn a percentage of qualifying volume from several generations.

A generation is therefore not necessarily the same as one ordinary recruitment level. A single generation may include multiple levels of distributors before another qualifying leader appears.

Generation plans are often designed to reward distributors who develop and support several independent leadership organizations.

Board or Cycle Plan

A board or cycle plan places participants into a small, fixed structure. When enough positions are filled or sufficient qualifying activity occurs, the board may split or cycle, and a participant may receive a payment.

These plans are frequently presented using terms such as boards, tables, circles or cycles.

The critical issue is the source of the money used to fund participant payments.

If compensation depends primarily on new participants paying to enter the structure rather than on sales to genuine customers, the program may raise serious pyramid-scheme concerns.

The diagram itself does not determine whether the program is legitimate. The underlying customer sales, economic substance and source of compensation matter far more than the shape of the structure.

Hybrid Compensation Plan

Many modern MLM companies use hybrid plans that combine elements from several compensation structures.

A hybrid plan might include:

Hybrid plans can provide several potential sources of compensation, but they can also make the opportunity more difficult to evaluate.

When a plan contains numerous bonuses, identify which forms of compensation are realistically available to an ordinary participant and which require a high rank attained by only a small portion of the sales force.

Rank Advancement Bonuses

Many direct-sales and MLM plans include bonuses for reaching a new rank.

A representative may receive a one-time cash bonus, increased commission rate, product credit, travel award or access to an additional component of the compensation plan.

Rank advancement commonly requires some combination of:

Reaching a rank once may not be sufficient. Some companies require representatives to maintain the qualifications each month to continue receiving the related commissions or benefits.

Leadership Pools

A leadership pool sets aside a percentage of company sales or commissionable volume to be shared among qualifying distributors.

For example, a company might allocate 1% of eligible sales to a pool and divide it among participants who hold a particular rank.

The amount each participant receives depends on the size of the pool, the number of qualifiers and the company's allocation formula.

Leadership pools can sound substantial during a presentation, but participation is usually limited to higher-ranking distributors.

Fast-Start Bonuses

A fast-start bonus rewards a sponsor for the early sales or purchases associated with a newly enrolled representative.

The bonus may apply only during the new representative's first several weeks or months.

Fast-start bonuses are intended to encourage recruiting and early sales activity.

Before evaluating one, determine whether the bonus is based on retail customer sales, a starter package purchased by the recruit, recurring product orders, or some combination of these.

Matching Bonuses

A matching bonus pays a distributor an amount based on commissions earned by personally recruited distributors or other qualified team members.

If a team member earns a $500 commission and the sponsor qualifies for a 10% match, the sponsor may receive $50.

Matching bonuses are generally presented as compensation for leadership, training and support rather than simply for adding new participants.

Qualification may require a particular rank, minimum personal volume or a specified number of active team members.

Affiliate Pay-Per-Sale Programs

Pay per sale is the most familiar affiliate compensation structure.

An affiliate promotes a product or service using a unique tracking link. When a visitor follows the link and completes a qualifying purchase, the affiliate earns a commission.

The commission may be:

For example, an affiliate program might pay 10% of a $200 sale, producing a $20 commission.

Unlike a traditional direct seller, an affiliate usually does not purchase inventory, process the transaction, fulfill the order or provide the primary customer service.

Affiliate Pay-Per-Lead Programs

A pay-per-lead program compensates an affiliate when a referred visitor completes a specified action without necessarily making a purchase.

A qualifying lead might involve:

The affiliate may receive a fixed amount for each valid lead.

Programs usually define what constitutes a qualified lead and may reject duplicates, fraudulent submissions or leads that fail to meet stated requirements.

Affiliate Pay-Per-Click Programs

Under a pay-per-click arrangement, an affiliate earns a small amount when a visitor clicks a qualifying advertisement or link.

No purchase or completed lead may be required.

This model is less common in conventional retail affiliate programs because the advertiser assumes more of the conversion risk.

Payments per click are generally much smaller than commissions paid for completed sales or qualified leads.

Flat-Fee or Bounty Programs

A bounty program pays a fixed amount when a referral completes a defined action.

For example, an affiliate might receive:

The payment does not necessarily change with the value of the customer's purchase.

This model is common when the advertiser understands the approximate value of a new customer and wants a predictable acquisition cost.

Recurring Affiliate Commissions

Recurring commission programs pay the affiliate while the referred customer continues paying for a subscription or service.

This structure is common with software, memberships, web hosting and other subscription-based services.

An affiliate might earn 20% of the customer's monthly payment for a limited period or for as long as the customer remains active.

Recurring commissions can create continuing revenue from earlier referrals, but payments usually stop when the customer cancels, fails to pay or no longer satisfies the program's terms.

Multi-Tier Affiliate Programs

A multi-tier affiliate program allows an affiliate to earn not only from personal referrals but also from the activity of other affiliates they introduced to the program.

For example, an affiliate might receive:

This resembles a limited network-marketing structure, but multi-tier affiliate programs are usually shallower and do not include the extensive rank, qualification and downline systems found in many MLM plans.

The central question remains what produces the compensation. A legitimate affiliate program should primarily reward completed sales, qualified leads or other commercially valuable customer actionsâ€"not enrollment by itself.

Hybrid Affiliate Programs

Affiliate programs can also combine several payment methods.

An affiliate might receive a fixed fee when a customer opens an account, a percentage when the customer makes a purchase and recurring commissions if the customer maintains a subscription.

Some programs increase commission rates when an affiliate reaches higher monthly sales thresholds.

These arrangements can reward strong performance without requiring affiliates to recruit or manage a downline.

Direct Sales Compared With Affiliate Marketing

Direct sales and affiliate marketing overlap, but they are not identical business models.

A direct seller may:

An affiliate usually:

Some companies use elements of both models. A participant may earn retail commissions from customer referrals while also participating in a team-based compensation structure.

The Compensation Plan Is Only Part of the Opportunity

A compensation plan can explain how commissions are calculated, but it cannot determine whether the business opportunity is economically sound.

Before joining any direct-sales, MLM or affiliate program, also consider:

A simple compensation plan is not automatically a good one.

A complicated plan is not automatically a bad one.

The most important question is not how many bonuses appear in the presentation.

It is whether the plan rewards profitable sales to genuine customers through a structure that an ordinary participant can understand, evaluate and realistically pursue.

Compensation-plan terminology and rules vary by company. This article provides a general explanation and should not replace the actual compensation plan, distributor agreement, affiliate agreement or income disclosure issued by a specific company.