[ForEntrepreneurs] Cloud/SaaS Sales Compensation: How to Design the Right Plan

We have great expertise in supporting organization in their management and transformation journey and in setting the best incentive plans. We offer a portfolio of innovative recruitment support services (social profiling) and some B2B/enterprise sales training as well. Our capabilities are proven by the appreciation of our customers. Let’s have a talk!

On this subject, here is an article about cloud/SaaS incentive plans: Sales compensation is a more complex topic for SaaS/subscription revenue companies. Unlike traditional software sales, the job of sales doesn’t end when a new customer signs a contract. Instead, it is crucial to retain customers over many years, as that is how you maximize your revenues. In this blog post we will explore how to design sales compensation plans that help drive the right behaviors.

While much has been written about sales compensation, we have heard enough requests for help on these topics, that we thought it was worth putting together an in-depth discussion and “how-to” type guide.

The Guiding Principle

When we’re designing sales compensation, the goal is to align sales behaviors with the desired business objectives. Therefore, the process should start with identifying your key business objectives.

What are the key business objectives for a SaaS business?

The primary business objectives related to sales are usually some combination of:

• Book as much new recurring revenue as possible.
• Collect as much cash upfront as possible. (Particularly important in the startup phase where cash is in short supply and expensive to raise).
• Sign longer term contracts (e.g. annual terms vs. monthly, multi-year vs. annual)
• Make sure customers are happy after purchase so they will remain long term customers.
• Drive the maximum renewal rate.
• Drive expansion revenue with existing customers to have a revenue retention rate of greater than 100%, even when you lose some customers due to churn.
  • (We often refer to this as “negative churn”. Since this is a crucial concept for success in SaaS, if you are not already familiar with it, we would highly recommend that you read this blog post: SaaS Metrics 2.0.)

Secondary objectives

Beyond these primary objectives, there are likely some secondary objectives:

• Add as many new logos as possible.
• Optimize deal size (sometimes worth trading this off for faster sales cycles, and then expanding after getting in the door).
• Drive a specific product mix: i.e. selling a new product that has just been added to the product line.
• Drive gross margins as high as possible.

Other objectives

And there may be other objectives that might matter in the early days of a startup, such as:

• Sign up accounts that are willing to be references.
• Sign up a particular type of customer: i.e. larger customers, well recognized brands, customers in a specific new vertical, etc.
• Reward sales reps that don’t discount too much to win deals.
• Get a consistent flow of bookings, as opposed to a few very large deals that are unpredictable in timing and certainty of closing.
• Get a large number of customers quickly to maximize market share, which might be done at the expense of optimizing the deal size.
• Land and expand: use a low entry deal size to break into accounts, and then expand once you have a foot in the door.
• etc.

The point we’re trying to make here is simple: it helps to write down and prioritize your business objectives so you can drive the sales compensation accordingly.

Keep Sales Compensation Simple

While the thinking behind the comp plan may not be simple, it is important to keep the plan itself as easy to understand as possible. The sales reps need to easily understand the plan, and it should be very obvious how to behave to get the best rewards.

Marcus Bragg, SVP of WW Sales and Customer Success at Zendesk, advises “Hopefully you have no more than two to three major drivers of the variable commission.”

It’s OK to then layer on top of that one or two SPIFFs to incent some additional, but secondary objectives.

Designing Sales Comp to Drive Desired Behaviors

The primary element of sales comp is the variable piece. Here are the components that will likely drive that:

New sales

Usually the biggest part of sales comp goes to finding and winning new accounts. This is typically rewarded in the form of a commission paid on MRR (monthly recurring revenue) or ACV (annual contract value). When paying on MRR or ACV you are paying commission ahead of when you can recognize the revenue which is a risk if a customer churns before the contract is up. An alternative approach is to pay salespeople when the cash is received but this can be confusing and difficult for sales reps to track.

Note: ACV is different to TCV (total contract value) when you have contracts longer than one year. It is rare to see full commission paid on TCV unless the whole amount is paid in cash up front.

The importance of gross margins

Focusing only on bookings, ignoring gross margin, may help to keep things simple in the early days of a SaaS startup. But as the company starts to scale, the impact of good gross margins will become very important. In a SaaS company the cost of goods sold includes not only the cost of running the software (e.g. Amazon AWS bill), but also the costs of providing on-boarding and support. In certain companies, sales can’t affect this, so it’s not worth complicating their compensation by factoring in gross margin. But in other companies, sales can affect gross margins, e.g. by selling to customers that do not require a lot of support, and selling less professional services, etc.  In the latter situation, you may consider paying lower commission on low margin products such as professional services, or simply paying commissions on the gross margin dollars, instead of the total booking.

Reward your winners / penalize your losers

High performing salespeople are very profitable for the company, and underperformers are usually expensive. When a sales rep sells beyond their quota, this really drives profits for the organization. Base salaries remain fixed, so all new revenues above quota will have a much higher return. There is also an opportunity cost of underperforming reps taking up valuable sales slots. The goal is to reward behaviors that separate the top salespeople from the average ones.  The classic way to do this is with accelerators – i.e. the commission rate gets higher after the rep has exceeded quota. This can really drive performance. Another less common approach, which not only rewards your winners, but also penalizes your low performers, is to have graduated commission rates that start low.  If you want to push performance even higher, you might want to consider a tiered accelerator model. With a tiered approach, the first-tier is set at a point where the majority of the company’s sales reps historically attained (i.e. 100-110%), the second-tier is set at a point reached by a much smaller percentage (i.e. 110-125%), and the third-tier target at a point hit only by a small percentage (>125%). David McNeil of HubSpot comments “we combined the top tier accelerators with President’s Club and stock awards over 125% and it really drove over performance”.

Accelerators and other awards can also help attract other top talent. It can be a big help to recruiting to have some stories floating around of reps who have made big money and award trips by exceeding quota.

This blog post describes an approach used by Gary Messiana, former VP Sales and CEO of Netli that does exactly that. And this plan used by Jason Lemkin of Saastr has a similar approach of penalizing the low performers.

Expansion bookings

You will also want to incentivize expansion bookings through upsell and cross sell. Our SaaS survey shows that it can be about five times cheaper to get expansion revenue than new revenue, which would mean you can pay a lower commission rate for expansion revenue. But this can vary greatly from company to company, and your own situation needs to be thought through and commission set accordingly. You may even decide to separate who is upselling vs cross selling. There is no right or wrong here – it will depend on the nature of what you are selling and the best way to get it sold.

Renewals

Who is responsible for making sure customers renew? At the highest level, the answer to this question is many different groups, including on-boarding, customer success, product management, development, Q&A, operations, etc. But, to actually get the renewal contract signed, most SaaS companies will use their Account Managers. Renewals are typically paid a much lower commission than new sales.

Here are the relative commission rates our survey found:

Median commission rates by type of sale

Source: 2015 SaaS Survey

(1) Same rate (or higher) as new commission sales

Note: Paying commissions on a combination of new business, add on sales, and renewals can be confusing so keep it simple and design a compensation plan that aligns to primary business objectives. You can use other tactics such as spiffs, awards and (or) promotion criteria to drive alignment with secondary objectives.

SPIFFS to incent specific additional business goals

Beyond quota based commissions, it is very common for SaaS companies to use extra incentives to drive specific business goals. The most common business goals rewarded in this way are collecting more cash upfront and multi-year contracts. While all revenue is good, collecting cash up front can really help cash flow. At one post-Series A company we work with, salespeople got an additional 2% if the customer paid for 12 months in advance, and 2% on top of that if they closed a 24-month or longer contract. Incentives can also be cash bonuses. Another company we work with offered a $2,000 bonus to anyone who closed a deal with one of the “target logos” they wanted to add to their website.

Non-cash rewards

Also keep in mind, incentives do not always need to be cash-based awards. The traditional “President’s Club” type vacation awards continue to be used for good reason – they are strong, very public motivators. We’ve also seen companies, especially those with more team-oriented sales orgs, get good results offering team based rewards like group parties or outings. A good steak dinner or a staff party after hitting a quarterly team goal can help build enthusiasm and team spirit.

Unit Economics for the Sales Person

As a very rough guide, when your sales process starts to work well, quotas should be at least 5x the OTE (On Target Earnings), which includes base salary + bonus. Ideally quotas are 6-8X OTE to be considered high performing. These are guidelines we’ve observed based on empirical data from a number of successful companies we’ve worked with. But, this is just a guideline. The complexity and difficulty of your sale will determine the ratio your business can support.

Matt Bertuzzi at The Bridge Group shared this graph showing the relationship between quotas and OTE:

But, it’s worth noting that because many of the respondents to this survey were early stage startups, the numbers here are lower than you might expect and there is significant divergence.

How Sales behavior Can Drive Higher Revenue Retention

A common view of sales is that they should be responsible for signing up new accounts, and let the rest of the organization worry about how to retain that customer. But you will quickly find that this way of thinking has negative consequences on your churn rate/revenue retention.

Here are four sales behaviors that you may want to incent to avoid these issues:

Don’t oversell

It is easy for sales to oversell a customer, in a way that the product cannot deliver, which will lead to an unhappy customer who will churn quickly. While you have a contract, you have very little leverage should they decide to break the contract. So sales commissions need a penalty for this situation. If commissions are paid upfront, we typically see this in the form of a clawback when a customer churns. This creates the right disincentive so that sales people don’t oversell or sell to the wrong customers where there is not a good fit.

Sell to the right types of customers where the product is a good fit

You may also find that there are certain types of customers that are the right fit for the product and vision, and have lower churn.

Sell the sticky feature/module

In the early days while you are still refining product/market fit, you may discover that your product is not sticky unless the customer implements a specific feature/module. In this case, customers who purchase that additional module will be far more valuable over their lifetime than the other customers who will likely churn faster. So naturally you would incent your salespeople to optimize sales to customers who purchase and implement that module.

Sell to the most valuable customer segments

Your most valuable customers will have a high LTV:CAC ratio, and a short time to recover CAC. To get high LTV, we are are looking for customers that have a high ACV, low churn, and a high potential for expansion revenue. If you are able to identify a particular segment that has these characteristics, and it doesn’t cost too much to sell to them, then they are your optimal segment.

Sales Comp Should Change as Business Objectives Change

As you have probably realized while reading this, your business objectives are going to change as new challenges emerge and priorities shift. This means you will want to adapt your sales comp plans to keep them aligned. For example, if your company is doing really well at signing up new customers, but these customers are churning out very fast, then your top priority may be retaining customers and driving renewals, with new customer signups falling slightly behind this. Or, you may be launching an additional product, and want to get your salespeople to shift some of their efforts to selling this in addition to the existing product. A balanced approach is important, you don’t want to create a plan that shifts the focus too quickly. For example, paying a 2x rate on a new product that is not ready to sell could impact core product growth, or paying commissions on up-sell could slow down new business acquisition. Always make sure you have checks and balances built into the compensation plan (i.e. minimum new business dollar thresholds before accelerators are paid) to mitigate the risk of shifting too quickly to something new.

Sales comp in the very early days

While you are still searching for product/market fit, you’ll need “first-in” salespeople who can help you figure out the sales process, rather than just maximize the number of sales. You need someone who is passionate about the product and can help you figure out such areas as:

• Which customer segments to focus on?
• Who to sell to in the organization?
• What problem are you solving for them?
• What message?
• What missing product features are needed to solve the problem fully?
• What pricing?

This is usually not your typical salesperson, but rather someone who is very entrepreneurial and can troubleshoot each potential sale, referring issues back to the product team. And since revenue is both low and unpredictable, you may want to pay a higher base and less variable compensation at this stage. Justin Roberts, the Vice President of Sales at Lever, a Matrix portfolio company, says:

“In the early stages, I like to keep compensation very straightforward, emphasizing base and equity and investing primarily in learning what is holding each sale back.”

Conclusion

Sales compensation is a more complex topic for SaaS/subscription revenue companies. Unlike traditional software sales, the job of sales doesn’t end when a new customer signs a contract. Instead, it is crucial to retain customers over many years, as that is how you maximize your revenues. In this blog post we will explore how to design sales compensation plans that help drive the right behaviors.

While much has been written about sales compensation, we have heard enough requests for help on these topics, that we thought it was worth putting together an in-depth discussion and “how-to” type guide.

The Guiding Principle

When we’re designing sales compensation, the goal is to align sales behaviors with the desired business objectives. Therefore, the process should start with identifying your key business objectives.

What are the key business objectives for a SaaS business?

The primary business objectives related to sales are usually some combination of:

• Book as much new recurring revenue as possible.
• Collect as much cash upfront as possible. (Particularly important in the startup phase where cash is in short supply and expensive to raise).
• Sign longer term contracts (e.g. annual terms vs. monthly, multi-year vs. annual)
• Make sure customers are happy after purchase so they will remain long term customers.
• Drive the maximum renewal rate.
• Drive expansion revenue with existing customers to have a revenue retention rate of greater than 100%, even when you lose some customers due to churn.
  • (We often refer to this as “negative churn”. Since this is a crucial concept for success in SaaS, if you are not already familiar with it, we would highly recommend that you read this blog post: SaaS Metrics 2.0.)

Secondary objectives

Beyond these primary objectives, there are likely some secondary objectives:

• Add as many new logos as possible.
• Optimize deal size (sometimes worth trading this off for faster sales cycles, and then expanding after getting in the door).
• Drive a specific product mix: i.e. selling a new product that has just been added to the product line.
• Drive gross margins as high as possible.

Other objectives

And there may be other objectives that might matter in the early days of a startup, such as:

• Sign up accounts that are willing to be references.
• Sign up a particular type of customer: i.e. larger customers, well recognized brands, customers in a specific new vertical, etc.
• Reward sales reps that don’t discount too much to win deals.
• Get a consistent flow of bookings, as opposed to a few very large deals that are unpredictable in timing and certainty of closing.
• Get a large number of customers quickly to maximize market share, which might be done at the expense of optimizing the deal size.
• Land and expand: use a low entry deal size to break into accounts, and then expand once you have a foot in the door.
• etc.

The point we’re trying to make here is simple: it helps to write down and prioritize your business objectives so you can drive the sales compensation accordingly.

Keep Sales Compensation Simple

While the thinking behind the comp plan may not be simple, it is important to keep the plan itself as easy to understand as possible. The sales reps need to easily understand the plan, and it should be very obvious how to behave to get the best rewards.

Marcus Bragg, SVP of WW Sales and Customer Success at Zendesk, advises “Hopefully you have no more than two to three major drivers of the variable commission.”

It’s OK to then layer on top of that one or two SPIFFs to incent some additional, but secondary objectives.

Designing Sales Comp to Drive Desired Behaviors

The primary element of sales comp is the variable piece. Here are the components that will likely drive that:

New sales

Usually the biggest part of sales comp goes to finding and winning new accounts. This is typically rewarded in the form of a commission paid on MRR (monthly recurring revenue) or ACV (annual contract value). When paying on MRR or ACV you are paying commission ahead of when you can recognize the revenue which is a risk if a customer churns before the contract is up. An alternative approach is to pay salespeople when the cash is received but this can be confusing and difficult for sales reps to track.

Note: ACV is different to TCV (total contract value) when you have contracts longer than one year. It is rare to see full commission paid on TCV unless the whole amount is paid in cash up front.

The importance of gross margins

Focusing only on bookings, ignoring gross margin, may help to keep things simple in the early days of a SaaS startup. But as the company starts to scale, the impact of good gross margins will become very important. In a SaaS company the cost of goods sold includes not only the cost of running the software (e.g. Amazon AWS bill), but also the costs of providing on-boarding and support. In certain companies, sales can’t affect this, so it’s not worth complicating their compensation by factoring in gross margin. But in other companies, sales can affect gross margins, e.g. by selling to customers that do not require a lot of support, and selling less professional services, etc.  In the latter situation, you may consider paying lower commission on low margin products such as professional services, or simply paying commissions on the gross margin dollars, instead of the total booking.

Reward your winners / penalize your losers

High performing salespeople are very profitable for the company, and underperformers are usually expensive. When a sales rep sells beyond their quota, this really drives profits for the organization. Base salaries remain fixed, so all new revenues above quota will have a much higher return. There is also an opportunity cost of underperforming reps taking up valuable sales slots. The goal is to reward behaviors that separate the top salespeople from the average ones.  The classic way to do this is with accelerators – i.e. the commission rate gets higher after the rep has exceeded quota. This can really drive performance. Another less common approach, which not only rewards your winners, but also penalizes your low performers, is to have graduated commission rates that start low.  If you want to push performance even higher, you might want to consider a tiered accelerator model. With a tiered approach, the first-tier is set at a point where the majority of the company’s sales reps historically attained (i.e. 100-110%), the second-tier is set at a point reached by a much smaller percentage (i.e. 110-125%), and the third-tier target at a point hit only by a small percentage (>125%). David McNeil of HubSpot comments “we combined the top tier accelerators with President’s Club and stock awards over 125% and it really drove over performance”.

Accelerators and other awards can also help attract other top talent. It can be a big help to recruiting to have some stories floating around of reps who have made big money and award trips by exceeding quota.

This blog post describes an approach used by Gary Messiana, former VP Sales and CEO of Netli that does exactly that. And this plan used by Jason Lemkin of Saastr has a similar approach of penalizing the low performers.

Expansion bookings

You will also want to incentivize expansion bookings through upsell and cross sell. Our SaaS survey shows that it can be about five times cheaper to get expansion revenue than new revenue, which would mean you can pay a lower commission rate for expansion revenue. But this can vary greatly from company to company, and your own situation needs to be thought through and commission set accordingly. You may even decide to separate who is upselling vs cross selling. There is no right or wrong here – it will depend on the nature of what you are selling and the best way to get it sold.

Renewals

Who is responsible for making sure customers renew? At the highest level, the answer to this question is many different groups, including on-boarding, customer success, product management, development, Q&A, operations, etc. But, to actually get the renewal contract signed, most SaaS companies will use their Account Managers. Renewals are typically paid a much lower commission than new sales.

Here are the relative commission rates our survey found:

Median commission rates by type of sale

Source: 2015 SaaS Survey

(1) Same rate (or higher) as new commission sales

Note: Paying commissions on a combination of new business, add on sales, and renewals can be confusing so keep it simple and design a compensation plan that aligns to primary business objectives. You can use other tactics such as spiffs, awards and (or) promotion criteria to drive alignment with secondary objectives.

SPIFFS to incent specific additional business goals

Beyond quota based commissions, it is very common for SaaS companies to use extra incentives to drive specific business goals. The most common business goals rewarded in this way are collecting more cash upfront and multi-year contracts. While all revenue is good, collecting cash up front can really help cash flow. At one post-Series A company we work with, salespeople got an additional 2% if the customer paid for 12 months in advance, and 2% on top of that if they closed a 24-month or longer contract. Incentives can also be cash bonuses. Another company we work with offered a $2,000 bonus to anyone who closed a deal with one of the “target logos” they wanted to add to their website.

Non-cash rewards

Also keep in mind, incentives do not always need to be cash-based awards. The traditional “President’s Club” type vacation awards continue to be used for good reason – they are strong, very public motivators. We’ve also seen companies, especially those with more team-oriented sales orgs, get good results offering team based rewards like group parties or outings. A good steak dinner or a staff party after hitting a quarterly team goal can help build enthusiasm and team spirit.

Unit Economics for the Sales Person

As a very rough guide, when your sales process starts to work well, quotas should be at least 5x the OTE (On Target Earnings), which includes base salary + bonus. Ideally quotas are 6-8X OTE to be considered high performing. These are guidelines we’ve observed based on empirical data from a number of successful companies we’ve worked with. But, this is just a guideline. The complexity and difficulty of your sale will determine the ratio your business can support.

Matt Bertuzzi at The Bridge Group shared this graph showing the relationship between quotas and OTE:

But, it’s worth noting that because many of the respondents to this survey were early stage startups, the numbers here are lower than you might expect and there is significant divergence.

How Sales behavior Can Drive Higher Revenue Retention

A common view of sales is that they should be responsible for signing up new accounts, and let the rest of the organization worry about how to retain that customer. But you will quickly find that this way of thinking has negative consequences on your churn rate/revenue retention.

Here are four sales behaviors that you may want to incent to avoid these issues:

Don’t oversell

It is easy for sales to oversell a customer, in a way that the product cannot deliver, which will lead to an unhappy customer who will churn quickly. While you have a contract, you have very little leverage should they decide to break the contract. So sales commissions need a penalty for this situation. If commissions are paid upfront, we typically see this in the form of a clawback when a customer churns. This creates the right disincentive so that sales people don’t oversell or sell to the wrong customers where there is not a good fit.

Sell to the right types of customers where the product is a good fit

You may also find that there are certain types of customers that are the right fit for the product and vision, and have lower churn.

Sell the sticky feature/module

In the early days while you are still refining product/market fit, you may discover that your product is not sticky unless the customer implements a specific feature/module. In this case, customers who purchase that additional module will be far more valuable over their lifetime than the other customers who will likely churn faster. So naturally you would incent your salespeople to optimize sales to customers who purchase and implement that module.

Sell to the most valuable customer segments

Your most valuable customers will have a high LTV:CAC ratio, and a short time to recover CAC. To get high LTV, we are are looking for customers that have a high ACV, low churn, and a high potential for expansion revenue. If you are able to identify a particular segment that has these characteristics, and it doesn’t cost too much to sell to them, then they are your optimal segment.

Sales Comp Should Change as Business Objectives Change

As you have probably realized while reading this, your business objectives are going to change as new challenges emerge and priorities shift. This means you will want to adapt your sales comp plans to keep them aligned. For example, if your company is doing really well at signing up new customers, but these customers are churning out very fast, then your top priority may be retaining customers and driving renewals, with new customer signups falling slightly behind this. Or, you may be launching an additional product, and want to get your salespeople to shift some of their efforts to selling this in addition to the existing product. A balanced approach is important, you don’t want to create a plan that shifts the focus too quickly. For example, paying a 2x rate on a new product that is not ready to sell could impact core product growth, or paying commissions on up-sell could slow down new business acquisition. Always make sure you have checks and balances built into the compensation plan (i.e. minimum new business dollar thresholds before accelerators are paid) to mitigate the risk of shifting too quickly to something new.

Sales comp in the very early days

While you are still searching for product/market fit, you’ll need “first-in” salespeople who can help you figure out the sales process, rather than just maximize the number of sales. You need someone who is passionate about the product and can help you figure out such areas as:

• Which customer segments to focus on?
• Who to sell to in the organization?
• What problem are you solving for them?
• What message?
• What missing product features are needed to solve the problem fully?
• What pricing?

This is usually not your typical salesperson, but rather someone who is very entrepreneurial and can troubleshoot each potential sale, referring issues back to the product team. And since revenue is both low and unpredictable, you may want to pay a higher base and less variable compensation at this stage. Justin Roberts, the Vice President of Sales at Lever, a Matrix portfolio company, says:

“In the early stages, I like to keep compensation very straightforward, emphasizing base and equity and investing primarily in learning what is holding each sale back.”

Conclusion

[to continue, click HERE]