One of the biggest challenges in selling Cloud-based solutions is getting your salespeople to sell it. As you will quickly discover, your perpetual license sales compensation plan actually works against you in the Cloud.
The reason is simple. With a perpetual license the salesperson gets a big commission up-front. When selling a month-to-month subscription-based license the salesperson might get paid based on $99 per user per month.
Not exciting at all for salespeople. But what to do?
The ideal solution is to set up a separate Cloud sales team, but for many reasons this may not be practical or financially possible. One option would be to set up a quota for on-premise sales and a separate quota for Cloud sales…and the salesperson must hit both to meet their targets. Some companies that use the same salesperson for Cloud and on-premise, same-size the commissions, in other words, paying the salesperson the on-premise commission whether they sell a perpetual license or subscription. This is done to avoid salespeople pushing a prospect to buy on-premise when they really want the Cloud version, just to get a bigger commission. The risk is that the prospect takes their business to a vendor that is happy to sell them the Cloud solution.
However, commissions are rarely the same for perpetual and subscription licenses. The industry standard for monthly subscriptions is to pay the salesperson 100% of the first month subscription fee – 1/12 of the annual contract value is 8.3%, or roughly the standard commission for software sales. This gives the salesperson an up-front commission.
With these types of front-loaded commissions, you can quickly see that renewals are absolutely critical to a successful subscription-based model. Given the cost of the commission and the marketing it took to get a customer to sign (the “Customer Acquisition Costs”), if the customer fails to renew after the first year…or even after the first two or three years…you will have lost money.
With renewals being so important, most pure SaaS companies will split their sales roles. They will have:
• “Hunters” – Responsible for going out and bringing in new customers
• “Farmers” – Responsible for cultivating existing clients to increase number of users and ensure renewals
The farmer typically gets 20 percent of the hunting commission for a straight renewal and 40 percent of the hunting commission for additional revenues added to the subscription during the first year.
EXAMPLE – Subscription of $1,000 per month
• Year 1: Hunter receives a commission of $1,000.
• Year 2: Customer renews at $1,000. Farmer receives a commission of $200.
If the farmer has done a good job of nurturing the account and has managed to double the subscription value to $2,000, the farmer gets an additional $400 for the increase.
But what happens when the hunter closes a longer term contract, say three years? They might expect the same level of commission for each of the three years, or $3,000. In the SaaS world it is typically structured differently, because you will still have the cost of the farmer, who will be nurturing the account. The industry standard is to pay 100% of the normal commission in year one; 60%of the commission for the second year; and 20% for the third year (and every subsequent year on longer contracts). So, on a three-year contract the salesperson would get $1,000 for the first year, $600 for year 2 and $200 for year three, for a total of $1,800.
Of course, all of the above is based on subscription only. For companies also receiving revenue from professional services, other software, hardware or extended services contracts, the compensation structure may have to take other factors into consideration. In such cases, the focus might be on the gross margin contribution from the overall transaction.
By the way, you have heard the phrase, “timing is everything.” Right? Well, this is especially true for SaaS-based sales. With on-premise software, theoretically, it doesn’t matter if a sale closes in January or December. The company books the revenue for the year and collects the cash. The salesperson gets paid their full commission. All is good.
Not so in the SaaS world. Each month of delay in closing a deal is one month of revenue the company will never see. In our example above, if the deal is booked on January 1, the company will see $12,000 by the end of the year. Book it on December 1, and the deal will be worth about $1,000 for the year. All to say…compensation and performance tracking should be structured to motivate getting deals done sooner rather than later.