Part 8 of 9
We will look at sales compensation from a couple of perspectives. The first is if you decide to use the existing salespeople, but you want them to drive some level of SaaS sales. There are a number of things you can do to influence their behavior.
- Separate quotas. Give them a specific quota for perpetual licenses and SaaS subscriptions, both of which become KPIs they have to meet. The challenge with this approach is they are likely to continue selling what they are comfortable selling and will try to exceed their quota for on-premise to compensate for not hitting the SaaS quota. When/if separate quotas don’t work, the next step is to…
- Adjust the commission structure. Reduce the commission on the project or on-premise sales until they retire the SaaS quota. For example, let’s say the salesperson gets a commission of 8 percent and has a quota of $2 million for projects and $250,000 for your SaaS solution. Reduce the commission for project sales to 4 percent until they hit the $250,000 SaaS quota, and only then do they get the normal 8 percent. You will find they will work as hard as they can to retire the SaaS quota, then focus on selling projects for the rest of the year.
- No deal-based commissions. This is not a major trend by any means, but it is surprising to see how many companies have moved away from paying commissions based on specific transactions. They implement quarterly bonuses based on a number of KPIs, which could include revenues, renewals, customer satisfaction, etc.
Now let’s look at compensation models for salespeople selling only subscriptions. Compensation should always be tied to the value a salesperson brings to you as an organization. For a SaaS company, this usually comes down to one or a combination of:
MRR – Monthly Recurring Revenues
ACV – Annual Contract Value
TCV – Total Contract Value
However, many ISVs have complex solutions that require services. When service revenues greatly exceed the license value, focusing only on subscription revenues won’t align compensation with the value of the client relationship. Compensating on the gross margin or the total deal size would be a better option.
Another metric often seen with fast-growth SaaS companies is compensation based on net-new logos rather than revenues. Many solutions are sold using a “land and expand” strategy. Salesforce.com is an example of that. A lot of their sales have been to individuals in large companies with the objective of getting more and more people within the same company to use it, until it gets adopted as the overall corporate solution.
This should impact compensation. It is better for a company to have 100 clients generating $1000 each in revenues than two clients generating $100,000 each. So paying commissions only on the revenues won’t lead to the best outcome.
Sales compensation is a complex topic involving a wide range of variables. You would be advised to research this question more deeply. However, there is a commission formula that is used quite widely.
For contracts with a duration of one year or less, whether it is month-to-month or locked in for 12 months, the industry standard for monthly subscriptions is to pay the salesperson 100 percent of the first month subscription fee – 1/12 of the annual contract value is 8.3 percent, or roughly the standard commission for software sales.
The farmer would get 20 percent of the hunting commission for a straight renewal. However, you also want the farmer to actively expand the use of the product, so they would typically get a commission equal to 40 percent of the sales commission for the first year of expanded use, e.g., more users from the same company. This would go back to 20 percent for renewals after the first year.
By way of example:
- If the hunter brings in a subscription of $1,000 per month, a commission of $1,000 is paid.
- If the contract renews for the same amount at the end of the first year, the farmer gets a renewal commission of $200.
- If the farmer does a great job and doubles the subscription to $2,000, a commission of $600 is paid. That’s $200 for the $1,000 renewal and $400 for the $1,000 increase.
What do you do with longer term contracts? This is where the metric changes from MRR (monthly recurring revenues) or ACV (annual contract value) to TCV (total contract value). If you sign a three-year subscription and maybe even collect the entire amount up front, the salesperson will expect to receive a full commission on the full amount, as they would if they were selling an on-premise license.
The industry standard is to pay 60 percent of the regular commission for the second year and 20 percent for the third and following years. In some respects, the hunter is also the farmer since the renewals are baked into the contract, so they get the renewal fees.
In the example of a $1K-per-month subscription, they get $1,000 for the first year, $600 for the second year and $200 for the third and any additional years. There are a couple of reasons for the digressive commission:
- You are still likely to pay a farmer for managing the account.
- Longer term contracts, and especially up-front payments, usually involve an extra discount to the customer. It is a business decision the vendor and client agree on and isn’t always fully attributable to the salesperson.
Since it is a longer-term commitment, the hunter is also the farmer.
At the end of the day, you have to decide what is important to you. If you really want to get longer term contracts, then you might want to pay a bigger percentage, maybe even the full commission, for the extended term.
Setting quotas for SaaS subscriptions is different from project sales or perpetual license sales. A simple formula for setting the quota is to use an OTE (On-Target Earnings) multiplier, which is usually 6-8 times the on-target compensation. For example, if an inside salesperson is expected to have fixed and variable earnings of $100,000 and the multiplier is 6, then the annual quota would be $600,000 in annual recurring revenues.
The quota measurement is usually the recurring revenues that will be generated – not the amount actually collected. For projects or on-premise software it’s easy. If their quota is $1 million, then that is the amount they sell and you collect from their customers.
But with subscriptions the revenues build up over time, so salespeople get quota credit for the annual contract value. For example, if they sell a subscription paying $5K per month, they get quota credit of $60K, even if the money hasn’t been collected.
For projects and perpetual licenses the timing of revenue collection isn’t really critical. A salesperson with a $1M quota could take it easy for the first half, then work overtime during the second half to hit their quota. If they close everything in December, they still hit their number, the company collects the money and books the revenues. Not an ideal scenario, for sure, but manageable.
With SaaS though, it is really important to book the deals as quickly as possible. If the salesperson waits until December to close all of their deals, the company has lost a full year of revenues – revenues that will never be recovered. For this reason, quota tracking and compensation is structured to motivate the sales team to get deals done sooner rather than later. There are a couple of approaches, which are variations on the same theme.
The first one tracks the progress measured against the annual quota with a lower commission rate for the first 25 percent of quota achieved. The commission percentage increasing as they get closer to their quota. For example, they might get 25 percent of their normal commission for the first 25 percent of their quota, so instead of getting a full month subscription revenue as their commission, they only get 25 percent of it. Once they hit 50 percent of their quota, whenever that is during the year, their commission goes to the normal percentage, and they get a 50 percent accelerator once they hit 75 percent of their quota. A really good salesperson who hits 75 percent of their quota in the first quarter, would get a 50 percent bonus on everything else they close that year. A lousy salesperson who stays below 25 percent of their annual quota for most of the year gets penalized, and will probably want to find something else to do.
The second method breaks the yearly quota into quarters. The commission is based on how well they do measured against the quarterly number. Again, good performers get rewarded and poor performers get penalized.
Previous blogs in this series
- Every SI should be an IP company
- Repeatable IP – strategic or opportunistic?
- Overcoming the cash flow chasm
- Managing customer acquisition costs (CAC)
- Minimizing churn
- How marketing changes for SaaS solutions
- Building the right sales organization
- Customer support
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