Thursday, January 22, 2009

Building Your SaaS Sales Compensation Plan

Compensating the sales force is a difficult task and the key is usually to keep things simple, so that each sales rep knows what he needs to optimize to make more money at the end of the quarter. For SaaS companies, we found that MRR is the best metric on which to base sales commissions. While it may make sense to offer very slight adjustments for favorable payment terms and one time revenue, net additions to MRR should dominate the sales rep’s thoughts. The reps’ top 3 priorities should be (i) MRR, (ii) MRR, and (iii) MRR.

I had the opportunity to exchange on this topic with Gary Messiana, a BVP Entrpreneur-In-Residence and former VP Sales and CEO of Netli and he shared with me the basic structure
he was using at Netli before the company was acquired last year by Akamai.
When he initially built the sales compensation plan, he wanted the sales rep to think MRR and the most logical thing to do was to give $1 of commission for $1 of MRR sold. $1 of MRR generates $12 of annual revenue, so $1 commission equals 1/12=8.3% which is very close to the typical 8% paid for sales commissions.

The second thing he did was to define was the ramp up of the commission rate to make sure the best sales rep would get the most upside. To do that, he applied another simple rule:
  • For 0-25% of the quota, $0.25 commision per $1 of MRR
  • For 25%-50% of the quota, $0.5 per $1 of MRR
  • For 50%-75% of the quota, $1.0 per $1 of MRR
  • For 75%+ of the quota, $1.5 per $1 of MRR

To avoid reps pushing deals from one quarter to the next, the quota was set annually and the compensation rules defined above were based on the annual target instead of a quarterly target. By doing this, the sales reps had a very high incentive to perform during the entire year.

Finally, he added a “continuity rule”. As a CEO, Gary typically based his sales board plan at 70% of sales quota. To ensure he would make his number, he defined a "continuity rule" stating that a rep who is below 70% of its annualized target at any point in the year would be on a “B” plan where he basically gets nothing (may be half or 25% of the “A” plan” defined above).

This simple compensation plan structure worked very well at Netli. The company had the chance of selling a very sticky product to large customers paying upfront, so there was no need to improve the sales bonuses based on cash collection and multi-year contracts. The payment rules were also very straightforward: 50% at signature and 50% at cash collection.

To know whether it is worth adding more complexity to this sales comp plan, you need to ask yourself two questions:

  • Am I better off with a one year contract to preserve my ability to raise the price or do I need multi-year contracts to reduce the churn?

  • What is my cost of capital and how much is worth an incremental upfront payment?

Typically, if you churn is low (98%+ renewal rates), you will tend to favor one-year contract to preserve the flexibility of increasing prices and it is not worth adding incentives to extend the life of the contract. If not, you might want to add some acceleration in the incentive structure to push the sales of longer contracts. If you assume that the cost to renew a contract costs you 20% of the MRR, then adding increasing the commission by 10% for each additional year seems reasonable.

Accelerating bonuses for upfront cash payment depends on your cost of capital. If you assume a 20% cost of capital (typical for equity, debt is generally cheaper), then getting an upfront payment for one additional year on a $10k MRR contract saves you $24k. You can therefore pay an incremental $2k commission to the sales person (20% acceleration) and make it worth it for everyone.

The table below gives you an example on how acceleration could work for a company willing to emphasize the focus on upfront cash payment and contract length:



As a SaaS company matures, it does not want to bog down its top performing sales reps with the job of renewing their growing account bases. So invariably the team splits into hunters for new accounts and farmers for renewals and upsells. Obviously, hunting takes more effort and resource than farming--the Vice-President Sales needs to determine the ratio between the two based on how easy it is to renew an account, and apply that ratio in the sales commissions. For example, $1 of MRR might generate $1 of commission for the first year, and 20 cents for each year of renewal. In this example, the new account sales rep can be compensated for longer term contracts by paying the “hunt commission” for year one and “farm commissions” for subsequent years (e.g. $1.20-1.40 for a three year contract). In this way, the rep will apply the proper attention to closing long term contracts where the risk of churn has been mitigated. Upsells are typically worth more than renewal and less than new customers so we found that 50% of new MRR worked pretty well.

For company with complex UI or usability issue, you might also want to add a small incentive to reward the sales of training module as this will impact churn, but this should be short term fix as your engineering team works hard to improve the product.

I hope this will give you the basic structure to help you build your SaaS sales compensation plan.

32 comments:

Joel said...

Philippe,

Interesting post. I have just finished designing a SaaS comp plan and my thinking is very similar.

The one question I have is how you might adjust it for smaller deal values. 10K/MMR is very very large for most SaaS players and Netli is unique in that it is at a very low level of the software stack. Maybe as similar to selling leased lines as to salesforce.com.

by Joel York
at Chaotic Flow

Lluis Faus @ vLex said...

Really interesting. Thank you for sharing !

Philippe Botteri said...

Joel - thank you for your note. I think most of the principles in this comp plan would apply for smaller deal size, in particular the $1 of commission for $1 of MRR sold. The ramp-up acceleration could also be similar.
If you are selling to very small accounts with a high volume of sales per month, then you might want to set monthly quota instead of quarterly and forget the "A" and "B" plan (annualized target).
The contract length/payment term matrix will also need to be adapted based on the type of products and plans you are offering

I hope this helps,
Cheers,
Philippe

Paul Kamp said...

Excellent article on the actual sales plan and associated incentives. However, it does not mention whether there is a base salary associated with the plan and if so what it is.

I'd appreciate any comments on how this would change as a base salary is added to the mix.

Michael said...

Philippe,

Nice structure! We had been doing things much more complicated then this.

Thanks Again

Michael Kassing
MarkTend.com

Andrew Burgert said...

Thanks for the insights Philippe.

Anonymous said...

Thanks for sharing
Sophie Dupont
Business Development Director
SD-Efficiency
Paris - France

Andy Greenawalt said...

Thanks for the great post. I was just wrestling with this and thought the great brains at Bessemer might have some thoughts. It solves for a number of the challenges I was trying to cover in ramping.

Ajay Mathur said...

Philipp,

This is an excellent article. I'm very happy to have "bumped" into it now as we are in the process of rolling out our on demand SaaS for making, sharing and using vector maps. Comm plan for our SaaS sales has been quite a difficult task as we are used to a traditional sales compensation model.

We still have some challanges to shift the sales rep's mindset to the SaaS model. Any experience on that?

Very useful matrix. Thank you very much.

Ajay, CEO Axes Systems

Dave Johnston said...

Philippe,

Great article. Our SaaS application and our practice is involved with sales incentive design and your design is right on for SaaS sales. I like the quota performance qualifier and the smaller payouts at lower performance levels give them a "taste" of incentive payout which whets the appetite for increased payout at higher performance levels.

Great job.

Paul, with added base salary you would look at the target total compensation (base plus incentive)that you would want to pay for achievement of 100% of quota achievement and then adjust the commission rate accordingly.




Dave

Anonymous said...

I would also love to know more about your thoughts of how Base salary gets baked into the OTE plan. So say the quota is $10,000 / month in new MRR. In Theory, on a straight line plan (always closing one year, paid annually), that means the rep closes $1.44MM worth of one year contracts. At the $1 for $1 matrix point, the rep earns $120K in annualized commission.

What is the right base and how do you back into a base against OTE and target? I guess my underlying question is, what % of closed business is an acceptable total package for a rep.

Example:
$1.44MM quota = $120K Commission
50/50 package = $120K base
$240K OTE = 16.6% of Year One Revenue

Sounds high, but is that considered a reasonable package?

Thanks for allowing me to tap your genius.

karthik said...

Phillipe,

Usually, SaaS sales guys think of total contract value, because that is what they are finally comped on. They don't break it down MRR, it gets too granular and complicated at MRR level of detail. Also, it's simpler to apply accelerators on the annual quota. Both the MRR approach and annual quota work out to be the same - don't they? I feel the annual quota approach is easier to track.

Another point I wanted to raise was that of clawback. What happens when the customer pulls out of a contract? How do you clawback revenue from the sales guy?

Karthik

karthik said...

Phillipe,

Usually, SaaS sales guys think of total contract value, because that is what they are finally comped on. They don't break it down MRR, it gets too granular and complicated at MRR level of detail. Also, it's simpler to apply accelerators on the annual quota. Both the MRR approach and annual quota work out to be the same - don't they? I feel the annual quota approach is easier to track.

Another point I wanted to raise was that of clawback. What happens when the customer pulls out of a contract? How do you clawback revenue from the sales guy?

Karthik

Cindy said...

How do you apply this to a company that has no contracts - all sales are month to month? Also, revenue is mostly based on usage and therefore "upsell" is a bit harder to define.

Thanks.

Cindy

Anonymous said...

A wise man told me one time that "A good sales compensation program should do 2 things;
1) Tell your sales people where to spend their time and effort
2) Tell the sales people what the company values"

Both apply in this plan which is good!
Nice to see some online content around sales compensation. Thank you for sharing!
Matt Tyre - Sales Resource Group

Anonymous said...

Good afternoon, had a rather elementary question. At one point in this post, Philippe says "Gary typically based his *sales board plan* at 70% of sales quota.

By sales board plan, are you referring to Gary's actual business planning forecasts? So in effect, his business plan showed 30% less than the sales quota?

Thank you!!

Zaki Usman said...

Very Informative. I was wondering about the cost structure for my sales team, etc. Thank you for posting this.

Zaki Usman
Director of Marketing
www.Severa.com

Bryan said...

Philippe,

Thanks for sharing! Just stumbled upon your blog as I'm working on developing my companies Saas comp plan. Can you share any thoughts on applying this model to a month-to-month subscription model with average revenue per sale of $99.

Thanks in advance!

Bryan

Roman Stanek said...

SaaS scale (as defined in Law #3 of the 10 Cloud Computing Laws) is reached when least two of the sales reps are making their $100,000 MRR quotas. $1 of commission for $1 of MRR sold would translate into $100,000 of monthly commission per sales rep. What am I missing here?

odszkodowanie said...

interesting publication

Anonymous said...

Good point on restricting sales people from pushing sales into the next period.

http://nirvaha.com/products/sales-compensation-software.html
Nirvaha Sales Compensation Software

John Bennett said...

1) Is the commission rate marginal or linear?

Marginal – commission is broken down into progressive brackets. Commission is awarded separately for the sales that qualify for each bracket individually. The commission paid equals the sum of the commission for each bracket.

Linear – the commission rate is determined by the rate of the highest commission bracket fulfilled.

2) The rate is calculated based on MRR, but the sales order will be an annual contract?

3) Implementing a commission structure where the rep can fall back to a Plan B as defined below you would have to use a Target Factor. So, based on the answer to question 1 it may or may not be possible to accomplish.

Target Factor – this option is available only for schedules based on quota that use a linear scale.

Designating a target factor lets you award a percentage of the target factor that is determined by the percentage of quota met.

Unknown said...

Interesting article and good example, thanks for posting!

Janet Williams
Sales Compensation

Odszkodowanie said...

Thanks for this post.

md888 said...

Is there a base salary?

Jerry Hegarty said...

Great summary,

I've found the complexity of managing all the exceptions and crediting rules that creative sales managers always seem to come up with to be something that often undermines simplicity Phillippe advocates.

Karthik - Clawbacks can be automated and managed easily enough with helpful techniques involving (but not limited to) capping the clawback amount recovered each pay period to make it more palatable for the reps.

The key is in proactive communication with the sales team so that expectations are clearly understood ahead of time. That said, recovering paid commissions is something everyone struggles with...

Thanks again for posting,
Jerry Hegarty

Anonymous said...

Can you perhaps share some examples to a new SAAS company that may not yet fully understand what the potential market can bare as fair quotas - my challenge is that I ma looking for a way to compensate sales managers. We presently pay 8 on the sales dollars to the reps. Any ideas on how we can motivate the sales managers to earn a living while we go thru the learning curve?

Thanks.
Darren

Anonymous said...

In the article, which I like very much, it states: "The payment rules were also very straightforward: 50% at signature and 50% at cash collection."

Does this mean that the company paid 50% at the time of signature (ok that is obvious), but then paid the remaining 50% commissions each month the client actually paid their monthly commitment.

Or is the assumption here that most of the Netli clients paid their monthly 1 year subscription all upfront at the beginning of the year.

Riffraffphotography said...

Great deals and a great way to ensure that my hard earned commission reaches me on time. Now I don't have to wait to celebrate. Thanks guys!...
Selling Commissions

Ashish Shandilya said...

Thanks for sharing this useful info. Keep updating same way.
Regards,AshishSales Training

Anonymous said...
This comment has been removed by a blog administrator.
Anonymous said...

LOL - Exactly my thought. I think may didn't want to write what you wrote with the fear of the wrath they may get i.e. "you should not be in sales if you don't know MRR or you should not be in SaaS if you didn't know what MRR is.

For your info: it is Monthly Recurring Revenue. At least this is what I know when talking SaaS.