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.