This is a shortened version of an article originally published on forEntrepreneurs.com. You can find the full article here: http://www.forentrepreneurs.com/saas-sales-compensation-plan/
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, Matrix Partners GP David Skok 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. Below is an introduction to the full post, which you can find on my forEntrepreneurs blog here.
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.)
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.
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.
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.
When building your plan, it’s important to keep the following in mind:
- Keep it simple. While the thinking behind your plan is not simple, reps need to easily understand the plan and know how to behave to maximize their comp. 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.
- Reward your highest performers. 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. And, rewarding high performers will also attract other high performers. Accelerators or graduated commissions, i.e. the commission rate gets higher after the rep has exceeded quota is a good way to do this. You can also use a tiered commission approach.
- Sales plays a role in driving higher revenue retention. Sales reps should be incentivized to sell to the right (highest LTV) customer who will be happy using your product and who will stick around for a long time. Customers who purchase an additional module will be far more valuable over their lifetime than the other customers who will likely churn faster. So naturally, you would also want to incent your salespeople to optimize sales to customers who purchase and implement these ‘sticky’ features/modules.
- Incentivize expansion revenue and renewals. 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. Though, this will vary greatly company to company. For example, in some cases these sales may be handled by a specialized team. 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.
- Think about using SPIFFS to incent specific additional business goals. It is very common for SaaS companies to use extra incentives to drive specific business goals such as 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.
- To set quotas use a top down approach (what have other companies achieved with the same types of sales people) and a bottoms up (how many deals can a salesperson be expected to close in a typical month and multiply that by the average contract value.) We’ve found that sales 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. Once you have quotas, you can figure out what the rough commission is to meet the desired OTE.
- Sales comp will change as your company evolves. In the early days when you’re still figuring out your process, who you’re selling to, biggest barriers, etc., your comp will likely focus less on the variable component. As you move through different life stages of your company, 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.
To read the full post and find more discussion on SaaS Sales comp on forEntrepreneurs, click here: SaaS Sales Compensation: How to Design the Right Plan.
Follow us on Twitter: David Skok, @BostonVC and Matrix Partners, @Matrix Partners.