Great article, thanks.

We’re moving from a license/maintenance model to a SaaS model, using the same sales reps, and to goal them with the same “on-target earnings” (OTE) means that commission rates will be much higher as a result of quotas being necessarily lower (say using ARR). Of course we could artificially remedy that by using a multi-year RR, but the really key issue we need to deal with is the company cash flow (float) issue that with annual upfront RR payments on our contracts, it is 3+ years before we realize the same cash from the customer as we would have under the license/maintenance model. Yet you advocate paying the rep basically the same upfront even though our initial payment sizes are decreasing dramatically.

Have you implemented, or observed any good models for trying to match cash flow of sales rep payments with inbound cash flow from customer? Without creating the “account management syndrome” you referred to in a response to an earlier comment, that is.

I’ve been thinking about doing something like the following:

1. Calculate the commission based on your model.
2. Pay say 65% of the commission at the time the deal is closed.
3. Pay say 25% of the commission on the first anniversary of the deal closing (which often will coincide with the customer renewal, but not always as we sometimes do initial subscriptions shorter than a year to allow customers to get started when they hadn’t even budgeted for a solution like ours in their current fiscal year).
4. Pay the final 10% of the commission on the second anniversary of the deal closing.

The rep would have to still be employed on the anniversaries to get the follow on payments, which creates a bit of a retention strategy. I had been contemplating also making the follow on payments contingent on the customer renewals, but to your point about not creating the “account manager syndrome”, it might be better to not make them contingent on the renewals – just purely a timing issue. I think perhaps using the penalty commission calculation you propose for deals that cancel in less an a year, or initial deals of less than a year that don’t renew is probably the best approach.

I think the reps could understand and even appreciate the issue we’re attempting to deal with, especially since they at least get disproportionate payment in the earlier years on each deal, even though the company’s payment is even over the years. Of course, for a rep making their on-target commission under the license/maintenance model last year, moving to a model this year where they only get 65% if they achieve their quota and have to wait for the rest won’t be desirable from their perspective. But in their second year under this model, if they’re making their quota, then they’ll get 65% in year 2 and 25% from the year before, so 90% in total. And then by year 3, they’ll be at 100%. And in years they underperform, they’ll have some carry forward from prior years.

Any other thoughts or pointers to models where companies have matched their inbound cash flow with outbound cash flow to reps would be appreciated.

Thanks

Mark.

The numbers are not unreasonable if they fit the business. First and foremost, your renewal rates must be strong, so that you are truly in a recurring revenue business. I did a little “what if” analysis using my SaaS Sales Commission Calculator for Long Term Contracts. Here is a scenario that fits this payout:

• baseline commission rate of 11% for annual contracts based on ARR
• cost of capital of 20%
• annual churn rate of 15%
• churn cohort of 20% for folks that pay month to month

Giving the following…

So, the sales commission would reflect the value to the company in this scenario. However, I agree that it is unlikely to motivate sales to “get clients to agree to a long term commitment.” What I suggest is to leave it up to the customer. In this plan you could offer a discount to the customer of up to 25%, 35% and 45% off the monthly price for customers that sign annual contracts (or equivalently a premium of 35% on monthly, and discounts of 15% and 25% on 2 yr and 3yr contracts relative to a standard annual contract price). With this approach, the sales commission is “contract neutral”, i.e., the sales person is paid about the same regardless what length contract is signed. The customer, however, now has a strong direct incentive to sign longer term contracts without feeling manipulated by the sales rep. And, the sales rep has a new tool. When a customer asks for a discount, the rep replies “Sure, no problem, I can give you a discount if you sign up for a longer term contract.” And, you get something in return for the discount.

Cheers,

Joel

We are moving from our original “license fee year 1 and 20% support and maintenance in subsequent years” model over to per user per month SaaS model (breakdown below).

On face value I think this may be viewed as a little one sided (in favour of the company)!

Scenario if a sale costs $20K upfront commitment 1 year, $40K upfront commitment 2 years and conversely $60K for upfront commitment 3 years on the following model the sales person would make an additional $800 (because it is only based on the first 12 months) whilst the company gets to realise the full additional $40K on a pay upfront 3 year signing:

PAYG 8% of first 12 months revenue
12 mts upfront 11% of first 12 months revenue
24 mts upfront 13% of first 12 months revenue
36 mts upfront 15% of first 12 months revenue

I would appreciate your thoughts as I have given my initial feedback that I do not think this will be viewed as favourable for sales people to try to get clients to agree to a long term commitment/upfront cost if the return is so limited.

Very best
CJ

Cheers
Nick

You are correct. It is the renewal term that determines the cost of capital charge, not the contract term. In the post, I assume these to be equal for simplicity.

In your case, a discount for say a one year contract that is paid monthly would have to be justified by a lower average churn rate, i.e., customers that sign annual contracts have lower churn than those that don’t, so you have two churn cohorts based on contract type. You would need to run you own numbers to validate this hypothesis, because it is possible that you simply have a big drop-off of annual contract customers at the end of the year that is equivalent to the gradual drop-off of monthly customers.

At any rate, the formula you are looking for can be found in this follow-on post. SaaS Sales Commission Calculator for Long Term Contracts that includes a spreadsheet that you can use to compare renewal term and churn scenarios.

Cheers,

Joel

Let’s start with your last comment “there are no exit barriers for the customer.” There are ALWAYS exit barriers to the customer and they can usually be measured by the amount of customer data that is input into your system. See for reference
http://chaotic-flow.com/saas-economics-101c-saas-adoption-and-switching-costs-the-double-edged-sword-of-data/

I see that EazeWork does employee self-service and payroll, so I’m sure there are plenty of switching costs that get higher the longer your customers use your system. Sometimes new customers drop off quickly…let’s leave that aside and come back to it.

If you pay out 10% monthly, the incentive you create is to build a territory and then sit on it and collect pay for past performance. This is the reason to pay up front, so reps will move on and find the next customer. You can always assign current customers to account managers and pay on retention. If I understand your current plan correctly, I believe it will slowly transform sales reps into account managers as they acquire customers.

What I don’t see in your comment is your target commission or quota. The payout seems to be based on the common misconception that the commission rate is the independent variable in a sales compensation plan. It isn’t. The commission rate is dependent and equals the target commission at quota divided by the quota.

Let’s say you want to pay your reps 100K/year to bring in 45K MRR per year in recurring revenue on a 50:50 split. I’ll take your 100 USD MRR and 15 users as the average deal. This has an average deal value of 1500 MRR. So a Rep would need to close 30 deals per year. Is this reasonable? If not, then the quota needs to be adjusted down or up as required?

The reps commission percentage would then be 50% x 100K / 45K MRR = 111% (per MRR).

And, the 15 user deal would pay 111% x $1,500 = $1667. And, will take you two months to generate positive cash flow (which BTW you can help manage by paying commissions quarterly instead of monthly).

If three months down the line the customer adds 10 users, then this is a a new deal and should pay a commission on the incremental lifetime value of the deal. 111% x 10 x $100 = $1111.
This confusion arose in the first comment above. In sales compensation, you want to pay on the lifetime value of the DEAL…not the customer. The lifetime value of the customer is the sum of all the deals.

CLTV = Deal 1 LTV + Deal 2 LTV + …. + Deal N LTV

Sales comp is based on the deal. This encourages reps to sell upgrades and upsell new services.

Now lets revisit the exit barriers problem. Often new customers rapidly segment into two groups. Those that stay and those that cancel early. There are two ways to handle the cancel early customers, neither of which involve paying the rep month to month.

1) Wait a little while to pay the rep in full, e.g., if customers often leave in the first 3 months, then pay your reps quarterly. Or pay 50% initially, and 50% in 3 months. But, don’t keep paying indefinitely. That turns your sales reps into account managers.

2) Pay up front. And, then back it out of future commissions if customers cancel early. For example, if the typical 15 user customer above cancels after three months, then adjust the next commission payment for the rep by 50-80% x $1667 and take the money back as a penalty adjustment for early cancellation.

Lastly, it appears from your comment that on a $1500 MRR deal, your reps will make $1800 per year the first year and then another $1800 the next year, etc. I’m guessing most of the hard work to acquire customers is done in first year. Why would you wish to continue to pay the same amount for simply sitting on the account? My guess is that an account manager can manage 10x the number of accounts that a sales rep can acquire in a year. (300 vs. 30 in this example)

Hope this helps…

Joel

Confusion..

My Scenario is… Annual contract with MRR = 100 USD per user and initial sale had 15 users. The client also has selected the option to pay monthly. So as you are suggesting we start paying the sales guy (assume 10% commission) – 15x100x10% = 150 USD per month and avoid Mistake # 1. Here I am pegging the payout to MRR.

If 3 months down the line the customer adds another 10 users then the sales guys monthly payout becomes 25x100x10% = 250 USD (its another discussion whether he should get full credit for the additional users / upgrades or part of that should be split with the services delivery team).

But when I read your comment in Mistake # 2 section “The best approach is to pay the sales rep in-full, up-front based on the recurring revenue, then tack on a 5-30% penalty for short term contracts as described in SaaS Sales Compensation Mistake #1 above.” the confusion sets in. We are not paying the sales guy up-front and are linking to the way the customer is paying, it is in a way linking to the cash-flow but isn’t that what is logical.

What is the value of an annual contract when there are no exit barriers for the customer?

I don’t think it holds for lower-priced offerings that really need to be driven via inbound marketing and sales, keeping acquisition costs low.

Joanna
Software-Marketing-Advisor.com

Lifetime value in this case refers to the lifetime value of the DEAL, not the customer. You should only pay the rep on the incremental recurring revenue of the deal.

An initial sale of $1000 ARR should pay out on that, done. No future payments on anything after the contract is signed.

An upgrade should pay on the delta in recurring revenue from the upgrade, not the recurring revenue of the entire subscription. And, it should ONLY be paid to the rep that closes the upgrade. For example, if a subscription in $1000 ARR is upgraded to $1500 ARR, the payout should be on $500 ARR = $1500 – $1000.

Separating hunters from farmers is best when upgrade potential is low and/or unaffected by anything the sales rep does, e.g., upgrades only occur as customers grow their business. In this case, the primary goal after the initial sale is retention, not upselling…hence the farming.

If the primary goal after the initial sale is more selling, because upgrade and upsell potential is high and the rep can truly drive it, and you pay out as I describe, your hunters will go hunting upgrades. Mine do.

JY

I was taught by sales that what you are suggesting here does not work.