At first glance, calculating commissions can sound fairly simple. Just think of it, sales reps have on-target earnings (OTE) with quotas they need to meet, and if they do, you’ll pay them a commission. The thing is, there’s a lot more that goes into designing a commission plan than simply calculating commissions.
For one, you’ll need to determine the right OTE, the perfect pay mix, and achievable quotas. Ultimately, with the right commission plan, you’ll be able to motivate your sales team and your company will be able to make more sales and generate more revenue.
For SaaS companies, commission calculation is even more complex. These companies place an increased emphasis on customer retention to generate more revenue. As a result, their sales compensation plans need to be designed to drive the right behaviors to not only drive sales but also improve customer satisfaction and ensure annual or monthly renewals.
So, as a SaaS company where do you start when you want to create an effective commission plan? What aspects should you consider when doing so? Fortunately, we’re here to help. In this post, we’ll look at these questions in more detail and show you how you can create an effective commission plan for your SaaS company.
SaaS Sales Models: A Recap
To start, let's first recap the different SaaS sales models. The sales model you use will depend on the type of product you offer. In turn, this impacts the sales commission you pay to your sales representatives. As a result, it's crucial that you choose the best sales model for your unique needs.
Generally, the different SaaS sales models are:
- Self-service. You'll typically use a self-service model for basic SaaS products that don't need a lot of support. As such, these products are usually fairly straightforward, with a few features, and quite simple to learn.
- Enterprise. On the other end of the spectrum, you'll find the enterprise sales model. In contrast to the self-service model, the products sold with this model are complex and require a bigger investment. These products, typically, also have an impact on an entire organization and, as such, they need to go through several tiers of approval before you'll be able to close a deal.
- Transactional. The transactional model fits somewhere between the self-service and enterprise models. Here, the products are more expensive than the self-service model but not as expensive as the enterprise model. So, they require less support and training.
The sales models don't only differ in respect to the products sold, but also in their sales approach. For instance, with a self-service model, you'll focus on marketing and support. So, you won't require any salespeople and the products basically sell themselves.
Conversely, the enterprise model requires an intricate sales approach. This requires highly skilled sales representatives and increased support. With a transactional model, customers typically require less support and training. As such, you'll only need a small sales and customer service team.
SaaS Business Objectives
Now that we've recapped the common types of SaaS sales models, it's time we look at some of the main objectives of SaaS companies.
These objectives are crucial because they, ultimately, shape the company's commission plan. This is because the commission plan must drive behaviors that help the company progress towards its goals. As a first step in creating your commission plan, you should first identify your company's objectives.
The primary objectives of a SaaS company are usually a combination of the following business objectives:
- Increasing recurring revenue. As SaaS companies rely on recurring revenue, one of their main objectives is to drive and increase recurring revenue. Simply put, the more subscriptions they sell, the more revenue they’ll be able to generate.
- Increasing cashflow. Apart from generating as much recurring revenue as possible, another key objective of SaaS companies is to improve their cash flow, especially during the startup phase when sufficient cash flow is crucially important.
- Signing longer-term contracts. One of the best ways to ensure better cash flow is by signing longer-term contracts. For instance, companies should aim to sign multi-year annual contracts instead of monthly contracts.
- Increasing average deal size. Another way to ensure higher revenue is by increasing the average contract value. In other words, SaaS companies should aim to increase the amount every customer spends on their product. In turn, this relies on maintaining sufficient customer satisfaction levels to ensure that customers become and stay long-term customers. And when customers become long-term customers, companies are able to rely on strong renewal rates.
- Increasing expansion revenue. It’s vital that SaaS companies increase their expansion revenue. This involves cross-selling and up-selling to existing customers which is much less expensive and selling to a new customer.
In addition to the mentioned primary objectives, there are several secondary objectives that SaaS companies will focus on:
- Attracting new prospects. To keep the sales pipeline healthy, it’s crucial that SaaS companies focus on attracting new prospects which could be turned into leads and, ultimately, paying customers.
- Minimizing expenses. Every sale a company makes comes at a cost. So, it makes sense that, to generate more profit, companies should focus on minimizing their expenses.
- Driving sales of a specific product. Depending on the company, it might be necessary to focus on driving sales of a new product.
- Reducing average discounts. In some cases, especially in the startup phase, companies might use discounts effectively to drive sales. If this is the case, it’s necessary to focus on reducing these discounts over time in order to increase profits.
- Increasing gross margins. It’s simple, the higher the gross margins, the higher the potential profits. As a result, SaaS companies should focus on increasing gross margins as much as possible.
Apart from the primary and secondary objectives mentioned above, there are also some ancillary objectives SaaS companies could have, especially those in the startup phase:
- Signing up specific types of customers that could lead to more revenue. These could include anything from larger customers to well-known brands or even customers in a new vertical which was previously unexplored.
- Signing up customers that are willing to become references for the product. This could be helpful in marketing the product to other, similar customers and making new sales.
- Achieving a consistent flow of deals that ensure continuous income. This is preferable compared to a few large deals from time to time which could be inconsistent and unpredictable.
- Aiming to acquire a large number of customers quickly to get a larger part of the market share even if it means making less profit from these deals. Moreover, another objective could be to use small deal sizes as an entry point into accounts and then expand once these accounts are in place.
- Rewarding sales reps that win more deals while not discounting a lot. Although, as mentioned earlier, discounting can be an effective tool to drive sales, it could have a significant impact on profits.
It’s important to remember that, depending on your company’s unique circumstances, your objectives might differ but, generally, they’ll involve some of the objectives mentioned above. No matter what your company’s objectives are, it’s crucial that you identify them as this will lay the foundation of creating a commission plan for your SaaS company.
Choosing the Right Commission Plan Type
The next consideration is the type of commission plan you’ll use. Here, you have a few options available and which you choose will largely be dictated by your company’s specific requirements.
This is one of the most common sales compensation plans used by SaaS companies. With this plan, you pay your sales reps a commission as a percentage of the sales they bring in or the revenue they generate. This commission forms the variable pay part of their on-target earnings.
To illustrate this, let's look at a simple example. Let's assume, you pay your sales reps an OTE of $100,000 per year, with a base salary of $60,000. Their commission will then be $40,000 and, with a quota of $500,000, their commission percentage will be 8%.
As we will describe later, you can also use accelerators to incentivize sales reps that exceed their quota. For example, based on the above, you can pay a commission of 10% to sales reps who exceed their quota of $500,000. So, the sales rep will then earn 8% commission on sales up to their quota and 10% on any sales above it.
You'll typically use this plan when you're unable to use a commission-based plan as described above. This would, for example, be in cases where you want to reward your sales reps for achieving non-revenue goals like sourcing leads for the company.
Draws Against Commission
With this plan, you'll pay your sales reps' commissions in advance. You'll then recover these payments from the future commissions they earn. Here, it's important to distinguish between recoverable and non-recoverable draws.
Recoverable draws are those commissions that you'll be able to recoup from your sales reps. In contrast, non-recoverable draws are those draws that you'll likely not be able to recover and that you pay more as a goodwill gesture. This will, for instance, be the case where you pay commissions to a new sales rep that doesn't have the client base to repay the commissions.
Properly Define On-Target Earnings and Quotas
The next step in creating your SaaS sales commission plan is defining your sales reps' on-target earnings and quotas. Your sales reps' OTE is the total amount of compensation they'll earn including their base pay and commission. In turn, their quotas are the targets they need to achieve to earn their OTE.
Here, there are a few crucial aspects you need to consider. When it comes to OTE, it's vital that you get it right. Not only will this help keep your sales reps motivated, but also help you attract the best talent.
To do this, you'll need to consider:
- The industry and market your company is operating in.
- The type of products you're selling.
- What other companies in your industry are paying.
- The skills and experience of the specific sales rep.
In respect of quotas, these need to be achievable by most of your sales reps. If they aren't it could decrease motivation and your sales reps' morale will suffer.
Moreover, if your sales reps can meet their quotas, they'll simply discount them accordingly. Conversely, if your sales quotas are too easy to achieve, you'll likely overpay for performance.
But what should your quotas be? Generally, you should aim for quotas that are about equal to five times a sales rep’s OTE. Ideally, however, you should aim for quotas that are equal to about six to eight times a sales rep’s OTE. Keep in mind, however, the quota will be determined by your company’s unique circumstances, industry, product, and the like.
Optimizing Sales Commission to Drive Positive Behaviors
Considering the above, sales commission is a crucial component of your sales reps' OTE. When creating your commission plan, you'll want to optimize it to drive positive behaviors. Let's look at some of these strategies in more detail.
The main component of your sales compensation should be to incentivize sales reps to make more new sales. As a result, your commission plan should include competitive commissions to motivate sales reps to make more sales.
These commissions will typically be based on a commission paid on monthly recurring revenue or annual contract value. Here, it's important to consider that you'll likely pay these commissions before you realize any revenue from a sale. This, in turn, poses a risk when the customer churns before their contract is up, especially in the case of annual contracts which typically attract a larger commission.
As an alternative, you could consider paying the commission once you receive the revenue from the sale. The problem with this approach is that it could be challenging for sales reps to keep track of their commissions.
Gross Margins are Key
Especially as a new startup, you might focus on making as many sales as possible, gross margins can become important, especially as your company starts to scale.
Reward the Right People
By this time, you probably know that high-performing sales reps generate significant amounts of profit for your company. As such, you'll want to reward them accordingly, especially when they exceed their quotas.
Think of it like this, if you pay a sales rep a yearly commission of $40,000 against a quota of $500,000, this commission is already factored into your budget and planning. This means that any revenue in excess of the quota will have a much larger return on investment.
So, it makes sense to incentivize sales reps to go above and beyond their quota. And this is where accelerators come in. With these accelerators, the commission percentage gets higher after a sales rep exceeds their quota. For example, for a sales rep with an OTE of $120,000 and a quota of $500,000, you could pay a commission of 8% or $40,000. You could then, as an added incentive, pay a commission of 10% for any amount exceeding the quota of $500,000. It’s easy to see that this strategy can be very effective at driving increased performance.
Accelerators also serve another purpose. They can be an effective tool to attract the best sales talent. Simply put, if other sales reps hear that your reps are earning attractive commissions for exceeding their quotas, they’ll be more likely to want to join your team.
Likewise, you'll want to motivate underperformers to perform better. Here, thresholds are an effective tool. With thresholds, you'll determine a level under which your sales reps won't earn any commission. This motivates these reps to perform better, especially when they're able to see what other reps are earning through accelerators.
Keep in mind, though, as is the case with quotas, these thresholds should be achievable. If they aren't, they'll only decrease sales rep motivation and morale which is exactly the opposite of what you want.
Renewals are a crucial component of a SaaS company's revenue. This means you'll need to increase the Customer Lifetime Value of every customer.
Now, the question is: Who is responsible to make sure that existing customers renew. The simple answer is that it's a combined effort. In other words, everyone from the customer support team, onboarding, operations, and product management is involved in ensuring renewals.
As a result, you'll need to consider how you'll incentivize renewals and what behaviors you'll want to prioritize.
Expansions through upselling and cross-selling could be very helpful to generate significant revenue at a far lower customer acquisition cost. In fact, according to For Entrepreneurs, it can be about five times cheaper to generate expansion revenue compared to new sales. In turn, this means you could pay lower commissions for expansion sales.
Incentivize Specific Business Goals
In the SaaS space, apart from quota-based commissions, it’s also quite common to implement additional incentives to drive performance and achieve specific business goals. One of the most common examples of this is where SaaS companies use incentives to motivate sales reps to make more longer-term sales. As mentioned earlier, this should be one of the primary objectives of SaaS companies as it helps them generate more cash upfront which, in turn, improves cash flow.
When designing your plan, it’s important to remember that not all incentives need to be cash-based. Non-cash-based incentives also have their place and can serve as strong motivators. These incentives are especially helpful in team-orientated companies where they can help you build your team.
Actionable Tips for Your Commission Plan
Now that we’ve seen the aspects you should consider when creating an effective commission plan for your SaaS company, let’s look at some tips you can use to improve your plan to drive more of the right behaviors.
Drive the Right Behaviors
As mentioned earlier, SaaS companies place an increased emphasis on customer retention. This, in turn, requires a unique sales approach that aims to extend the lifetime value of every customer while keeping customer churn at a minimum.
To implement this approach, your sales reps:
- Shouldn’t oversell. Your sales reps should be careful not to oversell what your product can’t deliver. If they do, it will only lead to dissatisfied customers that are more likely to churn which, in turn, leads to a loss of revenue. One way to prevent this is by penalizing sales reps in the form of clawbacks on their commissions is a customer cancels the contract early. In this case, you’ll recoup all or part of the commissions you paid to the sales rep when they made the sale.
- Sell to the right customers. Every product has a certain buyer persona that’s more likely to buy and use the product. These customers are less likely to churn and more likely to become long-term customers. So, your sales reps should aim, and you should incentivize them for selling the product to these customers. Ultimately, in the long run, this means you’ll be able to generate more revenue.
- Sell the sticky feature. In many cases, especially during the start-up phase when you’re still refining your product, you might find that certain customers use a specific feature of your product. It’s these customers that your sales reps should prioritize as they’re far less likely to churn and they tend to be more valuable over their lifetime.
- Sell to the most valuable customers. Your company’s most valuable customers will have a high customer lifetime value and a low customer acquisition cost. In other words, they contribute significant amounts of revenue while it’s not too expensive to sell to them. You’ll want to identify this segment of customers and incentivize your sales reps for selling to them.
Keep the Plan Simple
One of the most important tips you should use when creating and implementing your commission plan is to ensure that it’s simple. This enables your sales team to know exactly what’s required of them, what they need to do to meet their quotas, and what they’ll be able to earn if they do.
This, in turn, motivates your sales reps to perform better and meet their targets.
Keep Your Commission Plan in Sync With Your Objectives
As mentioned earlier, your company’s objectives will, to a large extent, shape your commission plan as you’ll implement specific strategies to drive the behaviors you need.
One of the most important aspects when creating and implementing a commission plan for your SaaS business, though, is keeping the plan aligned with your specific objectives. Let’s face it, as your company grows, your objectives will change. So too will the behaviors you require.
For example, in the early start-up phase, your main focus will be to drive new sales. As such, you’ll incentivize sales reps more for making sales. Later on, past this phase, other priorities for instance can include increasing customer retention as a priority. Your plan will then shift with your changing priorities.
Creating commission plans for any company can get complicated. For SaaS companies, this is even more so as they have some unique objectives which, in turn, require specific behaviors by sales reps. As such, a well-thought-out and effective commission plan for SaaS sales reps should consider these objects and motivate the behaviors to achieve them.
Hopefully, this post helped illustrate the aspects you need to consider when creating a commission plan for your SaaS business and some strategies you can use to improve yours.
Once you’ve done this, you need to calculate your commissions. And this is where Performio comes in. We believe commission calculations should be seamless, so you can spend more time on new product development, entering new markets, and making more sales.
Ultimately, we help companies automate and simplify their commission management. To learn more about our platform and how it can help you, request a demo today.