Compensating Cloud Salespeople

Many SaaS vendors will have a hybrid model of direct and indirect sales, which makes it
important to structure a sales compensation plan that will reward their salespeople for producing
the right results. For ISVs that sell purely through channels, knowing how your partners
compensate their salespeople will provide a good filter to determine which partners have
developed a viable approach to selling cloud-based solutions.
There are a number of factors that make compensation plans more complicated for cloud
solutions than on-premise. When on-premise perpetual license is sold, the entire license fee is
collected up-front, and the salesperson is paid a commission, typically 8% of revenues. With a
subscription model the payments are usually made monthly or quarterly, and the amount can
vary based on the number of users, or the resources that are consumed if it is a utility model.
This section will discuss the key elements of the compensation structure.
How do you define the contract value?
Commission structures should reflect the value of a revenue stream to the vendor, and there are
three definitions based on how revenues are collected:
1. The foundation for most compensation plans is Monthly Recurring Revenues (MRR),
and there are many SaaS companies that will only look at MRR as the basis for
commissions. While this an important metric used to measure a companys growth,
salespeople do not get excited by a commission based on x number of users at y$ per
month, so a model should be developed that generates the commission up-front.
2. Annual Contract Value (ACV) can be used for annual subscriptions, paying the sales
person one rate for the first year, and lower rates for renewals;
3. Total Contract Value (TCV) can be used when a client pays for multiple years up-front.
For some companies it is worthwhile offering customers a discount for a three-year
contract paid with the contract signing. By generating the cash up-front the cash flow
resembles an on-premise model more than a subscription model, but the discount has to
be measured against the cost of capital. In other words, what does the discount
translate into as an annual cost of capital, and how does that compare to other forms of
financing.
Sample compensation plans

MRR (Monthly Recurring Revenues) - A simple formula for monthly subscriptions is to

pay the salesperson 100% of the first month subscription fee 1/12 of the annual
contract value is 8.3%, or roughly the standard commission for software sales;

ACV (Annual Contract Value) break the commission into a hunting component and a

farming component. The initial sale would produce a full commission, say 8% of the
ACV, and renewals would produce 20% of that (1.6% of the original commission). This
keeps the salesperson engaged to help with renewals;
TCV (Total Contract Value) if you collect a three-year contract up-front, the
salesperson will expect to receive a full commission on the entire amount, as he would if
he were selling an on-premise license. However, the up-front payment is more of a
financial decision made jointly by a vendor and the customer, and is not directly
attributable to the salesperson. One option would be to assign a lower value to the
extended term, for example, paying 100% of the commission for a one-year paid
subscription, and commissions based on 80% of TCV for a two-year term when it is paid
up-front (effectively, 160% of the commission paid for a one-year term), and 60% of TCV
for a three year contract.

Deferred Commissions
When contracts and billing are month-to-month or quarterly, it can be tempting to stagger the
commission payment, so that the salesperson gets 50% of the commission at the start of a
subscription and the remainder at the end of the first year. This is done to 1) better match the
commissions paid with the cash received; and 2) reward salespeople for subscriptions that are
successfully renewed through the first year.
This can be counter-productive. First, salespeople should be focused on adding new accounts
and helping build MRR, and reducing the immediate reward for a hunter will be a disincentive
for many salespeople. Second, it makes commission tracking more complicated. Third, and
perhaps most important, the salesperson shouldnt be held responsible for the quality of the
product. Customers elect not to renew for many different reasons, most of which have nothing
to do with the salesperson (unless they have been setting unreasonable expectations).
Setting Quotas
A common formula for setting a quota is to use a multiplier of On-Target-Earning (OTE). This
formula starts with the compensation (base + commission) that a salesperson should get for
hitting their target, for example $100K. The multiplier determines the annual quota, so a
multiplier of 6x OTE results in a quota of $600K. An ISV would adjust the multiplier based on
the maturity of the company, the product, the market they are selling into, the price of the
subscription, the quality of the lead generation programs, etc. Multipliers will normally range
from 5x to 8x OTE.

Fine-Tuning the Commission Structure Based on Performance

It can sometimes make sense adjust the commission to encourage a faster ramp-up. This can
be accomplished by applying a simple rule:

For 0-25% of the quota, $0.25 commission 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

By way of example, if the quota is $400K, a salesperson would get 25% of the normal
commission rate for the first $100K in revenues, 50% of their standard commission when they
have achieved 25% of the annual quota, etc. The sooner they get to 75% of their quota, the
sooner they get 150% of the standard commission.
Another way to adjust the commission for performance is to measure the year-to-date
performance. In order to motivate a salesperson to make a consistent effort, the commission
can be set at a lower rate if they are running at less than 70% of the annualized quota. For
example, if the annual quota is $400K, they would have to be at $70K at the end of the first
quarter to get a commission equal to $1 of MRR. If they are below that, the commission could
be $0.25 - $0.5 per $1 of MRR.