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Designing a fair SaaS Sales Compensation Plan

Designing a SaaS Sales compensation plan brings a few extra challenges when compared to traditional companies, but in the end it’s not all that hard.

Salespeople are a special breed. They like to hunt for new clients and love the thrill of closing the deal. Although the exhilaration of the hunt motivates them deeply, they won’t work for free. They do want to get paid for their performance. That’s why they expect a compensation plan that reflects their performance.

Back in the days when salespeople visited clients to sell certain goods, determining a fair compensation was pretty straightforward. All you had to do was a simple P*Q-system to calculate the sales bonus. Q represents the number of items sold, and P the compensation (the price of the sale) per unit. If you sold PCs, and you offered $ 25 per unit sold, and your salesperson sold 125, the bonus would be $ 3,125.

Or you could make it even simpler, and offer a percentage. This is especially handy when you sell a lot of different products. A sales revenue of € 10,000 with a sales compensation of 2,5% yields your salesperson $ 250 in bonus.

But then came SaaS…

(Image: Rodnae Productions, via Pexels)

How sales are different for SaaS companies

In the past, most sales people would sell products to your clients. These sales could be one-time deals (for instance: multifunctional printers/scanners/fax) or it could be items that are regularly ordered (like selling beer to a bar). Both the occasional sale and the repeat sale followed the same road: the salesperson would visit (or call), take the order, and process it. This made tracking the value of the sale as simple as 1-2-3.

This is not how (most) SaaS products work. One of the predominant business models of SaaS companies is the recurring subscription.

 

Sales compensation for SaaS subscriptions

So what is the correct amount to pay your salesperson for closing another subscription? After all, you can never be certain how long a client is going to be around. Of course, an annual contract means you get paid for at least a year, but what happens after? Your salesperson probably wants to be rewarded not just for bringing new clients, but also for retaining them.

There have been, and still are, very lively discussions about the right compensation for SaaS sales. Some discussions rake up hundreds of responses. There are so many opinions on the topic, you’d start to think coming up with a proper compensation plan is harder than establishing a colony on Mars.

The thing is: despite the clear differences between SaaS and other products, sales compensation plans aren’t all that different!

Yes, we’ve said it. It isn’t rocket science. Like always, your sales compensation plan must reflect the lifetime value of the deal.

 

How to determine the lifetime value of the deal?

But…but… what’s the lifetime value of a deal? How can you possibly know how many times a client will renew their contract? You don’t have a crystal ball, so you cannot see the future. It’s just…so different.

Let’s pause for a moment. Take a breather and have a coffee. Let’s relax. And have a look at the traditional sales plans.

Remember the P*Q-system? The Q is the number of sales. That’s easy enough because your SaaS company is already tracking that metric (it should, anyway).

The P takes a bit more work, but it isn’t that difficult. Instead of using a unit price, we define P as the value of the deal. What’s the value of a recurring subscription? Exactly: the monthly (quarterly, yearly) revenue multiplied by the number of contract renewals. So take your MRR (Monthly Recurring Revenues), QRR or YRR, put it together with the average lifetime of a subscription and the lifetime value of the deal miraculously appears.

 

What’s the lifetime of this deal?

But wait… we still don’t have that crystal ball. We do have something else to help us determine the average lifetime, though: churn!

If only we had one of these… (Image: Nvodicka, via Pexels)

Churn is a metric that reflects what percentage of your subscribers decide to cancel their product. This metric is very useful when making projections for your SaaS. To determine the lifetime of a subscription just divide 1 by your churn (1/churn) and you’re done. An example (originally posted here):

Your churn rate is 15%. A client generates $ 500 worth of value per year. The average lifetime of your clients is 1/0.15 = 6,67 years. This results in a lifetime value of $ 500 x 6,67 =$ 3,333

 

Advanced lifetime value of recurring subscriptions

The calculation of lifetime value is not 100% accurate, but it is the simplest way of calculating the value. However, if you were to ask your business controller, he’d mention that the value of $500 paid ten years from now is less than getting the same $500 today. To keep it simple, let’s blame inflation.

To calculate the true value of the deal, you need to determine the “net present value”. Say you receive $ 500 a year from now, and inflation is 5%. That implies that a year from now, your $500 has 5% less spending power than it has now. So in present-day value, it is worth only $ 475 (95% of $ 500).

If you get $ 500 in two years, with 5% inflation, the value is only 95% of (95% of $ 500): 451,25

So, to calculate the real lifetime value, you “just” need to add all the individual NPV’s of all the payments during the average lifetime. Your business controller would probably come up with a formula he calls the present value of an annuity:

Lifetime Value of SaaS subscription: RR + RR(1-a)/(1+i)+ RR[(1-a)/(1=i)]^2 ….+ RR[(1-a)/(1=i)]^N

(a = attrition, for SaaS: churn), i = interest, N = number of payments on average lifetime).

 

Putting things together

All this gives us the two metrics we need to compensate your SaaS salespeople. We know the lifetime value of a sale, and we know the number of sales.

Now it’s just a matter of designing a sales compensation model that fits your company best. Most common compensation plans are based on sales quota. The more your sales rep sells, the more he earns:

Commission % = target commission at quota / quota
Sales compensation = Commission % * actual sales

(Note: the quota is the value of deals in the bonus period, so the target number of deals is multiplied by the average deal value).

You still need to figure out a fair target commission and set a quota which is challenging but possible. Sadly, there’s no hard mathematical formula to help. These numbers are determined by the conditions on the labor market and the type of salesperson you are looking for. In that, SaaS sales compensation plans are just like any other sales compensation plan.

 

Your SaaS sales compensation plan can be simple, or complex

Once you’ve done the hard work to determine the lifetime value, designing your SaaS compensation plan is just as much fun as any other sales compensation plan.

You can make your SaaS compensation plan as complex as you want. Chose a single percentage for all sales, or come up with an elaborate scheme where some sales earn a higher percentage, or where margins, tiers, and what-not come into play. You can use a fixed percentage or offer higher percentages upon certain milestones.

Tweak your SaaS sales compensation plan just as you like (and in a way your sales reps are happy). Really… SaaS is just like any other sales organization.

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