Have you heard the cobra story?
The story goes like this – there were a lot of cobras in Delhi and to kill them, the British rulers announced an incentive per killed cobra. Did it have an effect? Absolutely! Many cobras were killed and a lot of money was paid out. But did it reduce the cobra population? No. Why? Because people were smart – they started rearing cobras only to kill them and make money. When the British realized what was happening, they stopped the incentive, only to see that all the reared cobras were released and there were more cobras in Delhi than before they had begun the incentive!
- Sales compensation can drive behavior
- If not designed well, it can do more harm than good
If your sales team is the engine, then the compensation plan is the driver (quote borrowed from someone).
When I started doing sales in 2003, I had often heard the phrase that salespeople are like coin operators – they do what they are incented to do. Through my years of selling, I have lived through my own comp plans, in addition to designing them for hundreds of salespeople across geographies and products. In terms of tools that founders can use to turbocharge growth, sales compensation is one of the most powerful, yet one of the least understood and utilized.
I must also note that sales compensation is not an issue unique to SaaS companies. It is equally applicable to many other domains – a logistics company which sells to large enterprises; an eCommerce marketplace where a sales force is acquiring suppliers – essentially, anywhere humans are “closing deals” which lead to “measurable, material outcomes” for the company.
In any B2B selling, there are three different stages of evolution of the sales team, and accordingly the sales compensation philosophy needs to vary.
Stage 1: <$1M ARR
The founder(s) are the salespeople. You are selling not to create volume but to learn and to iterate rapidly. The founder(s) are directly involved in the accounts to understand how users are actually using the product, whether the product is delivering on its promises, what is the engagement level, what can they do to increase the value for the customer.
You do not need a comp plan. This is the pre-product market fit stage, founders are not motivated by comp plans. In fact, since you don’t know what you should incentivize people on, a comp plan can create a perverse incentive problem.
Well, this was simple.
Stage 2: $1M ARR – $10M ARR
You do have a real product which solves a real business problem, and you know who the buyer is. Well, almost. You are getting new customers, but not all of them fall into the same pattern – sometimes different buyers, different drivers of value, different price points. There is still plenty of discovery going on.
This is the stage where you have a few other salespeople – depending on the size, you could have a couple, 5, 10, or perhaps even more. You will realize, however, that there is still a lot of evangelism required for the product. There isn’t a well-defined recipe to sell, with new recipes still being discovered. You, therefore, need evangelistic salespeople; but they do need to be incented for selling.
My view at this stage is to have a comp plan that is fixed + commission – commission percentage will depend on your gross margins. For classical SaaS businesses, this could be a couple of percentage points, or even 10-20% of sales. It’s OK to pay the sales guys even if you sometimes feel you are paying too much. This is one of the best spends you can do – money is being given only when money is coming in.
You will have to make two other micro decisions even after you decide the commission percentage:
- Do you pay on Annual Contract Value (ACV) or on Total Contract Value (TCV)
- Do you pay when the deal closes or when cash comes in?
On (a), my strong bias is that you should pay on TCV, provided the cash is being collected upfront, even if it is a multi-year deal. Paying a salesperson for a multi-year deal when only the first year’s revenue is collected does not make any sense – this is because when the time comes for collecting subsequent cheques, the customer will need to be sold to again, and you will end up paying someone else for it.
On (b), it depends. If you are selling in India, then you must pay only when the cash is finally in the bank. I have been through the challenges of 1 year+ DSO, which essentially meant we were selling but not seeing any cash. If you are selling in the West, make a judgment call, though I would always suggest to pay cash only once you see cash.
Also, please do not create a comp plan based only on number of new logos. You will then have the cobra problem. Many new logos will come in for small value, only to churn later. You will end up getting customers who you should not be getting.
Stage 3: >$10M ARR
Now it’s a lot more fun. There is a “process” for selling, and you therefore have “process sales persons” running the show. Founders are not in the sales cycles themselves every day except the very large deals. This is truly your coin operator stage, when compensation plans will really matter.
While there are a lot of variations to what you can do, in my opinion, you should think about three things:
- The Fixed-Variable ratio – I find most founders to be meek on this front. Good salespeople should have as high a variable as the local culture supports. In US, it is very common to have 50:50 comp plans, and I have used the same in India with good success. Anything less than 60:40 does not make sense. Sales is a pay for performance function – if you are not happy with it, you should not be a salesperson. Of course, the 60% needs to cover for my basic expenses, but the reason I come in to work is the 40%. My recommendation is to be bold. Try it. You might be surprised.
- Accelerators – An accelerator is a non-linear incentive as a salesperson performs better and better. Let’s assume that you have a $500K quota for a salesperson, and a 6% commission rate. On quota the sales person makes $30K or approximately INR 21 lakh in commissions. Let’s assume the fixed compensation is INR 25L, making on target earnings of INR 46L. Now, suppose the salesperson does $700K, thus exceeding what they were supposed to. In some places, I have seen the commissions come with a cap, i.e. no matter how much you do, you cannot get paid more than a certain amount. That is dumb. You are essentially telling the sales person not to sell beyond a particular threshold. So, rule #1 is do not cap incentives – let them make money.
Rule #2 is to make sure that you have a higher incentive above quota achievement. So, for the first $500K, give 6%. But after $500K, give 8%, or even 10%. Encourage them to do more. In fact, you should tell them that the game starts after achieving their quota, that $500K was just table stakes! This is their chance to make serious money. In the case of the $700K example, by paying 8% on the above quota achievement of $200K, you can make the total incentive compensation to be $46K, almost 50% more than the base on-target amount.
Rule #3 is to make sure that you do not define gates. What does that mean? Some companies will tell their salespeople that if they do less than 70% of your quota, there will be no commission. Again, this is a dumb idea. Think about a salesperson who is at 50% achievement. He/ she can see an opportunity to do an additional 10%, but knows that there is no chance of getting to 70%. What do you think such salespeople will do? Not sell that 10% as there is no incentive do so. In fact, they might decide that they are better served be keeping that deal in hiding and surfacing it in the next cycle, to improve their chances of hitting 70%.
- SPIFFS – This is a fancy term that essentially means that you should think about special incentives to drive specific behavior that is important to the success of the company at that time. And this may not be only pure sales dollars. For example, if you have just released a new product, you are keen for your sales team to sell this new product. Typically, it is much harder to sell the new product and salespeople realize they can make more money by selling only the existing product. You then either split their quotas, or give them a higher commission on the new product.
Another common SPIFF worth thinking about is linearity. For large enterprise centric sales, you will notice that there is seasonality of sales. This is driven not necessarily by your customer’s fiscal cycles, but their realization that you have a fiscal cycle. As a result, a lot of your revenue gets back loaded into the rear end of any time period – Q4 of your fiscal cycle is likely to generate a lot more revenue than Q1; similarly, most revenues within a quarter end up in the last month and not in the first couple of months. As founders or VPs Sales, you have a lot of risk here as you are pinning your hopes on the end game – what if the end game does not turn out to be what you expected? There is little you can do then. Many companies design incentives on sales people bringing in the revenue earlier in the year.
Sales compensation can become a lot more complicated as you grow. It will depend on your geographical spread, your product spread and the kind of customer segments you are targeting. It will depend on whether you allocate territories every 6 months or every year. It will depend on whether there are services (on top of software) that your salespeople are selling. It will also depend on whether you have overlay sales i.e. specialist sales teams that assist your regular account managers to push specific (usually new) products.
We will leave these topics out for the moment. For most part, if you are a Series A – or even Series B – funded company, these topics may not be relevant.
Regardless, there is rarely one right answer to sales compensation, and like with everything else, experiment and iterate to find what works for you. I would love to hear from other founders what has worked for them and what has not worked.
 Metrics can be different for a non-SaaS company, but the principles will still be the same