SaaS Sales Commissions: Better to Base on MRR or Bookings?

December 27, 2011 by

When it comes to sales commissions, you must always start with your strategic objectives. Then translate these objectives into your sales strategy and then sales objectives. And only after do you align your sales team’s incentives to the strategy and the objectives.

Salespeople tend to be one-track minded. For them, its all about making the most money with the least effort.  So whatever direction you point them through sales incentives will be the direction they will go. In fact, if you design the incentives in a way that is not perfectly aligned with your objectives, you will most certainly miss those objectives (or at least not get the sales team’s support) — and you will only have yourself to blame.

Unlike other groups in your company, sales people are not designed to align themselves to corporate objectives… Unless their compensation is set up to do so.

So back to the question we started with.

Which is better: paying commissions on MRR or bookings?

Well, it depends on your objectives. Which is more important to your corporate objectives?

Typically, the SaaS businesses that should focus on driving MRR growth are ones where the offering is sold as relatively small transactions (and short sales cycles). In this case, licensing tends to be at a recurring monthly basis, where sales does not have to follow up on renewals (rather the product needs to please enough to prevent customer churn). These companies tend to be ones that sell to consumers or small businesses.

SaaS companies that should focus on bookings growth are ones where their offering is sold in relatively large transactions with long sales cycles. Licenses in this case tend to be purchased on an annual recurring basis, and annual renewals are significant enough to require sales team involvement.  These companies tend to sell to the range of small business to very large enterprises.

I have oversimplified this answer quite a bit. The real answer starts with a clear definition of the economic model that best suits your company, the economic goals you aspire to, the licensing/pricing model that best suits your customer, and the distribution model that best suits your market. Once you’ve defined all these variables, you will have a clearer picture of how you should commission your sales team.

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Discussion

  • Jim

    You’re spot on here…and it’s surprising the number of SaaS companies out there who are doing this backwards

    • http://bit.ly/1Gu8Ha Firas Raouf

      Jim, you’re right. But its getting better. It took a while for all of us to get through a number of years operating companies through the expansion phase. It took a bunch of experimentation to sort through the key metrics and goals we should be pursuing. I’m finally getting to a point where I feel I can mentor companies through a bunch of situations. But every time I think I’ve nailed a formula, a new situation arises that throws a wrench in it.  Typical!

  • Ken

    I agree that this is spot on- however this is at the tip of the iceberg. Consider those companies that sell SaaS solutions to larger enterprises, have longer sales cycles, and a higher ASP- and add the compensation complexities associated with multi- year contracts.
    For example- a 3 year contract for 150k per year raises the following questions.
    - How much compensation on total contract bookings vs. annual contract value?
    - How much compensation on bookings vs revenue?
    - Should annuity models be considered on multi- year contracts?
    Keen to hear your thoughts.

    • Jim

      Ken – in the spirit of full disclosure, I’ve been selling Saas-based solutions since 2001 so I’m a bit biased in my response. Before weighing in on your questions, I think it depends on whether or not the organization has an Account Management group that takes over the management of new clients. It also depends on the amount of on-going interaction the sales rep is expected to maintain with the account.

      My personal feeling is if a rep sells a 3-year contract, knowing the SaaS industry norm is typically 12 months, the rep should be compensated accordingly. For example, if the base payout is 6%, at a minimum, I think the payout should be 6% in year one, 5% in year two and 4% in year three. This is where the Account Management alignment comes into play. If the AM group is expected to manage the relationship moving forward, there’s probably room to move the payout. However, if the rep is also the AM or at least remains strategically involved, they should be compensated accordingly. Odds are in that 36-month period, the deal will have to be “resold” at least once due to client turnover, client budgets, etc. and the rep will be expected to do that work, not the AM team.

      Another aspect to take into account is annual pre-paid contracts. I think a 2% bonus at least is warranted on a deal that is paid upfront.

      I think deals need to be paid when they’re closed, not when they’re invoiced. That scenario has the possibility of turning the sales rep into a collections agent too and that is not the best use of their time. I also believe quota credit should be based on annual contract value at the time of contract execution and not invoiced amount (like an annuity approach). The problem with MRR is it means deals in Q1 are much more valuable to the rep than deals in Q4. For example, if I close a $120k in January, and my company pays me based on $10k per month of invoicing, that entire amount will be billed in that CY, thus giving me $120k in quota relief as well. However, if I close the same $120k deal in October, I will only see $30k of quota relief in the current CY. Sure it rolls over into the next CY, but I really only care about the current CY, especially if I haven’t hit my annual number yet. It also puts the rep in a position where their goals aren’t aligned with the company goals. For example, let’s say I’m $150k from my annual quota in Q4 and I’m working on a $300k deal. If I sign that deal in October, using an MRR approach, I’m only going to get $90k (3 months x $30k per month) of quota relief. However, I would consider going to the prospect and offering a “Q4 discount” down to $200k if they’re willing to pay for the first year up front. If the prospect agrees, I’ve made my number, but the company just lost $100k due to my discount.

      Make sense?

      Payout percentages aside, I think a rep should be paid on the annual contract value in the month following any deal they close. This gives the rep incentive to close the deal ASAP and not at the close of a quarter. I think there should be quarterly bonuses for quota attainment in the given quarter as well as an annual bonus for quota attainment.