Should I pay my sales commission on bookings, revenue or margin?

Yesterday I was at Chicago running a workshop for TechStars alumni (about 12 companies) on SaaS sales. The companies were largely B2B, selling to mid-sized or larger organizations. Most were trying to go beyond the founder being the primary sales person and were getting ready to build out their sales team. One or two of them even had a couple of sales people on board.

The section of sales compensation generated the most questions. Obviously most of the entrepreneurs were founders who did not have a background in sales, so they were curious as to why it was so complicated. Most were used to paying out salary + bonus or more likely salary + stock options for their engineering staff.

Sales compensation does not have to be complicated, but it can be made to appear so. Obviously it starts out fairly simple – most sales people like cash and are motivated by cash more than anything else. Entrepreneurs should like sales people that are motivated by making as much short term money as possible.

On Target Earnings (OTE) is the term we use for total compensation for sales people. OTE comprises of Base salary (fixed, paid monthly or every other week), which is typically between 40-60% of the OTE and Commission, which is variable making up the remaining amount. Sometimes a bonus is added to the mix to achieve certain objectives the company has – for example, an objective that is important, but does not generate revenue – getting reference customers or supporting a marketing program.

OTE = Base Salary + Commission (+) Optional Bonus

The question, specifically was about when and at what conditions is the commission paid?

1. Early in enterprise software, most companies paid commissions on bookings. When the purchase order has been signed by the customer, the sales person gets paid. That’s usually good for perpetual license deals, where the customer pays an upfront fee for the software and amortizes it over the life of the usage. Since most customers who could afford this were large, the possibility of them defaulting the payment was rare, so it made sense. Most large enterprise software companies did this.

2. Thanks to monthly recurring revenue (sometimes billed and recognized monthly and other times billed annually and still other times billed for 2/3 years), most SaaS companies started to pay commissions on recognized revenue. This aligned the interests of the company with the sales person.

3. Still other companies actually only paid out commissions on income. That is when the money hit the bank. This ensured that the sales person would ensure the customer would actually pay the money, but then puts the sales person in a position to be responsible for some non-revenue generating tasks.

4. Some companies pay out commissions on contribution margin achievement. So, software (high margin) would get X% margins, but services (lower margin) would get less than software margins. VSOE regulations prohibit vendors for arbitrarily charging different customers, different prices (or inconsistent price discrimination as it was known) so this practice is rarely followed.

5. Finally some startups pay their commissions on implementation. This is typical in companies where there is a lot of services to get a customer up and running. Typically, if a customer takes 3-4 (or longer) months to get the software working thanks to customization, then most companies would prefer to pay their sales people after the customer has successfully implemented.

Regardless of when you choose to pay your commissions to your sales reps, the method cant change as often as you’d wish, since it confuses sales people and creates a lot of angst.

I would stick to one method and keep it consistent. Realize though, that the later you choose to pay the commission (closer to implementation) the more time the sales person spends on non new sales opportunity related tasks. The earlier you choose to pay the commission the less the incentive for the sales person to see the customer be successful.

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