How to Build a Sales Incentive Plan
It takes close collaboration by the Chief Revenue Officer and the Chief Financial Officer.
Executive Summary
Enterprise SaaS companies employ a direct-sales Go-To-Market strategy where salespeople contact potential customers directly and often work several months to complete the sale. These types of salespeople have unique compensation structures in that half of the total compensation is based upon their sales production. Using a direct sales force is expensive so it makes sense to tie compensation to production.
Andy Wild, a senior sales executive with a background in successful start-up, turnaround and hyper-growth software, explains,
A well-designed sales incentive plan doesn’t just reward performance; it drives focus, aligns goals, and fuels a culture of excellence. Get it right, and it becomes a powerful tool that inspires your team to deliver results. Get it wrong, and you risk misalignment and disengagement. Eric’s coaching in this post highlights the complexities in plan design but at the same time how to keep it simple.
Andy and I agree that Chief Financial Officer and the Chief Revenue Officer must closely collaborate to ensure the Sales Incentive Plan rewards salespeople appropriately while maintaining acceptable profit margins.
Building a Sales Incentive Plan
A Sales Incentive Plan should be a simple and straightforward document that allows sales representatives to easily understand how they can earn sales commissions and at rates that provide incentive to produce the required Bookings as defined by the annual operating plan or budget.?
Under a Sales Incentive Plan, each sales representative has a base salary and a variable commission target, called a Target Incentive Commission (TIC) or On-Target-Incentive (OTI). The base and variable amounts are typically split 50%/50%, meaning that the sales representative can earn twice their base salary by producing enough Bookings to hit a contractual target, known as a quota.? The sum of the base and variable compensation is known as On-Target-Earnings or OTE. If a sales representative meets their assigned quota, then they will earn 100% of their OTE. Sales representatives who are assigned a quota are called Quota-Carrying-Reps or QCRs.?
To achieve their variable compensation, QCRs receive a predetermined, contractual percentage of the dollar value of the sale. The value of the sale is always expressed in annual terms, i.e. the Annual Contract Value (ACV). The commission rate is based upon the value of the bookings type. For example, higher margin Subscription Bookings carry a higher commission rate than that for Services. Further, QCRs earn a higher commission rate on New Bookings than they do on Expansion Bookings because the latter is already a customer with a known propensity to purchase the product. The Sales Cycle is typically much shorter and requires much less time than a New Booking. Similarly, Renewal Bookings pay an even lower rate than both New and Expansion Bookings.?
The percentage of the Bookings ACV paid to the sales representative is called the Base Commission Rate or BCR and they vary as follows:
Companies further incentivize Quota-Carrying Reps by offering incremental commission rates once the QCRs meet their quotas using what is called an Accelerator plan. The Plan accelerates sales commissions for Subscription Bookings with incremental rates at various stages over 100% of quota. A typical Accelerator Plan uses a schedule as follows:?
To illustrate, a QCR that has already met their quota each year and closes a New Subscription Booking that increases total annual production to 120%, will be commissioned at a rate 3% higher than the 10% BCR, or 13%. This incremental commission rate steps up in stages until a certain point when the rate drops back down to the BCR. This reset protects the company from paying an outsized commission rate on a deal that likely requires support from across the organization including executives.??
While we focused on Quota-Carrying Reps, other members of the sales team have compensation plans with a variable component based on Bookings production by the QCRs. While these folks do not personally generate Bookings, they have a significant impact on the QCRs ability to do so. Sales leadership will receive commissions based on the production of their direct reports as will middle managers such as those that manage QCRs in their GTM scope, i.e. specific geographies or market verticals. The sales operations team and other supporting members may have variable components in their compensation plan. And the Sales Incentive Plan will provide details for all these teams.?
The overhead expense is typically shown as a rate which is known as the Fully Loaded Sales Commission Rate. This overhead expense adds 6% to the BCR. For example, a $120,000 ACV New Subscription Booking will pay 10% to the QCR and 6% to the team members qualified for a commission. When modeling sales commission expense, make sure that you calculate the fully loaded expense.?
Other Incentives
Sales Performance Incentive Fund (SPIF)
A Sales SPIF is a short-term financial incentive given to sales team to motivate them to achieve specific sales goals or promote products within a defined period. Unlike regular commission structures or bonuses, SPIFs are typically additional rewards that encourage specific behaviors or achievements, such as selling a new or strategic product line, increasing the volume of sales within a short time frame (within one quarter as an example), meeting or exceeding targets during a promotional period and selling to a targeted segment or market, typically outside the current target market.
SPIFs can take various forms, including cash bonuses, gift cards, travel rewards, or other perks, depending on the company's budget and goals. They are a useful tool for sales management to boost motivation, align the team with strategic priorities, and drive short-term results that contribute to the company's broader objectives. The SPIF dollar value is typically based on an incremental percentage to the existing rate under the Sales Incentive Plan.
President’s Club
The President's Club is a recognition program for top-performing salespeople, designed to drive motivation, recognize exceptional results, and align efforts with company goals. By targeting high achievers who exceed annual sales targets, it promotes healthy competition and pushes team members to elevate their performance. The status associated with the club boosts morale, giving members recognition among peers and leadership. This acknowledgment, paired with rewards like retreats, bonuses, or trips, enhances retention by creating a sense of loyalty and belonging, helping the company retain valuable talent and reduce turnover.
When you add these other incentives, be sure to incorporate this expense into your sales and marketing expense forecast.
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Sales Commission Expense
So, what is a good target for sales commission expense as a percentage of revenue. Benchmarks are hard to find because it’s not a widely available metric and because the percentage varies significantly from one company to another. So, let’s create a theoretical company and estimate this metric based upon standard commission rates. Assume an Enterprise SaaS company that generated $150 Million in total annual revenue with:
Using these assumptions, we know that the company:
The sales team also sold $30 Million in Services Bookings.?
Total sales commission expense would equal $9.3 Million or 6.2% of total revenue as follows:
We can take this theoretical analysis a bit further to show that sales commission expense would be about one-fifth of the total sales department expense. To do this, we assume that this company operates at the Rule of Forty (RO40), meaning that the EBITDA margin is 0%. The median Gross Margin should be approximately 78% and Sales and Marketing expense would be about half of the operating expense, so $60 Million. Sales alone would make up 70% of this amount or $41 Million. Therefore, a sales commission expense of $9.2 Million would be 22% of the total investment in Sales.?
Summary
Ultimately, a thoughtful Sales Incentive Plan provides clarity and motivation for the team, fosters alignment with broader company objectives, and ensures the business invests wisely in driving revenue. With insights into various incentive structures and commission modeling, this article serves as a guide for crafting incentive plans that support both the salesforce and the company’s strategic financial health.
Where to find additional information:
About the Author
Eric Mersch has over 25 years of executive finance experience including twice serving in public company Chief Financial Officer roles. Eric is an equity partner at FLG Partners where he works as an Interim CFO to venture and private equity portfolio companies, specializing in Strategy and Operations, Strategic Planning, Equity and Debt Fundraising, Go-To-Market Strategies, Financial Planning and Analysis, Business Intelligence, and Accounting and Control. He’s worked with SaaS companies in the Big Data, Cyber-Security, Internet Infrastructure, Open-Source Software, Advertising/Marketing Technology, Mobile Application, Real-Estate Technology, and Payment Processing spaces.
Previously, he served as Chief Financial Officer, Chief Accounting Officer and VP, HR for ZipRealty, a publicly listed, real-estate technology company. In this role, he joined the management team in the dramatic turnaround and successful sale of the business to real estate conglomerate, Realogy Holdings Corp (NYSE: RLGY) in 2014. While at ZipRealty, Eric played a key role in reorganizing corporate overhead, developing a new go-to-market strategy and launching a new SaaS product. In his first public company role, he served as Chief Financial Officer for VitalStream (NASDAQ: VSTH), a Content Distribution Network (CDN) company, providing subscription-based data storage and streaming services for digital media companies. He introduced unit economic analysis and drove significant efficiencies in LTV/CAC. He managed due diligence in the company’s successful sale to Internap.
He also worked at Caesars Entertainment as Director Corporate Planning and later as VP, Finance for the Harrah’s and Flamingo Resorts, an $800 Million revenue business. Prior to his civilian career, Eric served in the US Navy as a submarine officer on the USS Los Angeles. Eric holds an MBA from Harvard Business School and a Bachelor of Science in Economics from the U.S. Naval Academy and is a graduate of the US Navy’s Nuclear Power School.
In 2023, Eric authored “Hacking SaaS: An Insider’s Guide to Managing Software Business Success,” a comprehensive resource for those wanting to understand the business model, from seasoned professionals to those new to the industry.
He can be reached at [email protected] and by direct message on LinkedIn.
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Experienced CFO and Operator
3 个月I’ve had a few questions about the photo. Those are not real people. I created the photo using ChatGPT.
SVP RevOps | Co-Founder | Big Picture Thinker | EQ Centric Leader
3 个月Thank you so much for the insights, Eric. The blog is very timely. What are your thoughts on the timing of comp payouts? Should sales comp be paid on bookings/billings/implementation or cash collections?