- Choose on-target earnings (base plus variable) relative to local market benchmarks
- The more complex the sale, the higher the OTE required
- Higher OTE leads to a better talent pool and lower regretted turnover
- Expect the top 10% of AEs to earn 2x to 3x the target OTE
- Choose the target pay mix
Ex: 60% base / 30% commission / 10% discretionary MBO. Continuing our example, $110K base, $55K target commission, $18K MBO
- Complex products with long sales cycles and significant team selling tend to have higher base salary percentages
- Set quotas working backward from revenue, profitability, or other business (ex: market share) goals.
Ex: With a 7.5% sales compensation as a percentage of revenue target and $184K OTE, the target quota is $2.44M.
- A test of reasonableness is that 60-70% of AEs should meet or beat quota. Over-performance should more than outweigh underperformance such that ~100% of the company revenue plan will be achieved. Moreover, at this level, sales turnover should be around the industry average of 18% (10% involuntary and 8% voluntary).
- Also as a test of reasonableness, the overall average quota is $1.57M (source: CSO Insights, 2015). A higher total book may be reasonable if the majority is likely to renew.
- Split quotas into recurring (such as MRR or ARR subscriptions) and non-recurring revenue (such as consulting services) components.
Ex: 90% recurring and 10% non-recurring which in our example is $2.2M recurring and $240K non-recurring.
- Set the commission on non-recurring revenue.
Ex: 5% for sales up to 100% of non-recurring revenue quota and 2.5% above. This means a target non-recurring revenue commission of $12K. Uncapped.
- The commission on non-recurring revenue should be lower than the commission on recurring revenue to provide a disincentive on non-recurring revenue since it almost always has a lower lifetime margin.
- In addition, you should consider a decelerator on high levels of non-recurring revenue attainment to provide an additional disincentive to focusing on non-recurring revenue.
- Some companies hold back commissions on non-recurring revenue until certain recurring revenue targets are achieved but that is complex and discouraged
- Set the commission on recurring revenue
Ex: Pay 10% on ACV in excess of expected average capped wallet retention (min of prior ACV and renewal ACV). Uncapped.
- – Here is how to compute this:
a. Recall the total ACV quota is $2.44M, of which $2.2M (90%) is recurring revenue.
b. Assuming capped wallet retention is 80%, $1.76M will be renewed in the normal course of business. This is covered by the AE’s base salary (which parenthetically means a 6.3% commission on expected renewals in our example).
c. As a result, AE’s are expected to bring in $440K of ACV in upsells and new logos.
d. Given $184K OTE, 30% variable target commission, and the fact that $12K has already been allocated for non-recurring revenue commission, there is $43K left for recurring revenue commission. That yields a rate of 10% (rounded up from 9.8%) on the target incremental ACV.
- Consider having multiple accelerators for achieving growth above quota.
- Unless reps have high or complete control of pricing, do not tie compensation to gross margin. Instead, ensure appropriate margin by limiting the discounts AEs can extend.
- Consider an accelerator on multi-year deals.
- Set the performance period
Ex: Quarterly performance period leads to $550K of ACV and $61K of non-recurring revenue per quarter (Assuming even distribution – see note below)
- The performance period is the time period over which you measure performance to quota
- Generally, shorter sales cycles and lower forecast visibility call for shorter performance periods.
- Note: Revenue is generally not distributed evenly. A more typical quarterly distribution is: 21% / 25% / 24% / 30%
- Set the payout frequency
- The payout frequency need not match the performance period but often does.
- Unless reps are directly responsible for generating invoices and collecting cash (very rare), do not tie payouts to cash collection.
- Strive to avoid claw-backs by modifying other elements of the plan to spread out collection & cancellation risk (which is usually outside of AE’s control) across the business.
- Set commission payment frequency based on reps needs for cash flow and based on quota reset frequency. More junior reps usually need higher frequency payouts.
Additional best practices:
- Keep the plan as simple as possible and provide real-time visibility into accrued commission
- Ensure metrics are easily measured & reported in real-time (ex: sales volume) and not subject to change (ex: pipeline).
- Reserve room in your compensation budget for short-term incentives (aka SPIFs – sales performance incentive fund) and for non-cash rewards (ex: annual “President’s Club”). However, be very wary of the negative side effects of SPIFs on customer experience and on other parts of your business.