Sales tales: need to design a SaaS sales rep’s target? — it’s all change!
Today’s tale: pay for the increase not the spend
By Devin Hunt and Stephen Allott, Venture Partners, Seedcamp
Seedcamp Sales Tales has 20 episodes.
Have you just hired a SaaS sales rep and you need to design their target? You have choices about how and when to measure performance:-
> monthly recurring revenue (“MRR”) or annual recurring revenue (“ARR”)
> bookings or revenue
> revenue or delta in revenue
> committed subscriptions or variable usage
> And where do quarterly targets fit in if you are using MRR?
Introducing our 9 step guide to making your choices
To help with these questions we produced our 9 step guide for you. Let’s start with a quick bit of history. Measuring sales team performance used to be easy. Sales were measured by what had been sold.
First you forecasted a booking. Second you won the booking by entering a legal contract with the customer. People often call that “closing a sale” or “closing an order”. Third you then invoiced the booking and collected the money. You measured sales by counting bookings.
Then SaaS came along. And now it’s not so simple.
What is the “booking” when a customer signs up for a monthly SaaS subscription? Does it matter whether it’s monthly or annual? What is Annual Contract Value (“ACV”)? Does it matter to you? Does it matter to your investors whether you sign monthly or annual subscription contracts?
Here are several different ways of asking the same things:
- How do you design sales targets for SaaS?
- How do you retire quota for SaaS? “Retire quota” means “count against a sales target”. Getting “quota credit” means the same as “retire quota”.
- Is the value of a SaaS booking based on the length of contractual commitment?
The answer in a SaaS business is to count the increase in spend rather than count the spend itself. The “net Delta MRR Method” is our favourite. This moves away from counting bookings and towards counting the change in monthly recurring revenue (“MRR”).
And how do you retire quota for variable usage charges on top of the subscription? Remember telephone variable usage plans when you paid both a subscription (often known as a “standing charge”) and for minutes and texts on top. How did those telephone companies design sales commission plans? Does a delta usage approach i.e. an increase in variable usage, fit well with a Delta MRR method?
Each building block of the “Net Delta MRR” approach needs some careful discussion and we’ll take each in turn. The handy thing is MRR is not only the way you target the sales team but also the way you plan your business and then report performance to investors. It’s the same MRR building block everywhere. MRR makes for strong foundations.
The 9 step guide
- Monthly Recurring Revenue (MRR) is the building block to use; not Annual Recurring Revenue (ARR)
MRR is the measurement currency to work in. Many people talk in ARR (MRR x 12 which is fine, simply multiply MRR by 12) but you cannot use ARR as the measurement currency for the simple reason that you may well have customer contracts that are not annual. Suppose your business has a mixture of customer commitments lasting a month, 6 months, 12 months, 18 months and 3 years. The MRR is the monthly value of each. But there is no Annual Recurring Revenue for a 6 month commitment. It’s just not a meaningful concept. And it’s stretching a point to say what the Annual Recurring Revenue of an 18 month commitment would be.
2. A great system for early stage companies is “net delta MRR” across the sales rep’s territory (book of business). It covers both wins and losses so reps will balance their time appropriately.
In SaaS, designing a target based on the net delta MRR figure at the end of each quarter across a rep’s territory (a “book of business”) is a great approach. In this book of business system, a rep manages both their existing accounts, protecting them from being lost (“attrition”), as well as seeking new business. As the commission rate is the same across both; a rep balances their time according to the revenue at stake or at risk. This is economically rational.
To be clear, if a rep wins 20 of new MRR but loses 5, their net delta MRR and hence quota credit is 15. Attrition is handled automatically under the net delta MRR system. Neat.
Here is a worked example of the net delta MRR system
It doesn’t rule out splitting territories into hunters for new business only and farmers of existing accounts which is often done in later stage companies.
3. Use net delta MRR to cover payment for consumption (variable usage)
Payment for the net increase in variable consumption fits elegantly with a net delta MRR system. The only point to note is that the revenue is “Recurring” because the customer has maintained the same usage levels rather than having a subscription. You can use the same quota retirement for subscription as consumption, dollar for dollar, even though one might quibble that a subscription is higher quality revenue.
4. Use quarterly sales targets
Quarterly targets work well in many businesses and fit with a US style quarterly planning and results system. One reason quarterly targets work well is that 13 weeks is a reasonable period to try a new sales tactic and see how well it works, Another reason is that 4 closing pushes per year is manage-able but having 12 per year is too many to get teams to put in extra effort. You should default to using quarterly targets unless there is a good reason not to. So targets should be the net delta in MRR over a quarter.
5. Annual commitments should get the same quota credit as monthly. Not more.
Whatever the length of the contractual commitment, it’s the same delta MRR. That means that under the delta MRR system your reps won’t bother trying to sign annual agreements. They will sign customers on monthly contracts because that will be easier. We like this.
At Seedcamp, given a choice between 10 monthly customers or 5 annual customers, we would prefer more customers to be signed. Go for the 10 monthly customers. You will keep them if your product is great. At early stages we don’t think effort spent on getting customers to agree to a one year contract is effort well spent.
6. Even if a customer pays a year’s cash up front; Annual = Monthly
Even if your customer pays a year up front, the quota credit should only be the net delta MRR. Let’s look at how would you retire quota with a full annual commitment and cash up front as compared to a monthly sign-up with no annual commitment?
Here is the cash flow in each case so you can see the impact on quota retirement, accounting revenue recognised and cash collected.
Taking the discussion in stages, a net delta MRR system ignores the length of contractual commitment as well as the cash timing, The management question is whether you want your reps to chase cash up front and if so what comp plan design to use? If you had lots of cash from investors you would want your reps to chase new customers but if cash was tight you might want them to chase cash up front.
What if you do want to incentivise your reps to get cash up front? There are 3 choices of approach in this situation:
a) The net delta MRR system already described with a separate spiff for collecting annual cash up front. A “spiff” means a bonus outside the quota credit and target system. The bonus might be 5% of the early cash collected.
b) An ACV (“Annual Contract Value”) system where targets are based only on annual bookings and where monthly contracts do not count to retire quota.
c) A hybrid bookings system where both monthly and annual bookings attract quota credit to their respective value and commission is released on receipt of cash. In this system attrition is not usually treated as a delta. So we are counting bookings not the change.
7. Splitting hunters and farmers is a mature business optimisation but not something to do from the start. Far from it.
Hunters and farmers. This discussion in a Seedcamp Sales Engine Workshop always prompts a question about whom should drive sales into the customer base of existing accounts: the original (“hunter”) rep who opened the account, a separate existing (”farmer”) account rep or the customer success function.
“Crazy” said a seasoned CEO recently. He told me my suggestion that the same rep keep an account to grow it after opening it was “crazy”. Strong words and so often wrong. People have heard about “hunters” and “farmers” and think that a minor optimisation of mature business territory design should be used from the start. To see why its so often wrong, imagine you have landed in a huge global account with a small early deal which took 6 months to close. There could be dozens of follow up sales. Why would you swap reps? Sounds crazy to me.
8. Paying a bonus at quota plus commission on every sale works well with delta MRR and you don’t need thresholds
A very elegant commission plan design is to combine commission and bonuses for hitting targets. See the payout curve in the chart below created by my former consulting firm, Trinamo. The commission plan design textbooks discuss the relative merits of commission on the one hand and targets on the other. One textbook is 500 pages long. But you don’t have to choose between commission and targets. You can have both in the same plan.
The “accelerator” (commission rate over quota) is a key feature in this design. Top sales people will want to negotiate their accelerators because they plan to over perform. You can have more than one slice if appropriate say for 100% to 120% over quota and then a higher rate for more than 120% over quota.
The delta MRR system also means you avoid having thresholds where a rep’s territory already has a productive book of business.
9. Avoid the Terminology Trap — know your synonyms
Each column sets out words for the same thing. Confusion can result. Discuss the agree the terms you will use in your company. And how they differ.
Bookings, invoices and cash are clear economic events and are how you drive the business. Net delta MRR is a type of booking. You win bookings. You issue invoices. You collect cash.
Accounting revenue is not how you drive the business but rather a presentation according to conventions of the business performance. It can be gamed. Measuring sales on accounting revenue recognised is rarely a great idea. That’s a measure for the CEO and CFO. Just ask some-one to explain to sales what “VSOE” is and you will find out why.
Follow the 9 steps when you design your sales commission plans and targets and do it at the start of your recruitment campaign not at the end.
Be ready with your proposal when you are hiring.
Great candidates need to be closed quickly. And then you can count the delta.