SaaS Sales Compensation Models - Twente Student Conference on IT

<strong>SaaS</strong> <strong>Sales</strong> <strong>Compensation</strong> <strong>Models</strong>
Boyan Lazarov
University of <strong>Twente</strong>
P.O. Box 217, 7500AE Enschede
The Netherlands
b.g.lazarov@student.utwente.nl
ABSTRACT
This paper has the purpose of introducing and analyzing the
emerging problem of compensating sales agents in companies
entering <strong>SaaS</strong> markets. At first general management of sales
force is overviewed, regarding sales roles, revenue and margin
focus, strategies, and quotas. Secondly, a <strong>SaaS</strong> compensation
model is given, placing the focus on recurring revenue. Next,
both product and service orientated compensation models are
compared. The conclusion is that the difference between both
compensation models is not the expected drop of commission
rate but it is the lack of clarity in the payment scheme of the
sales agents.
Keywords
Cloud computing, <strong>SaaS</strong>, sales compensation models, service
and product based software companies, incentive cost
1. INTRODUCTION
Nowadays, marketing strategies are more important for
software companies than ever before. The traditional enterprise
sales model is broken. Selling software, both through upfront
fees or long-term licenses, is “struggling” and “panting”
because customers’ and big businesses’ demands are changing.
Therefore, a different approach is needed and many software
companies have already followed the new trend in the
computing industry – Cloud computing.
Cloud computing is a term which originates from the early days
of the Internet. Basically, clouds were used as abstraction for
networks. Nowadays, by cloud computing is meant the
delivering of computing as a service rather than a product [8].
The cloud computing provides three general service models –
Software as a Service (<strong>SaaS</strong>), Platform as a Service (PaaS) and
Infrastructure as a Service (IaaS), and four deployment models
– Private Cloud, Community Cloud, Public Cloud and Hybrid
Cloud [9].
The focus of this study – <strong>SaaS</strong>, is a web-based software
available for clients via any up-to-date web browser. This
allows the customers to use the rich features and functionality
Permission to make digital or hard copies of all or part of this work for
personal or classroom use is granted without fee provided that copies
are not made or distributed for profit or commercial advantage and that
copies bear this notice and the full citation on the first page. To copy
otherwise, or republish, to post on servers or to redistribute to lists,
requires prior specific permission and/or a fee.
16 th <strong>Twente</strong> <strong>Student</strong> <strong>Conference</strong> on IT, January 27 th , 2012, Enschede,
The Netherlands.
Copyright 2012, University of <strong>Twente</strong>, Faculty of Electrical Engineering,
Mathematics and Computer Science.
of a desktop application but via any computer with internet
access. The services could vary from very simple applications
like e-mail clients to complicated and sophisticated programs
for accounting, financial management, project management,
content management systems and others [16].
The benefits that <strong>SaaS</strong> provides are many, such as [15]:
Time saving because it is ready to run software and it
does not require any installation.
Most of the cloud services are standardized assets
that can be used for enterprise’s core operations or
with other applications.
Low risk because <strong>SaaS</strong> uses pay-per-use business
model and the risk of investing large amount of
resources is eliminated.
Flexibility – cloud vendors could satisfy specific
customer demands by different set of functionality
which could be further evolved and enhanced.
Paper structure
The main objectives and motivation about this study are given,
followed by the research questions. In the next fourth chapter
the general management of sales force is discussed regarding
both classical software and <strong>SaaS</strong> companies. In the fifth chapter
the focus falls on <strong>SaaS</strong> sales compensation models and after
that, in the sixth chapter, it is made a comparison between
service-based and product-based compensation models. At the
end, a conclusion is drawn.
2. OBJECTIVES AND MOTIVATION
FOR STUDY
The uncertainty of global markets and the shift from competitor
orientated to customer orientated markets forces standard
software companies to offer services, such as maintenance, to
compensate the decreasing sales of products and customers’
satisfaction. However, it is estimated by Gartner that cloud
services will grow twice the speed of traditional software in the
future (fig.1), achieving five-year compound annual growth rate
[7] (CAGR 1 ) of 16,3%, while for the latter CAGR is 8,3%, and
as a result software companies will need to integrate even more
services. The transition of a software company from licensed to
service models is called serviceisation.
One of the issues which these companies will face is the
adaption of new compensation models for sales departments.
The calculation of commissions for that group will dramatically
change and there is no best approach for solving this problem,
yet.
1
( ) ( )

<strong>Sales</strong> volume
Introduction
Growth
Maturity
Decline
Billions of dollars
200
180
160
140
120
100
80
60
40
20
0
Enterprise
Application
Software
Worldwide market
2010 2011 2012 2013 2014 2015
103,8 114,4 123,7 133,4 144 154,8
<strong>SaaS</strong> 10 12,1 14,3 16,7 18,9 21,3
Figure 1. A forecast made by Gartner [11]
The purpose of this study is to investigate the emerging
compensation models for commercial employees in clouddriven
business. These models will be compared with the
product-based compensation models used in software
distribution. The primary goal is to introduce and recommend
compensation models for sales departments at <strong>SaaS</strong> companies.
3. RESEARCH QUESTIONS AND
RESEARCH METHODS
The research question is formulated as follows:
4. GENERAL MANAGEMENT OF
SALES FORCE
The motivation of salespeople is a challenge that every
company has to cope with. Unwritten rule is that if
representatives cannot control the factors affecting their success
and salary, it will have a bad influence on their performance
and motivation.
“Take into account how challenging the job is.” [12]
A good sales manager should always be aware of the level of
incentive of his or her subordinates [4].
In general, the major difference between <strong>SaaS</strong> sales
compensation and sales compensation for software and other
products is the basis on which the incentive cost is calculated.
For the former the basis is life time value (LTV) of a deal
whereas for the latter it is unit price. However, before
discussing the differences it is appropriate to begin with the
common factors behind both models.
Firstly, everybody strives for simplicity, simple is better, and
this also applies for sales. To achieve simplicity sales a clear
plan and obvious goals are needed. <strong>Sales</strong>people should do only
and only what they are paid for, nothing more, nothing less.
Furthermore, the prosperity of a sales force should not be
limited in any way. Unlimited compensation equals boundless
success for both company and salespeople [13].
I II III IV
What compensation models should be used in order to
prevent sales departments to become victims of the
migration process from classical software distribution
to <strong>SaaS</strong>
In order to answer the main research question, the following
derivative sub-questions should be answered first:
What are the compensation models for sales
departments used by product-based software
companies
What are the sale compensation models used by <strong>SaaS</strong>
companies
What are the similarities and dissimilarities between
both compensation models
How the migration will affect sales department
compensation models
3.1 Research methods
The research method which is going to be used is a literature
survey.
The first part of the study is focused on gathering information
about the problems. The literature survey will help to reach a
general idea of how both systems work. The second part will be
a comparison between both models. The third and final part is
to draw conclusions.
Time
Figure 2. Product Life Cycle
On fig. 2 is shown the PLC which is tidily connected with the
sales model of a company. During the different stages of the
cycle a company has different goals – entering and stabilizing,
increasing, and maintaining the market. To achieve these goals,
a company should consider the recruitment of special types of
sales agents [6]:
In the Introduction stage the main objective of a
company is to enter the market and to achieve to stay
there. <strong>Sales</strong> volumes will be low and a demand has to
be created. Customers have to be induced to try the
new product or service and for that purpose the role
of the sales force should be hunters. Hunters are
people whose job is to penetrate prospects and
customers, seek for new opportunities, develop leads
and dedication.
In the Growth stage economics of scale takes place.
The aim is a significant increase of sales. While in
the previous stage competition was not such an
important part, now it is necessary to be taken in
consideration. Moreover, the hunters have done their
job and as a result the product or service has some
public awareness, therefore, the sales force role now

<strong>Sales</strong> volume
Percent of employees
in range
shifts to specialist. By specialist is meant people who
have deep knowledge of the market’s segment and
customers’ business. This is needed because
customers demand for reliable information by people
who are aware of their business and the environment.
In the Maturity stage companies reach market
saturation. The focus is placed on brand
differentiation and feature diversification to maintain
or increase market share because of growing
competition. Therefore, the desired salespeople are
farmers. Their job requires excellent skills in
customer relations emphasizing on working internal
systems of the customers and also effective
explaining and clarifying issues to the customers.
The Product Life Cycle could also be used to explain how to
adjust the sales margin and revenue. Planning when to expand
and when to develop is always a challenge for software
companies. <strong>Sales</strong> revenue clearly means the income from sales.
When a company is revenue focused, its goal is growth.
Disregarding the efficiency of gross profit, those companies aim
for fast expanding on the market. This approach is suitable for
products and services in the Introduction stage and less relevant
in the next stage. <strong>Sales</strong> margin stands for optimizing the
profitability of a company. This means, a company has to
develop more effective way to increase the profits from current
sales. Since the profitability is not a main part of the first stage,
the sales margin focus starts to grow in the Growth stage and
increases to the Maturity stage where it hits a plateau (fig. 3).
I II III
Margin
focus
Revenue
focus
Time
Figure 3. <strong>Sales</strong> Revenue vs. <strong>Sales</strong> Margin focus on PLC
(vertical vs. horizontal scale)
The tools that a company has to manipulate the sales revenue
and margin are respectively quotas and bonuses. Quotas are
probably the most important part of a sales model, everything is
connected with them.
Firstly, quotas should be individually set for every salesperson.
This is done because of the fact that people have different
capabilities and skills, and cannot accomplish absolutely the
same performance as others. Also, other factors affect their
performance such as market changes, competition, bad periods,
etc. Taking in mind this uncertainties, quotas should be
extremely flexible. However, the sales model is built on
company’s goals and therefore in most of the cases one of the
goals is growth. Companies expect to sell more than they have
planned to do so as a growth rate.
50
40
30
20
10
0
Attainment
60% 80% 100% 120% 140%
Balanced 4 24 44 24 4
Growth 10 18 26 36 10
Figure 4. Quotas attainment by representatives [14]
On fig. 4 is illustrated an example of balanced and growth
focused quotas attainment by salespeople. It is obvious that not
all representatives could sell 100% of their quotas every month.
However, the majority should be capable of selling around
100%. The average balanced attainment according to this chart
is 100% while growth attainment is 104% which is 4% growth
in sales. However, if the attainment is not spread in such ways
and most of the salespeople have accomplish less than 100% of
their quotas, than there are two general reasons about this. The
first one is that there is no demand on the market and quotas are
set too high. In this case sales expectations are unrealistic and
the quotas should be reduce to more achievable level while in
the second option is that there is a demand on the market but the
salespeople are not capable of satisfying this demand. The
solution for this is to replace the personnel with better qualified
one. On the contrary, if the demand is big and the majority of
salespeople are selling more than 100% of their quotas than the
incentive cost will be higher than the amount of which a
company could afford to pay. In this case increasing the quotas
is the best choice to lower the incentive cost and keep the sales
rate. If the company sales more than one product or service than
a different quotas for each have to be set, in addition, an
optimal bonus function could be added for quota achieving of
multiple sales [1].
The representatives’ salary is mainly form by two parts - base
salary and commission which in most cases have equal amounts
[10]. The 50% base salary gives the salespeople confidence for
an assured income whereas the 50% of commission gives them
the power to control the factors affecting their final payment.
The latter is the incentive cost that companies are paying for
selling their products and services calculated on the base of
quotas attainment. By increasing the quotas a company actually
does not lower the cost, that it is paying to salespeople, but
transfers the money from the incentive cost to the base salary of
representatives opening a room for increase in salespeople’s
salary, company’s sales and respectively in revenue.
“Aligning the salesperson's incentives with those of the firm
itself.” [5]
5. SALES COMPENSATION MODELS
FOR SAAS COMPANIES
So far, sales were connected only with quotas, however, for
<strong>SaaS</strong> companies quotas have an outcome metric which is
recurring revenue while for product-based companies it is
bookings. Recurring revenue is portion of a company’s
subscription revenue that is predictable, stable and could be
counted on it in the future with a high degree of certainty. There

are three types of it – Monthly Recurring Revenue (MRR),
Quarterly Recurring Revenue (QRR), and Annually Recurring
Revenue (ARR).
MRR is probably the best metric on which to base <strong>SaaS</strong> sales
compensation model. It is a set of four revenue components –
new sales, renewals, upgrades, and losses or commonly referred
as revenue churn.
A good example of <strong>SaaS</strong> compensation model based on MRR,
which is suitable for small, medium and enterprise business, is
the one used by Netli [2]. The CEO and VP of <strong>Sales</strong>, Gary
Messiana wanted salespeople to think only about MRR and to
achieve that he proposed to be paid $1 commission for $1 of
MRR sold. Taking in mind that $1 of MRR generated $12
ARR, this means 1 / 12 = 8,3% as sales commission. The scale
rate of the commission respectively is [2]:
For 0-25% of the quota, $0.25 commission per $1 of
MRR
For 25%-50% of the quota, $0.5 per $1 of MRR
For 50%-75% of the quota, $1.0 per $1 of MRR
For 75%+ of the quota, $1.5 per $1 of MRR
However, to prevent representatives to push deals from one
quarter to another the target is based annually and by doing this
he keep the high level of incentive of his sales personnel for the
whole year. Moreover, to ensure that the company will
accomplish 70% sales quota, he adds a new rule where every
salesperson below 70% of his quota in any time of the year
basically gets nothing or a small part of the initial plan. The
payment is also very clear – 50% on signature and 50% on cash
collection.
“Accelerating bonuses for upfront cash payment depends on
your cost of capital. If you assume a 20% cost of capital (typical
for equity, debt is generally cheaper), then getting an upfront
payment for one additional year on a $10k MRR contract saves
you $24k. You can therefore pay an incremental $2k
commission to the sales person (20% acceleration) and make it
worth it for everyone.” [2]
6. COMPARISON BETWEEN
PRODUCT-BASED AND SAAS
COMPENSATION MODELS
“The primary principle of sales compensation is to pay the
sales representative in proportion to the value of the deal,
usually measured by the price of the product” [17].
For product-based compensation models sales commission
percentage is calculated by dividing the target commission at
quota by the sales representative quota (all of the following
formulas are presented by (York, 2010) [17]:
commission % = target commission at quota / quota
The quota itself is equal to the target number of deals multiplied
by the average value of deals:
quota = target # of deals * average deal value
And the sales compensation is calculated by multiplying the
commission percentage by the actual sales made:
York also adds and highlights that the target sales commission
is not only percentage of the sales revenue but it depends on
labor market rate for the different types of sales agents which
are needed in matter to fulfill the sales roles. This means that
the commission payout is based on a measure of performance
and examples of such measures are quotas, license revenue, and
recurring revenue. It depends on the company to choose which
one is going to use in order to align the sales representative
performance with company performance by sales
compensation.
Since the recurring revenue of a deal is always based on life
time value of a deal, it is not appropriate and efficient <strong>SaaS</strong>
companies to calculated sales compensation plans on absolute
LTV or, at least, it is more difficult and it opens rooms for
mistakes. By using any of the recurring revenue measures
(MRR, QRR, ARR), a company constrains the commission
percentage and respectively the target sales compensation of not
scaling up or down. The <strong>SaaS</strong> commission percentage, quota
and sales compensation basically are the same as productorientated
ones but with that difference of using recurring
revenue based on LTV instead of bookings based on unit price:
<strong>SaaS</strong> commission % = target commission at quota / quota in
recurring revenue
<strong>SaaS</strong> quota = target # of deals * average deal value in
recurring revenue
<strong>SaaS</strong> sales compensation = commission % * actual sales in
recurring revenue
York also mentions that once a type of measure for recurring
revenue is chosen it is important and critical companies to stick
to that measure throughout of the whole sales compensation
model.
7. CONCLUSION
In conclusion, it could be said that the sales agents are not
actually victims of the migration process from classical software
distribution companies to <strong>SaaS</strong> companies. The whole
compensation model shifts from fixed unit price and
commission to floating life time value of a deal and uncertain
recurring revenue which indirectly affects the final salary of
sales agents. Some new variables are added to the calculation of
<strong>SaaS</strong> sales compensation model that makes the estimation of the
commission more difficult and unclear for the salespeople. This
is the drawback that should be avoided in any cost in order to
keep high incentive level and clear vision of sales
representatives. Giving frequent feedback and good working
environment, which is part of the incentive cost, is important as
much as giving big bonuses and commissions [3].
As an enhancement of this paper it is possible to be deeper
examined the paper of Chung, Steenburgh and Sudhir, and to be
applied some practical experience examples.
REFERENCES
[1] Albers, S., Optimization models for salesforce
<strong>Compensation</strong>. 1995.
[2] Botteri, P. Building Your <strong>SaaS</strong> <strong>Sales</strong> <strong>Compensation</strong> Plan.
2009 08-12-2011]; Available from: http://cracking-thecode.blogspot.com/2009/01/building-your-saas-salescompensation.html.
sales compensation = commission % * actual sales

[3] Chung, D.J., T. Steenburgh, and K. Sudhir, Do Bonuses
Enhance <strong>Sales</strong> Productivity A Dynamic Structural
Analysis of Bonus-Based <strong>Compensation</strong> Plans. 2010.
[4] Coughlan, A. and C. Naramsimhan, An Empirical Analysis
of <strong>Sales</strong>-Force <strong>Compensation</strong> Plans. 1992.
[5] Coughlan, A. and S. Sen, <strong>Sales</strong>force <strong>Compensation</strong>:
Theory and Mangerial Implications. 1989.
[6] How to select a sales force that sales. 2001 14-11-2011];
6th Edition:[Available from:
http://www.turninpt.com/documents/talent_management/s
elect_sales_force.pdf.
[7] Investopedia. Compound Annual Growth Rate - CAGR.
2011 17-12-2011]; Available from:
http://www.investopedia.com/terms/c/cagr.asp#axzz1j9ym
N8Xk.
[8] Kim, W., Cloud Computing: Today and Tomorrow. 2009.
[9] Knorr, E. and G. Gruman, What cloud computing really
means. 2008.
[10] Misra, S. and H. Na1iry, A Structural Model of <strong>Sales</strong>-
Force <strong>Compensation</strong> Dynamics: Estimation and Field
Implementation. 2009.
[11] Public Cloud Services, Worldwide and Regions, Industry
Sectors, 2010-2015 report. 05-11-2011]; Available from:
http://my.gartner.com/portal/server.ptopen=512&objID=2
60&mode=2&PageID=3460702&id=1734724&ref=.
[12] Rouziès, D., et al., Determinants of Pay Levels and
Structures in <strong>Sales</strong> Organizations. 2009.
[13] Software <strong>Sales</strong> <strong>Compensation</strong> Guide. 2008 07-11-2011];
Available from:
http://www.keychainlogic.net/recources/KcL-
<strong>SaaS</strong>CompGuide.pdf.
[14] Spence, T. (2009) Effective <strong>Sales</strong> <strong>Compensation</strong> for <strong>SaaS</strong>
Companies.
[15] Wainewright, P. <strong>SaaS</strong> will dominate your cloud strategy.
2011 21-10-2011]; Available from:
http://cloudsourced.blogspot.com/2011/04/saas-willdominate-your-cloud-strategy.html.
[16] Williams, D.M.I., A Quick Start Guide to Cloud
Computing Moving your business into the cloud. 2010,
Great Britan: Kogan Page Limited. 5.
[17] York, J. <strong>SaaS</strong> <strong>Sales</strong> <strong>Compensation</strong> Made Easy. 2010 29-
11-2011]; Available from: http://chaotic-flow.com/saassales-compensation-made-easy/.