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How to Build Sales Compensation Plans for Recurring Revenue

Feb 25, 2018
5 min read
Sales incentive plans have many moving parts that help companies reach their goals. Learn everything you need to about compensation plans for recurring revenue.

The design of your sales compensation plan has a large effect on your company. Successful compensation strategies motivate sales reps to sell, while staying aligned with company objectives and within financial budgets. This can be a timely process, but luckily, Xactly’s Strategic Services provides a variety of training and consultation services to help our customers master the compensation process and increase overall efficiency.

Uncovering the Issue(s)

One of the most common plan design issues Strategic Services sees is how businesses should pay reps when the company sells a product with varying contract lengths and periodic payments (aka recurring revenue).

This subscription model is ubiquitous with SaaS/Cloud companies and becoming more common in other industries as companies transition to recurring revenue models. For example, a recent SaaS client came to us with the usual difficulties of trying to determine how much to pay reps and when to pay them. Based on our initial conversation with the company, we learned that:

  • The company wished to promote in-year revenue while also encouraging longer contract lengths because of needs for higher in-year revenue (to meet ownership expectations)
  • They wanted to delay paying the full commission amount up front when revenues were received over the life of the contract because of payment delaying several factors (there was concern about realizing a negative margin; a history of clawing back payments when payments were made up-front and a customer cancelled early; some deal values were not perfectly certain until well after the sales process was completed as larger strategic sales had many contract refinements during the implementation phase)

Once we’ve identified the issues the client is facing, how do we guide our clients through this minefield.

It’s tricky. We face two scenarios in this situation, and unfortunately, neither is a perfect solution:

  • If we recommend paying the reps up-front when certain deal values are unknown and push the company into negative margin, then we are asking the company to take-on all of the financial risk for each sale.
  • On the other hand, if we pay commissions as the subscription revenue is received, we sap the incentive plan of its motivational value, ask the reps to take the full financial risk of the sale and create a situation where current top performers are not necessarily the top earners (imagine trying to change a plan when commissions need to be paid potentially for years).

Assessing the Current Strategy

In situations like the one above, there are a few simple guidelines that we generally follow–establishing plan priorities and the value of term length.

Start by establishing two priorities in the plan–one that pays for achieving the maximum amount of value in the first year and another that promotes term length. This acts as a balancing act in the plan between the two problematic scenarios above. If the renewal rate is very high, then the optimal term length may be one year. If the renewal rate is low, long term contracts may be a higher priority.

As the strategic value of term length becomes higher, compensation plans need to allocate more pay towards promoting term length. Plans that fix the payments between term and revenue (e.g., TCV) may not offer the flexibility that the company needs to push the reps into promoting one side or the other.

he client in our example paid on total contract value (TCV), and reps were able to back-load the contracts so that first year revenue was low. The company was rich in the books but starved for cash, while their reps were credited for the full contract value up-front. As a result, the sales reps had very little motivation to push in-year revenue based on how they were paid.

Addressing Problems Within the Organization

For this client, TCV was not serving their strategy very well. We recommended a plan design that paid separately for the term length and the revenue, which allowed the company to align payments with their strategic priority of promoting more in-year revenue.

Plans that pay as revenue is received create a payment annuity tail that pays reps in future periods for past success. Companies should try to focus pay up-front as much as possible. Financing your payments and waiting for a high level of certainty of the revenues drains sales incentive plans of their effectiveness.

Our client’s sales reps felt that the company was withholding payments to them as a way of retaining them, and they were not able to know what their pay would be. Ultimately, this had several negative impacts on the sales team and company as a whole. The company wished to avoid any payment mechanic that would create the possibility of a clawback (rightfully so–clawbacks are demotivating and create high levels of animosity between the reps and the organization).

Providing Solutions

The first step is to try and separate the sales deals that have a different pay risk/level of uncertainty. If only larger deals have uncertainty about the final deal size, then a different payout mechanism must be created for those (not necessarily a different calculation – just a different timing on the release of the payments).

We found that 98 percent of our client’s deals had a reasonable level of revenue certainty, but payments were delayed for the two percent of deals that were larger, requiring the implementation team to adjust the deal. Payments could be made differently for the small number of larger deals (reps usually understand these exceptions and love the certainty of payments for the vast majority of their deals).

What should be done if there is no way to accurately gauge the revenue of a deal? There are usually two ways to approach this:

  1. Pay a certain portion up-front and the remaining portion a few weeks/months later when revenue certainty has increased (note: It may not be 100 percent certain, but at different stages in the process the risk of adjustments or cancellation falls to the point where a payment can be made)
  2. Pay the full amount up front at a base rate (i.e., no acceleration from over-performance) and reconcile at the end of the plan period for all sales adjustments (not just on a single deal) and acceleration. If the total amount of adjustments required is above a certain level (usually +/- 10%) then make the payment adjustment. Otherwise, make no adjustment.

Final Thoughts

Finding the right sales compensation solution for your business is not always an easy process. Often times, an outside perspective can be helpful in identifying problem areas and strategies. Xactly’s Strategic Services team can help design a strong compensation plan that motivates sales reps, is aligned with company objectives, and stays within the company financial budget.

Learn more about our plan design and optimization services today.  

  • Incentive Compensation
Jason Rothbaum
Jason Rothbaum
Senior Principal

Jason has led dozens of engagements with a large spectrum of clients on compensation plan design and implementation—from Fortune 100 to 40 employee startups. He has over 20 years of experience in sales compensation with tenures at the Alexander Group and Deloitte. He also ran Sales Operations teams at Charter Communications, Adecco Staffing, Sonic Healthcare ,and Veridian Energy. Jason holds an MBA from Yale University and an MA in economics from NYU.