Photo by Agnieszka
When enterprise software companies embark on selling SaaS, they typically run into compensation challenges, especially when existing license customers express interest in SaaS. First and foremost, the compensation setting should align with the SaaS strategy. Make sure to have buy-in at the senior leadership level if SaaS is the future business model for the company (a complete shift to Cloud/Subscription like Adobe) or a delivery option while continuing on the license software path. To achieve the former, you will need to lean into SaaS by encouraging sales reps to position SaaS offerings, while the latter requires minimal change to ensure sales reps don’t shy away from must have SaaS opportunities. Unlike a license sale where revenue is recognized immediately, SaaS revenue recognition is over the duration of the contract creating a multi-year EBITDA impact. Either way, you need to have a position before embarking on sales compensation; otherwise, you will not have the desired results. There are three approaches to compensation:
Defensive Position
Sales reps are encouraged to focus on license orders to maximize short-term revenue. SaaS ACV (annual contract value) orders and license orders (with support) retire quota for every dollar sold. In most cases, the license orders will be larger than the SaaS orders, because the first year of a SaaS subscription is typically a fraction of the price of a license. The result will be sales reps positioning license first, and if the prospect prefers SaaS, then it will be brought to the forefront. When selling SaaS, it’s a good idea to lock in a multi-year purchase to minimize the risk of a renewal loss the following year. Sales reps can be encouraged with a multi-year bonus paid immediately or during customer invoicing. The latter aligns to cash flow but further detracts from selling SaaS.
When a company chooses a Defensive Position, it may also put in safeguards to discourage sales reps from approaching customers with SaaS unless it’s lucrative to do so. Compensation criteria may require specific profitability requirements, which are achieved as a multiple of maintenance & support (M&S) to ensure the transition is gross profit accretive. For example, if an annual $100k M&S revenue stream yields $90k in gross profit, and the goal is to maintain profitability, calculate the minimum SaaS order by dividing $90k by the gross margin of SaaS. If SaaS gross margin is 70%, then $90k divided by 0.7 would be ~$130k. That is about 1.3x greater than the M&S revenue. Establish a threshold where sales reps will not get paid on an order unless it surpasses the 1.3x multiplier. Of course, there are many factors here, as a smaller deal is typically less profitable than a larger deal, and there is the sales cost to factor in, but a more straightforward compensation policy always outweighs a more complex and accurate compensation policy that sales rep’s don’t understand.
A more extreme compensation approach may include a “minimum” license quota before a sales rep can benefit from accelerators (increased levels of compensation after meeting their quota). A minimum threshold will not only encourage license proposals but may also have the side effect of sales reps “hiding” the option of SaaS until the customer asks (and in some cases insists) on SaaS. Likewise, to minimize unfavorable conversions and to avoid double compensation between new and renew sales reps, quota retirement can be “net new” revenue only, or the delta between the order, $130k in our example, and the M&S renewal order of $100k. The new business sales rep would retire $30k in quota and the renewal rep the expected $100k.
Neutral Position
Sales reps receive equal compensation for SaaS and license orders to facilitate customer choice. The key is equal quota retirement. SaaS orders are “grossed up” to a similar value as license orders using a multiplier to create a fair balance after discount, ensuring sales reps present both options to the prospect. For example, if a license proposal after discount is $500k with 20% support fee, the sales rep retires $600k in quota. If a comparable annual SaaS subscription after discount is $240k, then the sales rep retires quota at 2.5x ACV which would also equal $600k. Sales rep quota can be set with a 2.5x multiplier for SaaS to avoid additional sales costs. Of course, that assumes you have a target quota for SaaS and license that is realistic and achievable.
In some cases, customers want to purchase multi-year orders. Sales compensation still works the same as long as the order is CCV (committed contract value) and not cancellable for convenience. To calculate quota retirement, the average ACV is calculated by taking the CCV amount and dividing it by the number of years. Afterward, the SaaS ACV compensation multiplier is applied. The reason for the average is to avoid compensation issues when there is an onboarding phase in the contract with a smaller first-year subscription, or the duration of the contract is longer than 2.5 years. Alternatively, compensation can include CCV contracts up to 3 years (rounded up to keep it simple) which will encourage longer-term transactions, and there will be no need for a multi-year bonus.
Sales enablement is an essential factor for SaaS success. If you have an existing sales force that sells license only, it’s going to be critical that sales reps be enabled and supported by SaaS experts (usually an overlay team) to tackle questions on the value proposition, service levels, security, privacy, and compliance. Please check out my blog “What SaaS Expertise Do You Need” for further insight into the complexity of SaaS.
Aggressive Position
Sales reps are encouraged to focus on SaaS orders to accelerate a transformation to SaaS or to head off competition. As described earlier, it’s all about sales compensation. The ACV multiplier can be higher, let’s say 5x for the prior example, allowing sales reps to retire quota twice as fast. In effect, sales reps will feel like they are making twice the money selling SaaS. Another option is to create a threshold for SaaS quota. For example, sales will have to retire 50% or 100% of their SaaS quota before they are eligible for accelerators. A threshold may be a more cost-effective way to incentivize SaaS sales, but you can bet that sales reps will be very focused on closing SaaS deals even to the detriment of other options in their portfolio.
Further to my point on education, it’s critical when “leaning into” SaaS to enable sales reps to be self-sufficient selling SaaS, and to put in supporting structures to facilitate sales especially in the early stages of the transformation. Otherwise, you will have a flood of complaints that selling SaaS is “hard” and sales retention may become a challenge. On the other hand, I would highly recommend hiring sales reps that have “SaaS” on their resume. Experienced reps will help you accelerate the culture shift to SaaS which is usually the biggest challenge in a SaaS transformation.
Compensation is a critical decision point for your SaaS strategy and will define how fast you build out the SaaS business. Just don't forget there is an investment required if you want to move quickly, which will impact EBITDA. To learn more before embarking on a SaaS journey, check out my article "Introducing SaaS at an Enterprise Software Company."