For companies that don’t have a self-service customer acquisition model, no other function ties more directly to financial results than Sales. Because of this, it is critical to have strong alignment between their sales commission plan and their desired business results. If the sales team makes a ton of money but the company isn’t also celebrating amazing results, there’s a problem. The foundation for this alignment lies in selecting the right sales commission metric. Let’s explore further.
The best sales professionals do whatever puts the most money in their pocket, given the rules you put in front of them (their sales commission plan) and within ethical and legal limits. I wrote about this in a related article titled “5 Golden Rules of Sales Compensation”. Because of this, the best sales reps are often referred to as “coin-operated”, and it’s not an insult. In fact, they should do whatever puts the most money in their pocket as guided by their sales comp plan. This means that it’s up to you to make sure there is close alignment and synergies between that and your desired business results. If there is ever a situation where a sales rep makes a huge pile of money and you’re pulling your hair out in frustration (instead of also jumping for joy), you messed up somewhere – not them.
Selecting the Right Metric
You’ll first need to decide if you will deploy an Absolute or a Relative sales compensation plan (see related article titled “Absolute Versus Relative Sales Compensation Plans”). After that, the next most important thing you should do is select the right sales commission metric. For this, there are two litmus tests to use for guidance:
- Aligned to business objectives – The most important business objectives for a company change as they evolve. In other words, in the earliest days all focus might be on adding new customers. Later the focus might be on revenue growth, and ultimately on profitability. What is your current focus and what sales-related metrics are best aligned with that focus?
- Under the sales rep’s influence – You want your sales rep to close deals with customers in such a way that they contribute as much as possible to the desired business objectives. Since the rep gets paid based on their performance, the commissioned metric must be something under their influence. This will be clearer as we review some common metrics next.
Following are five of the most common sales commission metrics I’ve seen used with direct sales organizations, and some insights and special considerations for each.
Revenue is an extremely popular commission metric. Every company has a revenue forecast that extremely influences the rest of the company’s operating plan. When the sales team closes deals, they generate revenue for the company (hopefully), and the more revenue the better for both parties. Simple.
Considerations – If your sales team is focused on revenue, they won’t be concerned with profitability. You’ll need to decide if they should have any discount delegation and, if so, how much? Also try to identify any other factors that could affect deal profitability and make sure there aren’t accidental risks for misalignment. Fixed versus variable costs-of-goods-sold (COGS) or a heavy services component that must be priced into deals are examples.
It’s also possible that your accounting rules call for deal revenue to be recognized over time, even though new customers sign a contract and pay everything up front. With this situation, you’ll need to decide how to count “revenue” for sales compensation purposes. It’s possible that in order to be fair to the sales reps, you will decide to compensate based on booked revenue rather than recognized accounting revenue.
If the profitability of a deal is under the influence of the sales rep, or you want it to be, then deal gross profit could serve as a good metric. For example, the more discount the rep offers on a proposal, the lower the gross profit will be. This means they should be motivated to only discount the bare minimum to get the deal closed.
Consideration – This metric works best when the COGS for a deal are fixed or at least easily known by the sales rep. They must be able to determine the gross profit for any proposal before they submit it to a customer prospect.
Companies that sell to large enterprises often have deals that include a combination of product, services and support. They also often try to negotiate multi-year contracts. With either situation, compensating the sales team on the contract value (CV) of deals is common. The sales rep is motivated to get the largest commitment possible without jeopardizing the deal altogether or causing it to take excessively long to close.
Consideration – Multi-year contracts carry two potential complications. First, the sales rep gets paid up front based on the full contract value but the customer likely makes payments each year. That creates a cash in/out timing misalignment. Second, if the contract allows the customer to terminate within the contract period, it’s possible the sales rep gets paid for the full value but that value is never fully recognized by the company.
To accommodate these two issues, I’ve seen companies compensate based on a metric named Committed Contract Value (CCV), which is the portion of the contract that is fully and contractually-committed. I’ve also seen companies pay full commissions for the first year of a multi-year contract and partial commissions (perhaps 25% or 50%) for any additional years, as long as they are contractually-committed. Remember, even contractual commitments can be broken or require a lawsuit to resolve if the customer decides to stop payments.
New MRR / ARR
For companies with subscription-based offerings, either monthly recurring revenue (MRR) or annual recurring revenue (ARR) are very important business metrics, which means they can also be appropriate sales commission metrics. The concept is to motivate the sales rep to add new recurring revenue to the existing mix.
Consideration – If you have offerings that are available on a month-to-month basis or allow easy contract termination, you have a risk of paying sales commissions for a new customer that only stays around for a couple of months versus your assumption of a couple of years. One option is to only give full sales credit if the customer commits to a 1-year contract. Otherwise, maybe you give sales credit once the customer has paid six months’ worth of payments.
Some companies have a “land and expand” sales strategy. One sales rep lands a new customer with the sale of a specific offering that doesn’t vary much in value. Later, another company function attempts to expand the contract with the customer via upsell or cross-sell offerings. In this case, the first sales rep might get compensated based on the quantity of new customers acquired during the sales period.
Consideration – The definition of “new account” must be both clear and appropriate to get paid on. For example, if your intent and desire was for the new account rep to sell the $10,000 offering but instead they sell the $1,000 offering just to rack up a bunch of new accounts and exceed their quota, you’ve got a problem.
Most of the discussion to this point has related to the acquisition of new customers and how to best compensate the sale reps for that work. What about renewal sales? Should the sales rep that landed a new customer also get paid on the customer’s future renewal? To my way of thinking “renewal sales” is an oxymoron. In other words, there shouldn’t be anything for your sales team to actually sell. Customers make decisions about renewing/extending their contract because your product continues to provide value and they see value from your various support functions. Technically-speaking, if any functions should get compensated for renewals, it’s probably your product team and tech support team.
This is different than upsells (more use of the same product) and cross-sells (additional products) that occur after the initial sale. Sometimes this is the responsibility of the sales team, in which case they should be compensated on the revenue, gross profit, contract value, or whatever metric is best for follow-on sales to existing customers.
Finding the right sales commission metric that both motivates the sales team and aligns perfectly with the company’s business objectives is a huge win. There are reasonably high odds that one of the previously-mentioned metrics will work great for you. If not, step back and identify the important contributors to your business objectives to see if any are suitable to use as a sales commission metric.
You might need to experiment to achieve the right alignment. Just be careful not to whipsaw your sales team in the process. They absolutely, positively hate changing rules that directly affect their compensation. I don’t blame them.