The Principles of Good Sales Compensation

“Never, ever, think about something else when you should be thinking about the power of incentives.” - Charlie Munger

There are few things more important to running a sales team than how you compensate the team. Financial compensation is a powerful motivator for behavior. If you want to change the behavior of your sales team, change the compensation.

This isn’t to say that all salespeople are coin-operated, but most of them are financially motivated and compensation is a top priority for them. This is a good thing. You can use this to your advantage as a revenue leader.

We intuitively know that variable compensation is an important part of motivating a sales team, but so many companies are clueless with how to put a strong compensation plan in place. Getting the compensation right is more than plain math. It’s helpful to understand why good compensation plans work to motivate salespeople to perform better.

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Sales Compensation Principles‍

As we look to design a compensation plan for the team, we should first outline our principles or beliefs about how compensation should work.

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Salespeople don’t do sales and other things well. Let the salespeople sell, don’t saddle them with additional responsibility. For example: Sales and Customer Success are separate functions.
The compensation structure should be so simple that you can do the math on the back of a napkin.
No commission-only roles. Sales reps should get base salary + variable compensation.
At least 40% of sales reps On-Target Earnings should be in the form of variable compensation.
No “draw on commission” for ramping reps. New reps should have some mix of guaranteed variable compensation during their ramp period.
Sales reps should be paid “straight-line” up to 100% of quota. There should be compensation accelerators above 100%. There will be no compensation hurdles or decelerators for producing below 100%.
Annual quota for Account Executives should be 5x On-Target Earnings. For example: $500k annual quota, $100k OTE. This keeps your cost of sales to between 20 - 25% of gross revenue.

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This isn’t a comprehensive list of principles. But at least these principles must apply to any compensation plan we create for the team.

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Sales Compensation and the impact on Unit Economics

David Skok’s post on SaaS Metrics is the most comprehensive resource for understanding the basics of unit economics for SaaS businesses. Start with that article if you are unfamiliar with how unit economics work.

‍Sales compensation is the largest component of your Customer Acquisition Cost (CAC). CAC always includes your total sales and marketing expense, and potentially a portion of your customer success expense.

But sales compensation is the real driver here. Holding everything else equal, the more you spend on sales, the higher your CAC, the longer it takes you to recover your acquisition costs.

So what’s a good starting point for CAC?

We know that we want the CAC to be low, but how low should it be? This is all relative to how quickly you can recover the money you spent to acquire the customer. We call this the CAC-payback period, also called months-to-recover (MTR).

Conservice cash is critical for early-stage companies where resources are scarce. In fact, most companies could benefit from spending less and being more efficient in the customer acquisition process.

A good benchmark for CAC-payback period is 12 months. The best performing and highest growth companies can recover CAC in 5-6 months. The faster you can get cash back from customers, the more dollars you can re-deploy into customer acquisition.

To get a short CAC-payback period, design your sales compensation such that you are spending 20% - 25% of each dollar on sales compensation. For example, an account executive should carry a $500k annual quota to earn $100k in On-Target-Earnings. This will give you plenty of room in your operating margin to invest in customer success, marketing, and product.

Here’s how the math works: Let’s assume a license for your SaaS product costs $10,000 per year and you operate at 80% gross-margin (this is a common operating margin for SaaS businesses). At this rate, you can spend up to $8,000 per customer and keep your CAC-payback period to 12 months.

What could you do if you had $8,000 to spend to acquire each customer?!

Don’t let the math fool you, though. CAC can get out of control if you aren’t deliberate about spending only on what drives more revenue for the business. Be clear about your sales, marketing, and customer success expenses, and design your sales compensation with an understanding of how it influences your CAC.

Quick side note: If you are in revenue planning and trying to understand how much you should budget for total sales and marketing spend, the median for sales and marketing spend as a % of total revenue is 36% (source: Meritech Capital). In theory, the more you spend as a % of revenue, the faster your revenue will grow. Spending on growth has diminishing returns, so spend wisely and be mindful of your business.

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A simple compensation structure for each role:

Account Executive
This applies to both new logo account executives and install-base account executives. Assumptions: $10,000 Average Sales Price with 80% gross margins

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Annual Quota: $600,000

On-Target Earnings: $120,000 split 50% base salary / 50% variable

Total Annual Variable Compensation: $60,000

Monthly Quota $50,000

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The math is easy for this one. The Account Executive needs to close 5 deals per month at $10k each to hit 100% of quota. 100% of quota pays out $5k or 10% of the deal amount.

Commission pay out should be a straight line up to 100% of quota. If the rep his $30k on a $50k quota (60% quota attainment), they will receive $3,000 or 60% of their variable compensation for the month.

Introduce accelerators above 100% of quota, this incentivizes your best reps to “run up the score” once they hit their monthly target. You should be willing to pay more for performance above 100% of quota because each marginal dollar of revenue is less expensive than the dollar before it. The marketing costs, the base salary, and other fixed costs are amortized over each new dollar. Getting productive reps to be even more productive lowers your CAC, so spend more in compensation to get more bookings from your top reps.

Here’s how the commission payout structure would work for the example above:

Up to 100% of quota: 10% of bookings
100% 150% of quota: 25% of bookings
150%+ of quota: 15% of bookings

As the rep closes more customers, they get paid more. This accelerate goes down after 150% to protect against any significant overperformance that would make the CAC too high.

Sales Development Rep

SDR compensation should follow the same form as AE compensation with a different mix of base and variable compensation. The variable should be paid based on Demos Completed.

OTE: $58,000
Base Salary: $40,000
Variable Compensation: $18,000
Monthly Variable Compensation: $1,500
Demos Completed Quota: 10

Up to 100% of quota: $150 per demo completed
100% 150% of quota: $375 per demo completed
150%+ of quota: $225 per demo completed

This will incentivize SDRs to rush toward 10 demos completed and keep their foot on the gas as they accelerate beyond 100% of quota.

Ramp Quotas

Motivating new sales hires to success in the first 90 days sets the tone for their tenure at the company. For this reason, you want to stay away from a draw on commission or anything else that makes the reps overly worried about money in the first 90 days.

That said, you don’t want new hires to be no the milk train while they ramp. There needs to be some incentive to drive toward performance. Here’s a simple structure to coordinate ramp compensation, with an expectation that the rep will be fully ramped by their 5th month in the role.

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Month 1: full base salary and 100% of variable. No quota.
Month 2: Carry 25% of quota. 100% of variable at 100% of ramp quota.
Month 3: Carry 50% of quota. 100% of variable at 100% of ramp quota.
Month 4: Carry 75% of quota. 100% of variable at 100% of ramp quota.
Month 5: Carry 100% of quota.

Note that you will apply accelerators in the same structure throughout the ramping quota.

You will be paying more for CAC on a per-rep basis during the ramp period, so why does this work? When a new rep is ramping, you want them to achieve success and attach to the org. If they are overpaid for overperformance in the short-term, it will not affect your unit economics. The biggest risk for any new hire is that they fail to ramp quickly. That’s the most expensive part of hiring new reps, so give them extra incentive to ramp quickly and get into the money.
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More than financial compensation: help the team set personal goals.

One final note on sales compensation. Achieving financial success is important, but it’s not everything. It’s important that you work with each person on the team to establish individual goals: personal, professional, and financial.

Sales is a hard enough job. You are exposed to rejection all day every day. Going through that work just to get more money isn’t exactly an even trade-off. So dig a little deeper with your team. Understand the motivations. Find that “chip” on their shoulder. Unearth the career aspirations or personal goals they have set for themselves.

The financial compensation is really just a tool for each rep to achieve their individual success, and that’s the real motivator for salespeople.

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