How to Build a Winning Sales Incentive Plan for Enterprise SaaS

By Eric Mersch

Why leverage a Sales Incentive Plan?

Enterprise SaaS companies employ a direct-sales go-to-market strategy where salespeople contact potential customers directly and often work several months to complete the sales cycle. These salespeople have unique compensation structures in that half of the total compensation is based upon their sales production. Using a direct sales force is expensive, so it makes sense to tie compensation to production.

The Chief Financial Officer and the Chief Revenue Officer must collaborate closely to ensure the Sales Incentive Plan appropriately rewards salespeople while maintaining acceptable profit margins. It’s a delicate balance!

Building a Sales Incentive Plan

A Sales Incentive Plan should be a straightforward document, enabling sales representatives to easily understand how to earn sales commissions. And what rates provide the incentive to produce the required Bookings as defined by the annual operating plan or budget.

Under a Sales Incentive Plan, each sales representative has a base salary and a variable commission target, called a Target Incentive Commission (TIC) or On-Target-Incentive (OTI). The base and variable amounts are typically split 50/50, meaning that the sales representative can earn twice their base salary by producing enough Bookings to hit a contractual target, known as a quota. The base and variable compensation sum is known as On-Target-Earnings (OTE). A sales representative will earn 100% of their OTE if they meet their assigned quota. Sales representatives who are assigned a quota are called Quota-Carrying-Reps (QCRs).

To achieve their variable compensation, QCRs receive a predetermined contractual percentage of the dollar value of the sale. The value of the sale is always expressed in annual terms, i.e., the Annual Contract Value (ACV). The commission rate is based on the value of the booking type. For example, higher-margin Subscription Bookings carry a higher commission rate than Services.

New Business vs. Expansion and Renewals

Further, QCRs earn a higher commission rate on New Bookings than they do on Expansion Bookings because the latter are already customers with a known propensity to purchase the product. The Sales Cycle is typically much shorter and requires less time than a New Booking. Similarly, Renewal Bookings pay an even lower rate than New and Expansion Bookings.

The percentage of the Bookings ACV paid to the sales representative is called the Base Commission Rate or BCR, and they vary as follows:

• New Bookings: 10% of ACV
• Expansion Bookings: 8% of ACV
• Renewal Bookings: 3% of ACV
• Services: 2% of Contract Value

Companies further incentivize Quota-Carrying Reps by offering incremental commission rates once the QCRs meet their quotas using an Accelerator plan. The Plan accelerates sales commissions for Subscription Bookings with incremental rates at various stages over 100% of the quota. A typical Accelerator Plan uses a schedule as follows:

• 100% to 125% = 3%
• 125%+ to 150% = 4%
• 150%+ to 200% = 5%
• 200%+ to 250% = 6%
• 250%+ = resets to the original commission rate

To illustrate, a QCR that has already met quota each year and closes a New Subscription Booking that increases total annual production to 120% will be commissioned at a rate 3% higher than the 10% BCR, or 13%. This incremental commission rate steps up in stages until it drops back down to the BCR. This reset protects the company from paying an outsized commission rate on a deal that likely requires support from across the organization, including executives.

While we focused on Quota-Carrying Reps, other sales team members have compensation plans with a variable component based on bookings produced by the QCRs. While these folks do not personally generate Bookings, they significantly impact the QCR’s ability to do so. Sales leadership will receive commissions based on the production of their direct reports, as will middle managers such as those who manage QCRs in their GTM scope, i.e., specific geographies or market verticals. The sales operations team and other supporting members may have variable components in their compensation plan. And the Sales Incentive Plan will provide details for all of these teams.

The overhead expense is typically shown as a rate known as the fully Loaded Sales Commission Rate. Generally speaking, this overhead expense adds 6% to the BCR. For example, a $120,000 ACV New Subscription Booking will pay 10% to the QCR and 6% to the team members qualified for a commission. When modeling sales commission expense, make sure that you calculate the fully loaded expense.

Sales Commission Expense

So, what is a good target for sales commission expense as a percentage of revenue? Benchmarks are hard to find because sales commission expense is not a widely available metric and because the percentage varies significantly from one company to another.

So, let’s create a theoretical company and estimate this metric based on standard commission rates. Assume an Enterprise SaaS company that generated $150 Million in total annual revenue with:

• $120 Million ARR on annual contacts
• $20 Million in service revenue
• 90%  gross retention rate
• 120% net retention rate
• 40% growth in the most recent fiscal year

Using these assumptions, we know that the company:

• Started the year with $86M in ARR
• Renewed $77Min ARR
• Lost $9Mdue to churn and contraction
• Generated Expansion Bookings of $26M
• Added $17Min New Bookings
• Grew ARR to $120M

The sales team also sold $30Min Services Bookings.

Total sales commission expense would equal $9.3Mor 6.2% of total revenue as follows:

• New Bookings: 10% of $17Min New ARR equals $1.7Min commission expense
• Expansion Bookings: 8% of $26Min Expansion ARR equals $2.1Min commission expense
• Renewal Bookings: 3% of $77Min Renewal ARR equals $2.3Min commission expense
• Services: 2% of Contract Value of $30Mequals $0.6Min commission expense
• Loading is an incremental 6% of total sales commission expense on New and Expansion Subscription Bookings or $2.6M

We can take this theoretical analysis further to show that sales commission expense would be about one-fifth of the total sales department expense. To do this, we assume that this company operates at the Rule of Forty (RO40), meaning that the EBITDA margin is 0%. The median Gross Margin should be approximately 78%, and Sales and Marketing expense would be about half of the operating expense, so $60 Million. Sales alone would make up 70% of this amount or $41M. Therefore, a sales commission expense of $ 9.2M would be 22% of the total investment in Sales.

Summary & Resources

This simple overview shows the complexities of building a Sales Incentive Plan. Invest the time into getting this right!

Where to find additional information:

Hacking SaaS – An Insider’s Guide to Managing Software Business Success

Understanding Unit Economics for the Enterprise SaaS “Go-To-Market” Strategy 

The Unique Challenges of Enterprise SaaS

SaaS Glossary