The shift to a monthly recurring revenue (MRR) model isn’t simple. There’s a lot to figure out and adjustments to make. One of the most daunting obstacles seems to be sales compensation. On the traditional sales model, paying salespeople was relatively straight-forward. The two common concerns for many business owners considering an MRR model is that salespeople can build a book of business and get too comfortable and cash flow can become an issue if customers aren’t paying everything up front like they used to.
RSPA’s Inspire 2018 had an entire day of education dedicated to these topics and more. One of the most successful members when it comes to MRR, Hunter Allen of Cervion, participated in an expert panel and shared details of how he deals with many of these challenges.
As Allen explains, he has established several goals for his compensation plan. One is to enable the recruitment and retention of sales staff who can succeed in the position. Additionally, he wants a plan that can motivate salespeople and reward them for success. Also, he wants to provide enough financial security so salespeople can focus on performance, not worry about paying their bills. Finally, he wants his plans to minimize financial risk and maximize financial benefit for the business.
A key component of building a successful compensation plan is understanding the compensation level necessary to be able to recruit the talent you need. This is, of course, market-driven and individual for each company.
Another key component of Allen’s plan creation is defining what successful sales production looks like. This, too, can vary by company. You might want to set goals based on the size of a system, or a dollar value, or dollar value of MRR. You need to come up with some value that says if a salesperson has been successful for over a month, this is what they would have produced.
Next, you take those values and see how they work out. For example, if your target compensation is $75,000/year and your definition of a successful month is landing three customers, then each customer must generate at least $2,084 (3 customers x $2,084 x 12 months = $75,024).
The next step is to build a compensation plan the makes sure you hit that $2,084 number. Allen shared an interesting spreadsheet that illustrates two common structures (high base, lower commission vs lower base, higher commission). Using the example of a successful month (three systems), each commission structure rewards nearly the same salary. However, things diverge significantly depending on whether the commission structure is more heavily geared to a base salary or performance-based commission.
Allen shared his experiences here. “A low base salary increases the income differential based on performance,” he says. This means that while a low base salary might look appealing to you, know that an overachieving salesperson can earn a very high salary based on their commission.
Allen also says that a higher base salary increases short-term risk and reduces high production compensation. This means that lowering commissions might cause salespeople to underperform since they’re not overly reliant on commission as part of their compensation.
To determine what’s best for your company, you’ll need to model out your numbers and see what overproduction and underproduction look like.
Know your unit economics
An essential aspect of making these decisions related to an MRR business is figuring out what your profit and loss are on a one-deal basis. For Allen, gross revenue is equal to MRR multiplied by the months of service.
Allen measures P&L of these customers a few different ways. There’s the contract life of a Cervion customer, which is three years. There’s also a life cycle measurement, which is the period before Cervion has to start reinvesting in the customer (e.g., replacing hardware since Cervion offers hardware-as-a-service). During this time P&L will change. Additionally, he measures the lifetime of the customer.
You’ll need to figure all this out for yourself to determine your profitability. If you find that your revenue, cost of goods sold, sales compensation, or another factor is pushing your profit negative, you need to go back and rework your numbers. “Don’t build a sales compensation plan that drives your unit economics negative,” he cautions.
Pros and Cons of Different Compensation Models
Pay Now (Higher Base, Lower Commission)
- Has an upfront cash flow requirement. You’ll need to find money for salespeople.
- Provides immediate motivation to salespeople who are used to getting instant rewards for their “kills.”
- Lower administrative burden.
- Can be higher risk. If you pay $1,000 up front and the customer goes out of business, it could cause issues.
Pay later (lower base, higher commission):
- Easier on cash flow
- An employee can earn without current production by building a book of business that keeps them comfortable.
- May create employee hardship. They have to pay their bills, and if they can’t, then they’re not spending 100% of their time working for you.
- Can be golden handcuffs — get good HR lawyer. If you make certain promises of compensation, in some states you might have to continue to pay even if the employee leaves. Know your laws.
- Lower risk
Compensation Lessons Learned
Weigh the benefit of add-on products — Allen says that while add-on services can be a good place to start building recurring revenue, make sure you consider your opportunity cost. For some businesses, it makes more sense to upsell existing customers with add-on products. For others, it makes more sense to apply effort to land new customers. Your best bet is to watch your product margins and sell whatever drives the most.
Incentivize the right products — Allen advises that you structure the most compensation for the product you want to sell the most. “When companies transition to MRR, a big challenge is that the process doesn’t happen overnight and there’s a good chance that at some point a salesperson might have options to sell something as a service or not. If you set up your comp plan to prefer one or the other, they’ll go that way.”
Create annual comp plans — Review your compensation plans each year, adjusting carefully.
Keep it simple for everyone — Creating an overly complicated compensation plan will create administrative hardship and pull you away from more critical tasks.
Include clawbacks — Creating a mechanism whereby a commission adjustment can occur if a customer cancels or doesn’t pay will help reduce risk. Allen’s customers are on 36-month contracts, but his internal calculations assume that a customer stays for only 12 months. If they leave early, Allen prorates the sales commission.
Paying salespeople a lot isn’t bad — Allen says it’s okay to pay a salesperson a lot of money if you are making a lot of money. “Don’t fire a salesperson because they’re making more than you,” he says. “When they make a lot of money from commission, it means you’re making a lot more.”
Build models — Build a spreadsheet that allows you to evaluate your numbers and include over/under 10% variations to see how your business might change due to under or over performance.