SAAS VENDORS' BIGGEST BUSINESS CHALLENGE
Of all the really pertinent points made at SaaS Summit 2006 – and there were a lot of really pertinent points made – the most pertinent came during the VC Panel Discussion on Thursday afternoon when Hummer Winblad Venture Partners’ Ann Winblad was asked which challenge facing new Software-as-a-Service vendors is greatest. “Sales compensation,” she said.
During her authoritative pause, heads around the room nodded in violent agreement; there were a few muttered “Yeps” and “I’ll says.” Sprinkled throughout the audience, light bulbs went on over some attendees’ heads, and others quickly bent over their Silverado Resort pads and scribbled Notes to Self: “Talk to sales veep re comp.”
Out With the Old
Winblad briefly explained that traditional software incentive compensation plans just won’t work in the SaaS environment and hit all the right points. In the midst of the talk of multi-tenancy, security technology, and the need (or not) for a common platform, here was a Big Issue faced by many new SaaS companies for which few have a really good solution.
There’s no dearth of ideas about SaaS incentive compensation, but the big problem is that none of them are really new. Every SaaS executive I talk with admits to concerns about getting it right; ultimately, few actually break from the programs that worked so well at helping break the traditional software business model. As a result, most SaaS companies fall into the traps Winblad was counseling them to avoid.
What to Watch For – And Why
Generally, the problems fall into four categories, but they usually stem from the fact that, on the business side of their business (as opposed to its technical / operational side), providers often view SaaS as merely a different pricing scheme. They try to shoehorn an old-style comp plan into it, and they miss the opportunity to re-focus their sales teams in ways that will help them generate long term recurring revenue streams.
SaaS executives can be sure their comp plans are off-target when…
they don’t see their sales cycles shorten significantly, or when…
they’re meeting revenue goals without acquiring new customers, or when…
more new revenue flows out the door via sales paychecks than stays in house to support marketing and product development and Uncle Sam, or when…
their multi-level, product-specific commission structure generates one or two kinds of revenue, or (worst of all)…
they’re generating negative cash flow because they’re paying more in commissions than they’re billing in revenue.
Tricky vs. Complicated
The tricky thing about many incentive comp plans is that they often suffer from the same problem as most acts of Congress: the Law of Unintended Consequences.
Salespeople tend to be pretty uncomplicated. They usually do exactly what they’re paid to do. On the flip side, if they’re paid for doing a particular thing, that is usually what they will do. They look at a new comp plan and immediately identify the easiest path to commissions. The more complicated the plan, the more likely salespeople will choose paths that are least likely to have the intended effects.
SaaS vendors usually introduce unnecessary complexities by adapting traditional software plans, which tend to create other significant problems.
TCV = SNAFU
Software salespeople are used to making big commissions on a few high-revenue sales per year. The SaaS fix is to develop a deal’s Total Contract Value by taking its expected monthly revenue multiplying by the number of months in the contract term; big commissions are then paid on this TCV figure. Such comp plans present several issues, the most significant of which is that they generate negative cash flows by paying commissions before revenue is even billed.
Some SaaS companies fix this “fix” by calculating commissions on TCV but paying as revenue is received. Alternately, they adjust their model and try to bill customers in advance (more likely than not offering deep discounts to get them to agree). The first merely transforms the plan into an annuity program, which is fine for the insurance industry but presents problems of its own (discussed below). The second pushes the problem onto the customer and defeats one of the main purposes of adopting the SaaS model.
Worse, both add layers of complexity in administering both revenue and commissions, which further increase costs and raise the likelihood of focusing salespeople on the wrong objectives.
Worst of all, the TCV approach does nothing to help vendors adopt the service-oriented focus and culture that are cornerstones of the SaaS model. This “solution” merely re-casts the traditional sales comp model that has resulted in software companies paying up to 80 cents of every application dollar to their salespeople.
Annuities: The Long Road to Failure
At the other end of the spectrum, SaaS companies will pay smaller percentages of each month’s revenue for as long as it is billed. With each new customer, the commissionable base increases, and the salesperson’s pay inches upward. Inches, which is the primary problem: Annuities take time to grow into sufficient rewards to properly motivate high-performance salespeople.
Once they do, they have an oddly counter-productive impact. The annuitized salesperson soon begins to focus only on existing customers, farming the base instead of hunting new business.
The administrative complexities of annuity plans also present problems. Which salesperson earns the commissions when territories are re-aligned? Does the SaaS company charge back credits against commissions (which is also a problem in a TCV plan)? Is it a commissionable event when a customer contacts the company for additional services?
Mismatched Revenue
Improperly aligning commissionable events with the company’s business objectives is the fourth critical error many companies make, and this can be a particular problem for SaaS companies that are torn with the seemingly competing objectives of booking in-year revenue (i.e., monthly subscriptions, transactions, services, etc.) and growing their book value (i.e., signing long-term contracts).
While it’s important to strike a balance between near- and long-term revenue, companies are making a huge mistake when they pay three times the commissions for a 3-year deal at one monthly billing rate as they do for a 1-year deal at the same billing rate. This is another issue with the TCV approach, and it’s a bigger problem from a revenue matching perspective because it invariably motivates the wrong kind of sales activity.
Similarly, when a software application is more profitable than the business or consulting services that are often pulled through as part of the sale, it makes little sense to pay the same commission percentage for both; however, many companies do so almost reflexively.
Easier Than It Sounds
The first step to building a successful compensation plan is making sure that its objectives are aligned with those of the business. From there, the best rule is to keep the plan as simple as possible. Always keep in mind that salespeople are fairly simple beings. They will generally do exactly what they are paid to do, and the good news is that they’ll keep doing it over and over again.
During her authoritative pause, heads around the room nodded in violent agreement; there were a few muttered “Yeps” and “I’ll says.” Sprinkled throughout the audience, light bulbs went on over some attendees’ heads, and others quickly bent over their Silverado Resort pads and scribbled Notes to Self: “Talk to sales veep re comp.”
Out With the Old
Winblad briefly explained that traditional software incentive compensation plans just won’t work in the SaaS environment and hit all the right points. In the midst of the talk of multi-tenancy, security technology, and the need (or not) for a common platform, here was a Big Issue faced by many new SaaS companies for which few have a really good solution.
There’s no dearth of ideas about SaaS incentive compensation, but the big problem is that none of them are really new. Every SaaS executive I talk with admits to concerns about getting it right; ultimately, few actually break from the programs that worked so well at helping break the traditional software business model. As a result, most SaaS companies fall into the traps Winblad was counseling them to avoid.
What to Watch For – And Why
Generally, the problems fall into four categories, but they usually stem from the fact that, on the business side of their business (as opposed to its technical / operational side), providers often view SaaS as merely a different pricing scheme. They try to shoehorn an old-style comp plan into it, and they miss the opportunity to re-focus their sales teams in ways that will help them generate long term recurring revenue streams.
SaaS executives can be sure their comp plans are off-target when…
Tricky vs. Complicated
The tricky thing about many incentive comp plans is that they often suffer from the same problem as most acts of Congress: the Law of Unintended Consequences.
Salespeople tend to be pretty uncomplicated. They usually do exactly what they’re paid to do. On the flip side, if they’re paid for doing a particular thing, that is usually what they will do. They look at a new comp plan and immediately identify the easiest path to commissions. The more complicated the plan, the more likely salespeople will choose paths that are least likely to have the intended effects.
SaaS vendors usually introduce unnecessary complexities by adapting traditional software plans, which tend to create other significant problems.
TCV = SNAFU
Software salespeople are used to making big commissions on a few high-revenue sales per year. The SaaS fix is to develop a deal’s Total Contract Value by taking its expected monthly revenue multiplying by the number of months in the contract term; big commissions are then paid on this TCV figure. Such comp plans present several issues, the most significant of which is that they generate negative cash flows by paying commissions before revenue is even billed.
Some SaaS companies fix this “fix” by calculating commissions on TCV but paying as revenue is received. Alternately, they adjust their model and try to bill customers in advance (more likely than not offering deep discounts to get them to agree). The first merely transforms the plan into an annuity program, which is fine for the insurance industry but presents problems of its own (discussed below). The second pushes the problem onto the customer and defeats one of the main purposes of adopting the SaaS model.
Worse, both add layers of complexity in administering both revenue and commissions, which further increase costs and raise the likelihood of focusing salespeople on the wrong objectives.
Worst of all, the TCV approach does nothing to help vendors adopt the service-oriented focus and culture that are cornerstones of the SaaS model. This “solution” merely re-casts the traditional sales comp model that has resulted in software companies paying up to 80 cents of every application dollar to their salespeople.
Annuities: The Long Road to Failure
At the other end of the spectrum, SaaS companies will pay smaller percentages of each month’s revenue for as long as it is billed. With each new customer, the commissionable base increases, and the salesperson’s pay inches upward. Inches, which is the primary problem: Annuities take time to grow into sufficient rewards to properly motivate high-performance salespeople.
Once they do, they have an oddly counter-productive impact. The annuitized salesperson soon begins to focus only on existing customers, farming the base instead of hunting new business.
The administrative complexities of annuity plans also present problems. Which salesperson earns the commissions when territories are re-aligned? Does the SaaS company charge back credits against commissions (which is also a problem in a TCV plan)? Is it a commissionable event when a customer contacts the company for additional services?
Mismatched Revenue
Improperly aligning commissionable events with the company’s business objectives is the fourth critical error many companies make, and this can be a particular problem for SaaS companies that are torn with the seemingly competing objectives of booking in-year revenue (i.e., monthly subscriptions, transactions, services, etc.) and growing their book value (i.e., signing long-term contracts).
While it’s important to strike a balance between near- and long-term revenue, companies are making a huge mistake when they pay three times the commissions for a 3-year deal at one monthly billing rate as they do for a 1-year deal at the same billing rate. This is another issue with the TCV approach, and it’s a bigger problem from a revenue matching perspective because it invariably motivates the wrong kind of sales activity.
Similarly, when a software application is more profitable than the business or consulting services that are often pulled through as part of the sale, it makes little sense to pay the same commission percentage for both; however, many companies do so almost reflexively.
Easier Than It Sounds
The first step to building a successful compensation plan is making sure that its objectives are aligned with those of the business. From there, the best rule is to keep the plan as simple as possible. Always keep in mind that salespeople are fairly simple beings. They will generally do exactly what they are paid to do, and the good news is that they’ll keep doing it over and over again.
posted by Ken Boasso at 00:33
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