The purpose of this article is to provide an economic framework in setting up a sales compensation plan. In my experience, I usually see a commission rate as the starting point and debate around the entire plan. However, what I will illustrate in this article, is that the commission rate is merely formulaic and thus should not be a focal point.
Comp Plan Framework:
The economic framework and inputs for setting up a sales comp plan are OTE (Base Salary + Variable Commission), Quota, and the OTE to Quota multiplier.
OTE: On Target Earnings
| Base Salary | 50% |
| Variable Commissions | 50% |
| On Target Earnings | 100% |
Quota: Sales Target
Quotas can range from $300K to $2M depending on the ACV (annual contract value) size, TAM (Total Addressable Market), and GTM (go to market) stage. When setting sales quotas, it’s best practice to triangulate with the following three approaches.
Top Down:
Benchmarking: quotas to similar companies in stage and ACV size is a great place to start. This approach also aligns with expectations from sales reps in similar industries who join your startup. For example.
Revenue Growth Goal Seek: Goal seek the year over year percentage revenue growth you would like to achieve. Take the new revenue required to achieve the growth percentage, and divide by the total amount of quota carrying sales reps. For example.
Bottoms Up:
Deal velocity: Now that you have a guiding quota amount, take the quota target and divide it by the annual contract value, in order to determine how many deals, it would take to achieve the quota target. For example.
Pipeline Funnel: Are there enough MQLs and SQLs to achieve the total sales target? Analyze each conversion process of the sales funnel to understand the expected deal velocity. For example, tracking how many leads convert to MQLs, that then convert into SQLs, that then convert to closed won deals will provide guidance into how much pipeline is needed to generate X amount of deals.
Quota Multiplier: The quota multiplier is the foundation of the sale comp economic framework. The multiple is used as a relationship between on target earnings and quota. For example, the industry standard of the multiple is 5, which would indicate that if a sales reps’ OTE is $200K, then their quota should be $1M.
The OTE to Quota multiple is what David Skok refers to as the salesperson unit economics. This framework is the foundation for setting up a sales comp plan. Breaking down the mechanics of a sales comp plan is comprised of OTE, Quota, and Commission Rate. OTE is an input based on the sales role, seniority, and location. Commission rate is formulaic based on the variable commission to quota. The only variable that needs to be solved for is quota. The economic argument for quota in relation to OTE, should be at least 5 times greater. Let’s use the previous example of a sales rep with an OTE of $200K.
| Sales Comp Economic Framework | ||
| Base Salary | $100,000 | Input |
| Variable Commissions | $100,000 | 50% of OTE |
| On Target Earnings (OTE) | $200,000 | Base + Variable |
| OTE to Quota Multiple | 5X | Input |
| Quota | $1,000,000 | OTE * Quota Multiple |
| Commission Rate | 10% | Variable ÷ Quota |
As you can see from the table above, the only inputs are base salary and quota multiple. The quota multiple is the component that drives the economics. The multiple can range from 3 up to 8 for high performing reps. I think 5 is a good benchmark to use. Below are some references for OTE to Quota multiples.
Benchmarks:
Matrix Partners: 5X-8X “quotas should be at least 5x the OTE (On Target Earnings), which includes base salary + bonus. Ideally quotas are 6-8X OTE to be considered high performing”
SaaStr: 5X “I did an analysis of what inside sales reps at SaaS companies are usually paid. Usually, all-in, they are taking home about 20%+- of the ACV at the end of the day”
tomtunguz.com: 5.5X
Peter Levine @ A16Z: 3-4X
Below are the comp changes from multiples ranging from 3 to 8
| Base Salary | $100k | $100k | $100k | $100k | $100k | $100k |
| Variable Commissions | $100k | $100k | $100k | $100k | $100k | $100k |
| On Target Earnings (OTE) | $200k | $200k | $200k | $200k | $200k | $200k |
| OTE to Quota Multiple | 3X | 4X | 5X | 6X | 7X | 8X |
| Quota | $600k | $800k | $1.0m | $1.2m | $1.4m | $1.6m |
| Commission Rate | 16.7% | 12.5% | 10.0% | 8.3% | 7.1% | 6.3% |
The OTE to Quota multiple is the guiding force in setting up the economics of the sales comp plan. The scientific work in the comp plan should be spent on quota setting, while the quota multiple can be adjusted to align with the business unit economics and cash burn parameters of the company. Generally, quota should directionally align with the ACV. The lower the ACV, the lower the quota, then the lower the OTE to fit within the OTE to Quota Multiple parameters.
Let’s take a hypothetical look how OTE changes with respect to lower quotas, assuming a quota multiplier of 5.
| ACV | $6.2k | $12.5k | $25.0k | $50.0k | $100.0k | $200.0k |
| Base Salary | $40k | $50k | $60k | $70k | $80k | $90k |
| Variable Commissions | $40k | $50k | $60k | $70k | $80k | $90k |
| On Target Earnings (OTE) | $80k | $100k | $80k | $140k | $160k | $180k |
| OTE to Quota Multiple | 5X | 5X | 5X | 5X | 5X | 5X |
| Quota | $400k | $500k | $600k | $700k | $800k | $900k |
| Commission Rate | 10% | 10% | 10% | 10% | 10% | 10% |
OTE to Quota is not a one size fits all. There is a plethora of nuances such as complexity of the sale, go to market stage, product pricing, deal sourcing, etc., which all impact the appropriate quota relative to OTE. I have provided different approaches to quota setting and triangulation. So long as the OTE to Quota Multiple is between 3-8, your sales comp plan is in good economic shape.
5/26/2020
SaaS Finance Blog 