TOMASZ TUNGUZ
venture capitalist at redpoint

# 3 Key Ingredients of a Sales Compensation Plan

Like most things in a startup, a sales commission plan should evolve as the company scales. For example, as Mark Roberge, CRO of Hubspot, wrote in The Sales Acceleration Formula, Hubspot adopted three different sales compensation plans throughout its early evolution which embody the three key ingredients of a sales compensation plan.

Hubspot’s first sales plan paid \$2 of commission for every \$1 of MRR an account executive booked. When the company decided to focus on revenue retention, the sales team adopted a new sales model. Account executives were divided into quartiles by customer retention. The top quartile received \$4 of commission for \$1 of MRR; the next quartile received \$3, and so on. Hubspot’s third sales model paid \$2 for every \$1 of MRR, but not immediately. 50% of the commission was paid in the first month, 25% in the sixth month, 25% in the twelfth month - provided of course, the customer was still subscribed.

Hubspot’s journey highlights the three key components of a sales compensation plan: commission ratio, acceleration and payment schedule. The commission ratio of a sales compensation plan equals the customer revenue divided by the sales cost for a year. In the case of the \$2 commission for \$1 of MRR, the commission ratio is 3.3, calculated in the table below.

\$2 for \$1 Commission Plan
Quota400,000
Monthly MRR Quota2,778
Monthly MRR Commission5,556
Annual MRR Commission66,667
Annualized Customer Revenue216,667
Commission Ratio3.3

I’ve assumed a quota of \$400,000 in bookings for this AE, which implies a monthly MRR quota of \$2.8k. If the AE achieves plan, the commission is twice the quota or \$5.5k; multiplied for 12 months equals \$67k. The annualized customer revenue is \$217k, or the sum of MRR for all customers over the first year. This implies a 3.3 commission ratio.

Most commission plans I’ve seen for inside sales teams maintain a commission ratio between 3 and 4. The lower the commission ratio, the more a company pays to each AE for a sale, and vice versa.

Each company’s commission ratio will vary depending on quite a few factors. For example, lower commission ratios are common when salespeople are educating the customer base and experiencing longer sales cycles. Companies can sustain higher payment ratios when account executives can sustain high sales velocity - meaning they can close deals quickly. Ultimately, the sales commission plan has to balance the cost to the business and the ability of the account executive to earn market wage.

Acceleration is second part of the sales commission plan. Not all commission plans feature acceleration. Hubspot’s first plan doesn’t. If a sales rep closes 125% of quota, or \$3.4k in a month, the sales rep receives \$6.9k. However, it’s common to see accelerators. For example, if an AE closes 125% of quota, the rep would earn 125% commission or \$8.7k in a month.

On the positive side, accelerators reward above-quota performance. On the negative side, accelerators can encourage sandbagging - the practice of lumping contracts in one particular period to juice the commission payouts. Like any incentive, accelerators must be actively managed.

Hubspot’s second commission plan employs accelerators, but based on a different axis, customer retention, rather than quota outperformance. This is a great example of how to align the incentives of the sales team with other parts of the business, in this case customer success.

Payout timing is the third component of the sales compensation. Hubspot’s third plan delays the commission payout to encourage customer retention. Payment timing can also be used to encourage setting the right expectations with customers, pursue account expansion and promote renewal.

Hubspot’s example shows the evolution of their sales plan and the way they embodied three key characteristics of a startup’s compensation plan. There is no global optimum for sales plans. They must evolve with time and reflect the needs of the business.

Published 2015-03-30 in

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