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Optimizing Sales Compensation in a Cloud-First World

This document is for informational purposes only. The opinions and views expressed in this document are those of Neural Impact Inc. and do not necessarily state or reflect those of Microsoft. MICROSOFT MAKES NO WARRANTIES, EXPRESS, IMPLIED OR STATUTORY, AS TO THE INFORMATION IN THIS DOCUMENT.

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Optimizing Sales Compensation in a Cloud-First WorldThe Cloud, SaaS and subscription licensing have effectively rendered traditional compensation models obsolete. Licensing revenue, which was historically collected upon contract signing and used to fund sales and marketing costs, is now recognized over a much longer period of time, while project services are increasingly bundled into monthly fees and/or replaced with subscription revenue tied to partner or 3rd party IP. At the same time, customer demand is shifting towards solution sets comprised of multiple Microsoft and partner developed components (ERP, CRM, ISV, Office 365, Power BI, SharePoint, Azure, managed services, IP, etc.). Combined, these changes have resulted in the need for a new approach to compensation design.

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Getting startedOptimizing sales compensation in a cloud first world involves balancing two competing interests – your need for predictable growth at an acceptable cost of sale and your sales team’s desire to maximize their earning potential. Transfer too much risk onto the sales professional and you risk bad behavior, employee churn and difficulty attracting the best candidates. Retain too much risk and you slow down the customer acquisition process and lower profitability. The key is to strike the right balance.

As your first dedicated cloud sales professional will likely be responsible for generating new business and renewing existing customer contracts, you will need a compensation structure that can accommodate both “blended” and “dedicated” Business Development Representatives (BDRs).

Once you have acquired a solid foundation of cloud customers you should separate your initial blended role into dedicated new business and dedicated renewal roles. The time frame for this shift varies based on solution set, average deal size and close ratio, but ideally should be within 18-24 months. As blended sales professionals will be primarily focused on new customer acquisition, candidate selection criteria should favor skills and behavioral traits that align with a “hunter”, rather than a “farmer” profile.

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Compensation Plan DesignThere are three steps to designing a balanced compensation plan:

· Defining on-target earnings (OTE)

· Configuring the quota elements

· Developing a compelling bonus structure

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Regional variations must be taken into account with regard to both base salary and fixed vs. variable compensation ratios. In the US, base salary expectations will be higher in New York than in the Midwest, while in Europe they will be higher in Germany and France, where they have historically represented up to 80% of OTE (on target earnings), than in Spain, Italy, or Eastern Europe.

Step 1: Define On-Target Earnings Levels

Base Salary Ratios

Sales Role Base Salary Compensation at Quote Attainment

Base Salary %

Blended 40,000 ($/€) 72,063 ($/€) 56%

Dedicated New Business 43,500 ($/€) 84,938 ($/€) 51%

Dedicated Renewal 30,000 ($/€) 49,688 ($/€) 60%

To attract candidates with the right psychological profile and disqualify marginal candidates, your base salary offering should satisfy the lower end of your target candidate’s “acceptable” range, while their earning potential should exceed the upper end of their expectations. As a percentage of total compensation, base salaries are lower for roles focused primarily on new customer acquisition and higher for roles focused primarily on renewal and extension, as shown in the Base Salary Ratio example below.

Base Salary Ratio Example

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To provide sales professionals with a compelling and achievable OTE target, blended and new business quotas will likely range between 900,000 and 1,000,000 ($/€). Dedicated renewal quotas will likely range between 1,000,000 and 1,200,000 ($/€).

Most importantly, quotas must be set at levels that ensure an acceptable cost of sale, both prior to and after attainment. As a guiding principle, at 100% quota attainment your blended cost of sale should fall in the 7-8% range, your new business cost of sale should fall in the 8-9% range, and your renewals cost of sale should fall in the 3-5% range.

Cost of Sale

Sales Role Quota Attainment

Base Salary Annual Revenue Generation

Annual Compensation

Sales Compensation / Revenue

Blended 100% 40,000 ($/€) 975,000 ($/€) 72,063 ($/€) 7.4%

Dedicated New Business 100% 43,500 ($/€) 975,000 ($/€) 84,938 ($/€) 8.7%

Dedicated Renewal 100% 30,000 ($/€) 1,125,000 ($/€) 49,688 ($/€) 4.4%

Compensation should be paid on total contract value but not on renewals beyond the initial contract term (assuming a minimum two year commitment). Compensation is only paid on year one of CRM Online and Office 365 given their lower year two revenue contribution.

Step 2: Set Appropriate Quotas

Cost of Sale Example

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Compensation plans must provide incentives that discourage revenue deferral. Unless there is sufficient motivation to continue closing deals, many sales professionals will, consciously or unconsciously, stockpile opportunities for the following period rather than deplete their pipelines. This behavior can be averted by including “incentive bands” and “revenue accelerators” in compensation plans to encourage sales professionals to close as much business as possible prior to a period end.

Incentive bands are incremental bonus percentages (%) paid on revenue that is generated after a sales professional has achieved 100% of their quarterly target. For clarity, a sales professional must be at or above their YTD (year to date) commitment to be eligible for a bonus. You must also consider which revenue categories “qualify” for bonuses as not all solution elements are equal. Revenue generated by managed services, professional (project-based) services, migration fees, and partner developed IP should always be included in a bonus structure as they carry a higher margin contribution, whereas other solution elements (Office 365, and 3rd party/ISV software) may be limited to the first year of a contract term or excluded altogether. The tables below show recommended incentive bands for both new and renewal revenue as well as which solution elements should be included and excluded from incentive band bonus calculations.

Step 3: Set Appropriate Incentive Structures

Bonus Incentive Bands

Quota Attainment

New Business Renewals

100% 4.25% 1.75%

110% 4.50% 2.00%

125% 4.75% 2.25%

150% 5.00% 2.50%

175% 5.25% 2.75%

Incentive Bands

Solution Elements Bonus Eligible

Managed Services (contracted) Yes

Own IP Subscriptions Yes

Project Services Yes

ERP Subscriptions Yes

CRM Online Subscriptions Year 1 Only

Office 365 Subscriptions Year 1 Only

Incentive Band Examples

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Once a BDR retires 100% of their annual quota, their base salary is effectively removed from the cost of sale equation, which allows for incremental compensation incentives. While each incremental incentive band must pay out higher bonus percentages, it must also produce a consistent or decreasing cost of sale. The Blended BDR example below shows the cost of sale impact once a blended BDR triggers various incentive bands.

To further incent sales professionals to sell specific products or services, revenue “accelerators” should be applied to solution elements with the highest margin contributions. For example, partner-developed IP typically generates gross margins of approximately 65%. When a revenue accelerator of 1.75 is applied to a 50,000 ($/€) annual partner IP subscription (based on a two year contract commitment) it retires 175,000 ($/€) of quota (50,000 ($/€) x 2 years x 1.75 revenue accelerator = 175,000 ($/€)) which significantly increases BDR compensation. The table below suggests which solution elements provide sufficient gross margins to warrant an accelerator:

Bonus Incentive Bands

Solution Element Margin (Year 1) Revenue Accelerators

Project Services 35% n/a

Manages Services 45% 1.5

ERP Subscriptions 25% n/a

CRM Online POR Fees 20% n/a

Office 365 POR Fees 20% n/a

Own IP Subscriptions 65% 1.75

Blended BDR Example

Bonus Incentive Bands Example

Blended BDR

% Quote Achieved (New Business)

% Quota Achieved (Renewals)

Quarterly Revenue Generation

Quarterly Bonus

Total Annual Compensation

Total Sales Compensation / Revenue

100% 100% 243,750 ($/€) 8,016 ($/€) 72,063 ($/€) 7.4%

110% 110% 268,125 ($/€) 9,488 ($/€) 77,950 ($/€) 7.3%

125% 125% 304,688 ($/€) 11,543 ($/€) 86,172 ($/€) 7.1%

150% 150% 365,625 ($/€) 14,766 ($/€) 99,063 ($/€) 6.8%

175% 175% 426,563 ($/€) 18,293 ($/€) 113,172 ($/€) 6.6%

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Revenue accelerators can have a significant impact on quota attainment and compensation. The table below shows the result of a blended BDR selling 250,000 ($/€) of managed services and 50,000 ($/€) of partner developed IP (green cells) over the course of a year. While 975,000 ($/€) of new revenue has been generated, the BDR is compensated for 1,300,000 ($/€) of revenue production (133% of quota) due to the accelerators, which increases total compensation from 72,063 ($/€) to 92,687 ($/€). Note that quota credit for CRM Online and Office 365 subscriptions (yellow cells) is limited to year one of the contract term.

The previous examples and recommendations are built upon a working assumption that managing to an acceptable cost of sale is a critical requirement for overall partner profitability. That said, you may choose to consciously over-invest in sales (higher base salaries, more lucrative incentive bands and additional revenue accelerators) in order to attract higher calibre sales professionals that accelerate customer acquisition and growth.

For more information on building your cloud practice visit http://aka.ms/cloud-surestep and watch Structuring a Balanced Cloud Compensation Plan Video.

Blended BDR Compensation Example

Blended BDR Compensation Example

Solution Elements Annual Revenue Generated

Average Contract Term (years)

Total Actual Revenue Generated (Quota)

Total Accelerated Revenue (Quota Credit)

Managed Services 250,000 ($/€) 2 500,000 750,000 ($/€)

Own IP Subscriptions 50,000 ($/€) 2 100,000 175,000 ($/€)

Project Services 250,000 ($/€) n/a 250,000 250,000

ERP Subscriptions 50,000 ($/€) 2 100,000 100,000

CRM Online Subscriptions

15,000 ($/€) 2 15,000 ($/€) 15,000 ($/€)

Office 365 Subscriptions

10,000 ($/€) 2 10,000 ($/€) 10,000 ($/€)

Totals 625,000 ($/€) 975,000 ($/€) 1,300,000 ($/€)

Compensation 72,063 ($/€) 92,687 ($/€)

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Sales Compensation Model The sales compensation model was developed to help you create sales compensation plans that accurately reflect your unique business scenario and growth objectives, as well as the market conditions in your geography. Adjusting the input variables allows you to see the impact to both the cost of sale equation and BDR earning potential. The five key compensation plan inputs that need to be considered are:

• Average Deal Assumptions

• Base Salary

• Target Quota

• Bonus Bands

• Revenue Accelerators

The examples provided in the modeler tutorial are in USD

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Step 1: Define the anticipated average deal assumptions (cells highlighted below).

Step 2: Adjust the minimum base salaries (cells highlighted below) to reflect what will be required to attract your target candidate profile. You will require different base salaries for new business, renewal and “blended” sales professionals.

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Step 3: Adjust the quotas (cells highlighted below) for the various sales professional profiles.

Pay close attention to how these adjustments impact your sales costs in the Comp Model tab (cells highlighted below). Total sales compensation should not exceed 8% of blended revenue, 9% of new business revenue and 5% of renewal revenue.

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Step 4: Adjust the quota achievement and bonus bands, if required (cells highlighted below) to incent quarterly overachievement

Step 5: Adjust the revenue accelerators, if required (cells highlighted below), to incent the sale of higher-margin products and services.

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At the end of your adjustments, ensure there is still sufficient upside earnings potential for exceptional sales performance, as well as an acceptable cost of sale at all levels of sales achievement (cells highlighted below).