Managing a Sales Org: Revenue Composition

TL;DR

A sales organization should pay commissions on new business and upgrade business, service repeat business through a lower-cost group, and inspect churn. For example, within $10,000,000 of annual recurring revenue, only a couple of million dollars might come from new and upgrade business in a year. The distinction matters because those two components produce ARR growth, as the detailed breakdown explains.

Transcript

the next part of managing a sales organization is managing revenue composition and revenue composition is the additive components that equal the total revenue that you're getting over a period of time when I talk about managing revenue it's how do you decide what revenue to pay salespeople on versus what revenue might you not pay salespeople on the... Read More

Key Insights

• Compensation follows revenue timing: Sales compensation should reflect how revenue actually comes into the business and how that revenue is reported. Using annual revenue creates a common basis for payment and reporting. Total contract value may describe a larger commitment, but the recommended commission basis is the annual portion rather than the entire contract amount.
• Revenue categories need separation: Treating all revenue as one undifferentiated total hides the different roles of new, upgrade, and repeat business. The speaker separates these categories because each calls for a different management response. New and upgrade revenue should drive commission payments, repeat revenue should receive service, and lost repeat revenue should receive inspection.
• ARR includes a subtraction: Annual recurring revenue is not presented only as the sum of positive revenue sources. New business, upgrade business, and repeat business contribute to it, while churn reduces it. This makes churn structurally different from the other components because it represents expected repeat business that did not renew.
• New business drives expansion: New business adds revenue that was not already present from earlier contracts. That makes it one of the two components on which company growth depends. Paying salespeople for new business directs their effort toward obtaining additional customers or contracts instead of simply benefiting from revenue created in previous years.
• Upgrades also produce growth: Upgrade business deserves commission alongside new business because it increases revenue within the existing base. The speaker treats acquisition and expansion as the two productive sales outcomes that increase ARR. This distinction prevents existing customers from being treated as a single category when only some of their revenue reflects new sales work.
• Repeat revenue reflects past wins: Much of current ARR may come from contracts secured in prior years rather than from the current sales period. In the $10,000,000 ARR example, only a couple of million dollars might represent new and upgrade business for the year. Paying equally across the total would reward current sellers for substantial revenue inherited from earlier work.
• Growth requires offsetting churn: If a company relied only on repeat business while experiencing churn, its ARR would decline over time. Increasing ARR therefore requires new business and upgrade business to add revenue beyond the losses. This is why the commission plan should concentrate rewards on the components capable of expanding the revenue base.
• Expected revenue can weaken focus: Commissioning repeat revenue may encourage salespeople to sit on business already expected to return. The speaker describes this as resting on the laurels of the past, an approach that defeats the productivity of the sales organization. Incentives should instead direct sales attention toward incremental revenue creation.
• Customer success lowers service cost: Repeat business still needs customer contact and support, but it does not necessarily require a full sales commission. A service group or customer success group can speak with these customers at a relatively low cost compared with the revenue being maintained. This separates ongoing account care from commission-bearing growth work.
• Broad commissions dilute spending: Paying commission on all revenue would create a large payout while delivering little benefit on the activities that matter most for growth. The problem is not merely the expense. Broad payment also fails to distinguish revenue actively created this year from revenue expected because of past contracts.
• Churn requires active inspection: Churn should be examined to understand what is happening when customers fail to renew. The goal of inspection is to determine whether the company can do anything to raise the likelihood of repeat contracts when each contract period ends. Churn is therefore managed through diagnosis, not through ordinary commission payments.
• Three actions clarify ownership: The framework assigns one management action to each part of revenue composition. Pay commissions on new and upgrade business, service repeat revenue through an appropriate group, and inspect churn for renewal problems. This division gives the sales force a growth mandate while preserving lower-cost support for recurring customers.

Questions & Answers

Q: What is revenue composition in a sales organization?

Revenue composition is the set of additive components that produces total revenue over a period. For annual recurring revenue, those components are new business, upgrade business, and repeat business, reduced by churn. The breakdown matters because the organization should not manage or compensate every component in the same way. New and upgrade business should earn sales commissions, repeat business should be serviced, and churn should be inspected.

Q: Which revenue should earn sales commissions?

Sales commissions should be paid on new business and upgrade business. These categories represent additional revenue and are the sources of ARR growth identified by the speaker. Concentrating payment there motivates the sales force to pursue new opportunities and expand existing business. It also avoids rewarding sellers merely for revenue expected to continue from contracts secured in previous years.

Q: Why should salespeople be paid on annual revenue instead of total contract value?

Annual revenue reflects how the revenue actually comes into the business and how the company reports it. Paying on that same annual basis normalizes sales compensation to reported revenue. Total contract value is a different SaaS metric and may cover more than the revenue associated with one year. Using annual revenue therefore keeps the payment basis aligned with the company’s annual revenue reporting.

Q: What components make up annual recurring revenue?

Annual recurring revenue includes new business, upgrade business, and repeat business. Churn is the negative component that reduces the resulting revenue. Repeat business can include customers with contracts that renew later, such as customers holding two-year agreements. This composition reveals which revenue is newly created, which is continuing, and which expected revenue has been lost.

Q: How does churn affect ARR over time?

Churn occurs when a company does not renew its repeat business. It subtracts from revenue and can cause ARR to decline when new and upgrade business do not offset the loss. A business relying only on repeat revenue while experiencing churn would therefore shrink over time. New and upgrade revenue are necessary to increase ARR beyond that downward pressure.

Q: Why not pay commissions on repeat business?

Repeat business largely comes from customers and contracts established in previous years. Paying commissions on all of it could create substantial expense while providing little benefit on the activities that drive growth. It may also let salespeople rest on revenue already expected to arrive instead of pursuing new or expanded business. The speaker recommends servicing repeat accounts through a lower-cost service or customer success group instead.

Q: How can a company manage repeat business cost-effectively?

A company can place repeat business with a service group or customer success group. That team can communicate with existing customers and service the recurring revenue at a relatively low cost compared with the amount of revenue involved. This arrangement preserves attention for customers without paying full sales commissions on continuing contracts. It also leaves the sales force focused on new business and upgrades.

Q: How should a sales organization respond to churn?

The organization should inspect churn to understand what is happening when customers do not renew. That inspection should consider whether the company can do anything to increase the likelihood of repeat contracts when the contract period comes up. The purpose is to address the loss of recurring revenue rather than treat churn like a commissionable category. Within the broader framework, churn is inspected while new and upgrade business are paid and repeat business is serviced.

Summary

In managing a sales organization, it is crucial to consider revenue composition, which refers to the different components that make up the total revenue over a period of time. Rather than paying salespeople on all revenue, it is important to normalize how they are compensated based on how revenue is generated and reported. This includes focusing on annual revenue, distinguishing between total contract value and annual contract value, and understanding different components such as new business, upgrade business, repeat business, and churn.

Questions & Answers

Q: What is revenue composition?

Revenue composition refers to the additive components that make up the total revenue generated over a specific period of time. It involves understanding the various metrics and factors that contribute to revenue, such as total contract value, annual contract value, and annual recurring revenue.

Q: Why is it important to manage revenue composition in a sales organization?

Managing revenue composition allows for effective compensation strategies for salespeople. It ensures that salespeople are paid based on the revenue they generate or contribute to, rather than being compensated for all revenue. This helps align their incentives with the company's goals and focuses their efforts on generating new business and upgrading existing customers.

Q: How can revenue be reported differently in SaaS businesses?

In SaaS businesses, different metrics such as total contract value, annual contract value, and annual recurring revenue may be used to report revenue. It is important to standardize and normalize how revenue is reported in order to have consistency and accuracy in compensation calculations.

Q: What are the components of annual recurring revenue (ARR)?

Annual recurring revenue (ARR) consists of new business, upgrade business, repeat business, and churn. New business refers to revenue generated from acquiring new customers, upgrade business refers to revenue generated from upselling or upgrading existing customers, repeat business is the revenue generated from customers who renew their contracts, and churn represents the loss of revenue due to customers not renewing their contracts.

Q: How should salespeople be compensated based on revenue composition?

Salespeople should primarily be compensated based on new business and upgrade business, as these are the drivers of growth in a company. These components represent the revenue generated from actively acquiring new customers and upselling existing customers. Repeat business can be handled by a service group that services this revenue at a relatively low cost, without the need for high commissions. Churn should be inspected to understand customer behavior and identify possible actions to increase repeat contracts.

Q: What would happen if salespeople were paid commissions on all revenue components?

Paying commissions on all revenue components, including repeat business and churn, would result in little benefit in terms of growth and productivity for the sales organization. It would lead to unnecessary commission payouts and neglect the importance of actively pursuing new business and upgrade opportunities.

Q: What is the significance of managing churn in revenue composition?

Churn, which represents the revenue lost when customers do not renew their contracts, is an important aspect to inspect and analyze. Understanding the reasons behind churn can help identify ways to improve customer retention and increase the likelihood of repeat contracts.

Q: How can revenue composition impact the growth of a company?

The growth of a company is heavily dependent on new business and upgrade business, which are the drivers of increasing annual recurring revenue (ARR). By focusing on these components and properly incentivizing salespeople to acquire new customers and upsell existing ones, a company can experience sustained growth over time. Neglecting these components or paying commissions on less impactful revenue components would hinder the company's growth potential.

Q: What role does service play in revenue composition?

Service plays a crucial role in revenue composition, specifically in handling repeat business. A service group can be responsible for servicing customers who renew their contracts. This can be done relatively inexpensively, allowing for efficient allocation of resources. Having a separate service group enables the sales force to focus on generating new business and upgrading existing customers.

Q: How should revenue composition be managed in a sales organization?

Revenue composition should be managed by focusing on paying commissions to salespeople based on new business and upgrade business, while having a separate service group handle repeat business. Churn should be closely inspected and analyzed to understand customer behavior and identify opportunities for increasing customer retention. This approach ensures that salespeople are motivated to actively pursue growth opportunities and generate revenue, while also maintaining customer satisfaction and minimizing costs for servicing repeat business.

Takeaways

Effectively managing revenue composition in a sales organization is crucial for aligning salespeople's incentives with company goals. By compensating salespeople based on new business and upgrade business, while having a separate service group handle repeat business, companies can drive growth and optimize resources. Inspecting churn helps identify opportunities for improving customer retention and increasing repeat contracts. Properly managing revenue composition is key to sustained growth and productivity in a sales organization.

Summary & Key Takeaways

• Defining revenue composition: Revenue composition means the additive components that produce total revenue over a period. Managing it requires deciding which revenue should earn sales commissions and which revenue should not. Although organizations may naturally want to compensate salespeople on every dollar of revenue, the speaker argues against that approach. The central management task is to align compensation with the revenue that salespeople actively generate, rather than treating every component of reported revenue as equally deserving of commission.

• Choosing the correct metric: SaaS businesses may track total contract value, annual contract value, and annual recurring revenue as different measures. The sales compensation model should be normalized to how revenue actually arrives and how the company reports it. The recommendation is therefore to pay the sales force on annual revenue and report annual revenue, instead of calculating commissions from total contract value. This creates consistency between recognized revenue, reported performance, and the basis used to reward sales activity.

• Breaking ARR into components: Annual recurring revenue contains new business, upgrade business, and repeat business, with churn acting as a negative component. Repeat business includes existing customers whose contracts continue or renew, such as customers on two-year contracts who renew later. Churn occurs when a company does not renew that repeat business. Revenue composition can therefore be understood as the positive contribution from the three business categories, reduced by the revenue lost through churn.

• Paying for growth creation: Commissions should focus on new business and upgrade business, even though these may be the smaller portions of overall revenue. In a company with $10,000,000 in ARR, perhaps only a couple of million dollars in a year comes from those two categories, while much of the total reflects business won in previous years. Rewarding acquisition and expansion keeps salespeople focused on producing growth instead of resting on revenue already expected to return.

• Separating pay, service, and inspection: Repeat business can be assigned to a service group or customer success group that supports customers at a relatively low cost compared with the revenue involved. Paying commissions across all repeat revenue would produce little benefit on the activities that matter while creating a large commission expense. Churn should be inspected separately to understand what is happening and whether the company can increase the likelihood of repeat contracts. The operating model is simple: pay for growth, service recurring accounts, and inspect losses.