In a recent YouTube discussion, Ryan, VP of Sales, Marketing, and RevOps at QuotaPath, shared valuable insights on structuring sales compensation for companies transitioning to usage-based pricing models. With his extensive background in revenue operations and experience conducting hundreds of compensation plan reviews, Ryan offers practical guidance for SaaS executives navigating this complex transition.
Understanding Traditional Compensation Plan Fundamentals
Before tackling usage-based pricing, Ryan explains the essentials of a standard compensation plan:
"The first is an understanding of on-target earnings for the seller. So if a seller earns a $100K annual base salary and they have a $100K variable target, they have a $200K on-target earnings," Ryan explains. "Their first expectation is… if I do everything perfectly right, how much money should I expect to earn and then how much revenue do I need to close and over what period to earn that much money."
Traditional SaaS compensation typically follows a straightforward model where sellers earn a percentage of annual recurring revenue (ARR) up to a quota, with accelerators kicking in as they exceed targets. This creates a clear path to earnings that sellers can understand and predict.
The Complexity of Multi-Year Contracts and Expansion
Even before usage-based pricing became popular, SaaS companies grappled with how to compensate for multi-year deals and account expansion. According to Ryan, companies have typically handled this in one of two ways:
- Separate new business and account management teams with distinct compensation structures
- Creating a "grace window" where new business sellers receive credit for expansion during the first few months
Many sellers adapted by "baking in expansion over time into the initial contract," Ryan notes. "Sellers would say, 'Okay, this is a 30K contract for year one. It bumps to 40K for year two and 50K for year three.' And orgs would then pay them off of the average contract value versus year one contract value."
The Challenge of Usage-Based Pricing for Sales Teams
When companies transition to usage-based pricing, sales compensation becomes significantly more complex. Ryan emphasizes that this consideration should be immediate: "The second you start to think about usage-based pricing, you have to think about how you're going to reward your sellers for it. If you don't, you run the risk of alienating a lot of your top performers and having some unwanted attrition."
The fundamental challenge is determining how much ARR to expect from a usage-based customer in their first year, when traditionally sellers are compensated based on fixed contract values.
Three Approaches to Usage-Based Compensation
Ryan outlines three potential approaches for compensating sales teams in a usage-based model:
1. Seller Estimation Model (Most Seller-Forward)
The seller estimates the customer's first-year ARR and receives commission based on that estimate, with later adjustments:
"The seller estimates the annual recurring revenue of this customer in the first year, and you pay them commission off of that and you monitor over the course of the year. If they don't get to that point, the projected ARR, you then claw back the difference in commissions versus what they estimated and what actually happens. And if you go above that amount, you actually pay them more commissions as that comes through."
2. Monthly Payment Model (Most Business-Forward)
The business pays commissions only as actual revenue comes in:
"Pay the seller monthly their commissions on a deal over the first year as invoices are received. Every time an invoice comes through for the Jones deal for March, you pay them in April the component of their as it adds up to their expected kind of variable comp."
3. Hybrid Approach (Middle Ground)
The company pays on a conservative portion of estimated revenue with scheduled true-ups:
"Take half of [the estimated ARR] and give the seller quota credit and payout for half of that. If it's a $120K deal, they're at least going to pay us $60K in the first year. Pay the seller for that $60K in ARR. And then at month six, how have they progressed towards that $60K? If they're still below it, you're not going to pay them any more money. If they've gone above it, you're actually going to pay them on the difference. And then by the end of the year, you have a true-up."
The Most Common Approach in Practice
According to Ryan, most companies are adopting the middle-ground approach with minimum commitments:
"A lot of teams when they think about pricing and packaging for usage-based pricing, they will have some sort of minimum required amount for a certain package you're on… pay the seller on half or pay the seller the commissions upfront on the minimum and then track the expansion over time. That's been the most popular that I've seen."
This allows sellers to receive a significant payment when they close the deal while protecting the company from overpaying on anticipated revenue that may not materialize.
Systems Requirements for Supporting Usage-Based Compensation
Implementing usage-based compensation requires significant systems integration. Ryan explains:
"What you're trying to do is you're trying to join your CRM with your ERP, your invoicing tool. And so what you're going to want to have happen is as the deal is moved to closed-won in CRM, you have a way to, as the invoices populate, have a field in the CRM that's like 'total revenue received'."
This integration allows companies to track the projected deal value against actual revenue received, creating the foundation for appropriate compensation calculations.
Organizational Structure Implications
One fascinating consequence of usage-based pricing is its impact on sales team structure. Ryan observes:
"From an org design perspective in usage-based orgs, you're seeing a lot of account executives turn into more account managers. They build like a bit of a residual book… What a lot of AEs are arguing is, 'Okay, that's fine, but then I want to be the person who implements them and gets them set up for success and drives expansion.'"
This blurring of roles challenges the traditional separation between new business and account management, requiring companies to rethink rules of engagement and handoff points.
Recommendations for Implementation
For executives considering implementing usage-based pricing, Ryan offers several key recommendations:
- Set clear expectations with sellers: "Walk the seller very clearly through how they're going to earn with real-time examples."
- Establish a gradual transition: "If you're making a shift from a traditional SaaS model to more of a usage-based model, you have to ramp them along the way. You can't just say, 'Hey, all of a sudden in January we're switching to usage-based, so now your earnings drop by 80%.'"
- Use minimum commitments: Implement "usage-based pricing light" with tiered packages to provide more predictability.
- Let customer needs guide your approach: "Understand what your customers actually want and don't force the hot LinkedIn topic on them."
- Anticipate 20-25% variability: When estimating usage, build in sufficient buffer to minimize clawbacks.
The Future of Usage-Based Pricing
While there's significant discussion about usage-based pricing, Ryan notes that practical implementation lags behind the hype:
"Senior leaders all want to do it because they see great stories like the Snowflakes of the world and they want to be able to tie cost to outcome. I think that sellers don't love it because it's easier to sell, 'Hey, this is a $12K contract. Pay me right now.'"
He predicts that AI-driven SaaS products will drive greater adoption of usage-based models due to their margin structure: "These AI tools… they're going to need to get much more into a usage-based pricing model likely because they could have customers using the product much more than others. And it's not like standard SaaS where your margin's pretty protected. If somebody uses your product more and more, your margin goes down more and more."
Conclusion
Transitioning to usage-based pricing requires careful consideration of sales compensation structures to ensure both seller motivation and business sustainability. The most successful implementations involve clear communication with sales teams, systems integration to track actual usage against projections, and compensation models that balance seller incentives with business realities. By approaching this transition thoughtfully, SaaS companies can capture the benefits of usage-based pricing while maintaining sales team effectiveness and financial predictability.