Designing CS Compensation Structures to Boost Retention Rates
Primary Impact shares a customer success guide in this installment on compensation structures, drawing from the success of portfolio companies like Virtual Facility, Kinetics, and Andros.
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In our recent introduction of the CURE framework for renewals ownership, we advocated that CSMs should never own renewals outright, but that their variable compensation should be structured in a way that motivates CSMs to drive customer retention and growth — so how is that done? This article shares a customer success guide, drawing from the success of portfolio companies like Virtual Facility, Kinetics, and Andros.
One metric to govern them all
Net dollar retention rate — the composite of expansion, upsell/cross-sell, churn and contraction, typically calculated at a cohort level on either a calendar year-to-date or trailing 12 months basis — tends to be a safe bet as the governing metric for CSM comp plans, as it encompasses the hat trick of logo retention, pricing preservation, and account growth.
Net dollar retention calculation example (assume calendar YTD basis as of November 1)
Note that net dollar retention does not consider ARR from new customers added within the period of measurement (i.e. new customers signed between January 1 and November 1 would not be included in this metric).
Net dollar retention is a critical health metric for every SaaS business, but it can be a red herring when examined in isolation: a business with strong expansion and upsell mechanics could boast a 100%+ net dollar retention rate while masking a 40% gross churn rate (gross churn = sum of churn and contraction), a scenario that would cripple a company’s long-term growth prospects. Examining existing business bookings (effectively the total expansion and upsell/cross-sell ARR) is a similarly flawed approach, as an overemphasis on new ARR may distract from the cheapest form of growth, customer retention.
This example illustrates a scenario where strong expansion mechanics mask an unsustainable gross churn rate.
The most effective variable compensation plans focus on a business’s ripest opportunity areas. A business with 5% gross churn and 100% net dollar retention likely has room for improvement on existing customer expansion, a scenario in which incentivizing against a bookings target could make sense. But even in that scenario, a net dollar retention target would drive the right behaviors (i.e. set a 105% net dollar retention goal).
While there is no silver bullet for how to structure CS compensation plans, the net dollar retention approach will never lead a company astray. And in a situation like the aforementioned 40% gross churn scenario, organizations can mix and match metrics to drive the right outcomes: while a bonus plan that is ⅔ net dollar retention and ⅓ gross churn technically “double dips” on the churn number, it also ensures employees are appropriately rigorous about churn and contraction.
Net dollar retention works for variable compensation not only because it is a composite metric, but also because it is reasonably easy to understand and perhaps most importantly because it is rooted in company financial performance/ARR.
While the lion’s share of variable compensation for any job function should be tied to company financial goals, there is certainly merit in rewarding other meaningful business activities. When I ran the customer success teams at Sailthru and Campaign Monitor, our most typical CSM variable plan had ⅔ of the bonus allocation derived from net dollar retention, with the remaining ⅓ tied to QBR coverage inside of any given quarter. Note that QBRs were by no means a vanity metric; we had a templatized format that forced the topics of customer strategy and product roadmap/utilization, and we had data-driven evidence that these sessions with our client sponsors boosted satisfaction and retention. Tying part of the bonus allocation to an MBO rooted in “sticky drivers” (aka meaningful retention levers) or important business activities is a good strategy when combined with a financial metric such as net dollar retention. (At other points in our journey, we tied that remaining ⅓ to things such as CSM CSAT, time-tracking, and so forth.)
Quarterly bonus payouts can be helpful for accelerating upsell/cross-sell activity; if a CSM knows she has significant churn/contraction in a quarter, she can work to offset it with a material upsell or cross-sell. However, a large churn event in-quarter can also be demoralizing (particularly if it’s due to the “death or marriage” scenario of a company going bankrupt or getting acquired), so it is worth exploring ways to offset that type of blow:
- End of year “catch-up.” If CSMs achieve their annual targets, offer them the opportunity to “catch up” for any quarterly targets they might have missed. For example, if the quarterly target is 98% and the CSM has a quarter where her net dollar retention is 80% (missing the bonus payout) but her annual net dollar retention rate lands at 101% because of other overperforming quarters, she gets paid back for that missed quarter at the end of the year.
- Bifurcate targets into team and individual goals. Consider splitting the target between team performance and individual performance. At Sailthru, we set the team performance at the regional level (and we actually omitted unpreventable churn from the individual calculation, and left it for the team number).
Most bonus plans have a “floor” for a payout — perhaps the CSM must hit 90% of the target to earn a prorated bonus — but it is equally important that they also offer accelerators for achievement, particularly since these accelerators pay for themselves. You can also recognize a top performer with a flat SPIF (i.e. the CSM with the best QBR coverage each quarter earns a $1,500 spot bonus).
Sample Net Dollar Retention Accelerator
Another effective comp plan “kicker” is to increase in the bonus pool following each employee anniversary in order to reward tenure in the role; if the standard bonus pool for a CSM is 10% of base compensation, she would move to 12% following year 1, 14% following year 2, 16% following year 3, etc. “Career CSMs” who are committed to continuing to manage clients should ultimately have an opportunity to earn a similar bonus rate to those at the manager level (20% or higher).
In the same way that CSM variable compensation should be closely aligned to renewal outcomes, bonus plans for renewal owners — regardless of whether you have a renewals manager structure or an account management approach — should be tightly aligned to company objectives, including net dollar retention.
If renewal/account manager compensation plans are tied only to bookings, the company can still suffer from a gross churn issue. While a hybrid plan that accounts for both existing business bookings (expansion + upsell/cross-sell) and net dollar retention rate technically double-dips on the bookings metric, it ensures that the renewals owner is equally focused on price preservation and churn mitigation.
If a meaningful driver of a CSM’s variable compensation is tied to the commercial outcomes of her book, she will have reason to be invested in these metrics regardless of whether she is truly “owning” the renewal process.