Choosing the Right Contract Value For Your Sales Incentive Plan

Choosing the Right Contract Value For Your Sales Incentive Plan

As companies move to XaaS sales models with multi-year contracts, their sales incentive plan decisions must also account for choosing the best contract value calculation to incent sellers on. With transactional sales, there is no future sales value to consider. The seller is credited for the transaction’s value at the time the product or service is delivered. Contractual sales however consist of multiple calculations to account for the “present” and “future” nature of contracts that a seller can be credited for.

The 4 contract value calculations to choose from are:

Choosing the Right Contract Value For Your Sales Incentive Plan

  1. Total Contract Value (TCV)
  2. Annual Contract Value (ACV)
  3. First Year Contract Value (FYCV)
  4. Recognized Revenue

Following is a summary of the pros and cons of each of the 4 contract value calculations, and common use cases of each method. Combined with your specific sales and organization’s circumstances, you’ll be able to arrive at an informed decision of which contract value calculation is best for you. You can also create derivatives of these baseline calculations to further suit the needs of your sales organization. Emblematic of other sales incentive decisions, we must balance the financial risks to the organization with the perception of fairness to and driving the desired behaviors of the seller.

Choosing the Right Contract Value For Your Sales Incentive Plan

Total Contract Value (TCV)

TCV – The total value of the contract over the contract’s full term.

Pros +
  • Aligns well with the total “Sale” and timing of the sales effort
  • Simple, no calculation required for value
  • Easiest option to administer
Cons –
  • There is a risk of overpayment from final realized revenue amount being less than contract value
  • Adds complexity to quotas

The total contract value calculation is the simplest to administer because it does not require any additional calculation. Sellers are also able to quickly understand the amount of the sale that they are to be credited for. This contract value calculation also presents the largest financial risk to the organization. Generally, multi-year contracts have no guarantee of the full contract value being recognized as revenue. The risk grows the longer the contract term is. However, this option is the most rewarding for the seller and is typically aligned with aggressive sales roles focused on acquiring new business or accelerating company growth.

Alternative Crediting Option: Credit the value of the contract at a variable rate starting with 100% for year 1 and gradually decreasing for subsequent year values.

Choosing the Right Contract Value For Your Sales Incentive Plan

Annual Contract Value (ACV)

ACV – The total contract value divided by the total number years the contract includes.

Pros +
  • Aligns rewards with timing of the sale
  • Minimizes some of the revenue risk associated with TCV
  • Easily calculated
  • Manages multi-year contract discounting
Cons –
  • There is a risk of overpayment from final realized revenue amount being less than contract value
  • May require additional incentives for multi-year contracts
  • Adds complexity to quotas

The average contract value calculation accounts for the length of the contract to determine the annualized value the contract is worth. This calculation is helpful when you want to prioritize consistency in the annual value of a contract and manage multi-year contract discounting. This calculation does not incentivize multi-year contracts so additional incentives will be required to drive that sales behavior.

Alternative Crediting Option: Add a crediting multiplier to the average contract value to incentivize multiple contract years.

Choosing the Right Contract Value For Your Sales Incentive Plan

First Year Contract Value (FYCV)

FYCV – The value of the first 12 months of a new contract.

Pros +
  • Aligns rewards with timing of the sale
  • Easier to set quotas for
  • Mitigates the financial risk to the organization
Cons –
  • Estimates final revenue that may not be delivered
  • Best when revenue flows are consistent over the contract life
  • May require additional incentives for multi-year contracts

Crediting for only the first 12 months of a new contract usually assumes 1 of the following: most contracts are only for 1-year, there is a high rate of renewal, or there is high risk in revenue being realized beyond 12 months. This calculation is best for roles whose primary responsibility is to maintain existing relationships and retain revenue. For organizations that have moved into a mature growth rate phase, crediting on the FYCV greatly reduces the risk of crediting for revenue that will not be realized.

Alternative Crediting Option: Implement separate crediting rates for the first-year value of renewal contracts, and the first-year value for new customer contracts.

Choosing the Right Contract Value For Your Sales Incentive Plan

Recognized Revenue

Recognized Revenue – The seller is credited the amount of revenue that is recognized at the time of product or service delivery.

Pros +
  • Aligns with actual revenue for the company
  • Aligns well when role is focused on customer retention
  • Mitigates risk of crediting for unrealized contract revenue
Cons –
  • Delays crediting
  • Least aligned with timing of selling activity

Crediting when the revenue is recognized is most appropriate for roles whose primary responsibility is account retention and compensation plan does not have a large variable component. Because it doesn’t credit until the revenue is recognized, it is the option most misaligned to the time of the sell. This is the most conservative crediting option and only pays when revenue is recognized eliminating the risk of paying for unrealized revenue.

Alternative Crediting Option: Pay a nominal flat commission amount when contracts are approved as an advance on the commission to be paid once revenue is recognized to provide a financial “reward” at the time of the sale.

Analysis of historical revenue and contract data will further help assess your organization’s unique risk exposure associated with the various contract crediting options. This analysis along with the desired selling behaviors you want to prioritize, will help you choose the appropriate crediting type for your desired sales goals.

Choosing the Right Contract Value For Your Sales Incentive Plan

SalesGlobe is a leading sales effectiveness and data-driven creative problem-solving firm. We specialize in helping Global 1000 companies solve their toughest growth challenges and helping them think in new ways to develop more effective solutions in the areas of sales strategy, sales organization, sales process, sales compensation, and quotas. We wrote the books on sales innovation with The Innovative Sale, What Your CEO Needs to Know About Sales Compensation, and Quotas! Design Thinking to Solve Your Biggest Sales Challenge.

SalesGlobe On-Demand Insights

SalesGlobe On-Demand Insights provides relevant, timely, impactful information that informs incentive compensation. Contact us for more information or to obtain a subscription to unlimited SalesGlobe On-Demand Insights.

Stay Ahead in a Rapidly Changing World

Subscribe to our monthly newsletter below and never miss our latest SalesGlobe insights.