Getting your Sales Economics Right - Sales as Science and not an Art

Some of the most common questions I hear from fellow entrepreneurs center on sales: How to get more customers. How to make sales more predictable. Whether or not their comp plans are right. What channels they should be using.

Questions around sales are paramount, because new sales and new customers are the lifeblood of any business. Maybe also worth mentioning are a few other “hot” topics -- co-founder challenges (much more common than typically reported), raising money (always a challenge), product fit, HR or legal issues, etc. I’ll address those topics another day. Today is all about sales. As founders, we want Sales to be a Science and not an Art. How do we get there?

If sales is going to be scientific, you first need to understand your sales economics. Your business unit economics. My background is in engineering and math -- so as I transitioned to more of an entrepreneur and sales leader, it was essential for me to get the math right. That should be your focus too, as it is for any successful sales leader. My businesses have been SaaS businesses, so those will be my examples, but much of these concepts applies to other revenue models.

First off, what is a customer worth to you? What is their Lifetime Value (LTV)? If they pay $500/mo and typically stay with you for three years -- that's $18,000 over that lifetime. But, we really should take gross margins into account -- so let’s assume a healthy SaaS margin at 80%: then the LTV is $14,400 (80% of $18k). Traditional wisdom says you want at least a 3X Customer Acquisition Cost (CAC) to LTV -- so we’ve got a maximum of $4,800 to play with for our CAC. This math covers the very basics. But there’s plenty more to consider: what’s your time to pay back the CAC? Is that CAC "fully loaded"? Does marketing spend sit inside that? Sales overhead? The office space used by sales? What’s your sales comp plan (Sales Commission Plans) ratio as compared to the sales quota? Do you end up paying double commissions anywhere (multiple reps, marketing contribution, SDR vs. AE, etc)? There’s plenty of wisdom in each of these topics. Know them all! And most importantly, be consistent. This information forms the guardrails of your sales machine. It might seem pedantic, but the best founders and leaders know this stuff cold.

Marketing is in many ways a more complex topic than even sales. I’m a proponent of most marketing being included inside your sales calculations. Often large swaths of marketing gets left out and labeled branding or awareness or whatever fuzzy and unaccountable term you choose to use. Business development is just as bad or worse. SDR or BDR is usually located in sales but also can sometimes get lost or unaccounted for. My recommendation is to keep as much of this in your calculations as you can. At a minimum, certainly know what happens or how wide the changes are when you do/don’t include.

Let’s do the math

I like to do the CAC and sales spend exercise two different ways: bottoms up and top down. Get out your spreadsheets, people! Top down is perhaps the easiest (and maybe scariest). Here’s what you do: take your entire department spend of sales, marketing and BD and divide by the number of new customers you closed in that period as well as the number of new dollars closed (usually ARR / Annual Recurring Revenue generally). What’d you get? 10 new customers on a $500k spend? Yikes, okay, $50k per new customer. To get $750k in ARR? Okay, $1 dollar in CAC spend for every $1.50 in recurring revenue. These very well could be real numbers and they may be good or may be very bad -- we’d need to compare to LTV to know. Take out marketing and BD and maybe the numbers improve by 2X - $1 for $3 on sales only and $25k per customer. It’s not uncommon to see roughly equal spend in marketing vs. sales. This top down approach is instructive, but I find the bottoms up method more useful in understanding what’s really going on. Astute listeners might ask the question about the “window” size here: should we use per quarter or year or month or week or what? And whatever window period you choose, people always raise some exception that that window wasn’t typical for some reason or another. Don’t worry about it. Just keep tracking and comparing over time. My quick take is pick a period that makes sense for your business, usually something on the order of 2-3 sales cycles, and the exceptions will “come out in the wash” as you compare several window periods. Investors generally want to see consistency and improvement over time, more so than an one-off stellar month or quarter.

For bottoms up I like to do a Unit Economics type approach. As an early founder, one of my “professional” angels drilled me on this for hours. Over multiple weeks. It was worth it. What’s your average commission rate per deal? How much base salary goes into each deal? How much marketing spend do we allocate to each deal? What did you pay for those leads? Was a SDR in on it? Take your deals and see what % came from each channel and how expensive are each of those channels? Use all of this to create that bottoms up budget. $3k for commission. $5k to marketing. $3k for base salary. $3k for sales overhead. 80% product margins. 25% of deals through SDR at an average of $4k per. Credit card fees or other collections overhead. Etcetera etcetera. So how far off is your bottoms up from your top down calculation? What expense aren’t you including? Oh yeah, I think those onboarding costs should go in here too. $2k to account management and $2k to your training/onboarding team. How much T&E (Travel and Entertainment) do you spend on an average deal? Does the math pencil out? Keep accounting for your spend and check the buckets.

Once we have all this, and our math is working -- now let’s look at each channel. Is SDR working? For your PPC (pay per click) marketing budget, does that channel pan out? Or maybe that’s too competitive / too expensive for your model? What happens if you were to increase the sales quota by 25%? Should you be doing more in marketing or is the spend there dragging it down? Look at lead sources and trace it back. Yes, unfortunately, to make sense of this you need to be tracking this stuff in the first place! Each channel will have natural limits. Just because you can get 10 deals a quarter through trade shows at a certain cost -- doesn’t mean you can 10x that for 10x the cost. Often the more you want from a channel, the more costs balloon because you’ve already gotten the low hanging fruit.

Comp plans need several posts unto themselves. Rightfully so -- getting your comp plans right is probably one of the biggest things you can do to win here. Quickly: I’m all about strong incentive based plans, uncapped commissions, and making sales reps share the burden of lead costs -- meaning better incentivizing cheaper channels and taking a cut on more expensive ones. Incentivize the behavior you want. Remember, it’s base pay that kills you, not commissions. (Here's a place to start on that topic).

Does that all make sense? Google the terms and ratios you don’t understand. Push your finance team or ops team for more granular tracking. Then back the math out and incentivize where needed. New “spiffs”, promotions, or extra cash always get some attention! (Just be sure to include that cash back into the model!) Then sales will truly be a science. Now go close some deals! And good luck!