This discussion often comes up in our cost of sales workshops, and I believe it is good for any manager or director to have a simple and straight forward answer to the question. There are many obvious and hidden costs to consider, and by being transparent with your team about where the money goes, you will save yourself potential problems.
Let us take the Software example: You are working for a great start up B2B SaaS company, the team is great, you believe in both the company and the idea, but … they ask you to sell for a million, but your on-taget-pay is less than 100k. How can this be, seriously??
Most recent software companies don’t have California-style financing up front, you are in Europe. This means that somehow your company need to be profitable or close to profitable EBIT wise. What is your reasonable quota?
Cash is king. two different cases:
- Software have very high grown margins, but cash comes in slow nowadays with subscription and pay-as-you-go schemes.
- Traditional things, machinery etc are paid up front or at least in conjunction with the delivery, but, the internal margins after paying internal transfer – costs of goods are much lower.
The software case
Back to software – In the old days, software sales used to book sales during the same year: product/license money came up front, and training, services and installation services were invoiced during the first year. Additionally there used to be an annual fee to stay on maintenance, support and new versions etc. (20%-25% of the initial licence fee normally)
Now, subscription softare – SaaS, has completely changed the game plan. What used to be a 100.000 € deal, with annual maintenance of 20.000€ has now become a 3-4.000€ monthly subscription. Over time this is great, but the company needs the money now!!
To comlipcate the matter, in many companies, the sales department only sees the first year of revenue after signing. Next year your customer will be handled by the customer retention or “customer success” team.
Since your company have no external funding for the moment, what is the reasonable quota, or sales target you should carry? Lets look at the cost of sales and the money we can expect initially.
Profitable companies cover costs
A rule of thumb for any SaaS company who seeks profitability, is
New (first year ARR) sales, should at least cover this years customer acquisition cost (CAC) with new sales (new ARR > Cost of Sales, CAC).
This means for the company any new customer must be paid for already during the first year contract (from signing). Otherwise, the company will need external financing to cover while waiting for the second and future years payments. If first year contracts cover CoS, the company can grow with limited external financing, and not be restrained by a systematic cash flow problem for its growth.
Think about it:
For any new sales, you are using company resources that your activity need on a deal.. such as techsales, new features development, management and admin. (Customer services and support are handling your recurring revenue, coming years, so here both cost and future revenue is excluded),
Without going into any great detail on what may the case in your company, it will probably be a good rule of thumb to think that – If you sell for about 4-5 times the average sales employee total cost to the company, you are all right.
The real cost of any employee is around 1,5 – 2 time the salary, this way including social security fees, indirect taxes, the office space you use up, medical insurance, meal tickets etc.
As an example, if your salary is 60kEUR, your total cost is around 100kEUR, and the reasonable quota is 450kEUR-600kEUR . If your salary is 100kEUR, you should not be surprised if your quota is 800-1.000kEUR. Why?
Why is 4-5 times your cost, (or 10 times your salary) a good rule of thumb?
- One is to cover your own cost to the company
- One is to cover other direct new sales costs, Presales activities, free Consultancy, proofs of concept, development adaptations etc
- One is to cover other overhead and indirect sales costs, your sales director, your marketing personnel, a part of admin, all more or less involved in new sales.
- Between One and Two is to ensure some margin, because during the year one or more of your colleagues will not make their quotas, they may leave, the market was not good in their territory etc.
Needless to say, this is a very coarse estimate and way to think about quotas. In the companies I have worked I made sense for me and my team, under the circumstances I described above. If the market is bouyant, and your company is very agressive in marketing, for example, then your quota could and should be significantly higher. If the company is spending wast amounts of marketing, you job gets a lot easier, but at the same time the money you need sell to cover for the marketing team will increase.
For industrial products?
The same reasoning, but here we think that the total cost of sales plus any extras must be covered by the internal product margins, the contribution margin from your unit.
You sell industrial equipment that is produced elsewhere. The cost when delivered to your warehouse is 65% of List Price, leaving you with 35% to pay for your teaming cost of sales.
Let us assume that the sales effort is the same, one salary for you, one for Presales and other sales support, and one for management overhead and office etc. Add one for internal margin.
Your pay is 60k€/year – or total cost 100k€ per person. That makes 300k€, plus internal extra of 1-200k€. Total cost/internal margins from factory = 400k€/0,35 = quota of 1.143k€
The pure cost is 300k€, so if you sell for less than 300k€/0,35 = 857k€ your local unit will present losses!