Software sales & marketing costs

Periodically I’ll find a post in the blogosphere lamenting the amount of money that enterprise software vendors pour into sales & marketing. In most companies, sales & marketing expenses are 2-3X those applied to product development. While there are countless articles, books, methodologies and consultants available to increase the efficiency of product development, the cupboard is comparatively bare when it comes to efficiency in sales and marketing.

Sales and marketing expenses are, in the abstract economic sense, wasted money. If customers were omniscient they could order whatever they needed on a web site without vendor prompting or encouragement and take vendor sales & marketing costs down to zero.

I believe the root cause of sales & marketing expenditures is a two way street. Reducing these costs would neither be a vendor-only solution nor a customer-only solution.

Where does the money go? If all sales & marketing expenses are 100%, the breakdown for an average enterprise software company might look something like this:

Brand & general awareness building – 10%
Tactical marketing (demand generation, etc) – 20%
Quota carrying salespeople & associated overhead – 35%
Sales specialists (sales engineers and various other specialists) – 35%

I’m sure there is wasted money in marketing, but at 70% of the total, the bigger opportunity for improvement is in sales.

If you were to show sales costs as a simplified function of revenue it might look something like this:

Cost of Sales as a % of revenue = Revenue Per Sale / [ (N * S * T + C) * 1/P(w) ]

N is the average number of people working on a sale

S is the average salary of those people for a month

T is the average amount of time in months it takes for the sale to reach a decision (win or lose)

P is the probability of winning the sale

R is the revenue a company takes in a given year

C is costs associated with the sale (e.g. travel)

Three parts of this equation are relatively uncontrollable:

S is not an opportunity for savings. There is a market rate for good people in any profession. If you pay less than the market rate, you either get bad people or no people at all.

I don’t think there’s a big opportunity to reduce the average number of people working on a sale. You could argue that fewer sales specialists would reduce N, but I’d predict that this would result in salespeople doing this work themselves which would increase N back to the original level. Possibly there’s some optimization to do here but not a ton.

Revenue per deal is a big but I think untouchable lever. Doubling the amount you sell in one shot cuts sales costs nearly in half. Of course customers aren’t too thrilled about paying double and vendors aren’t too thrilled about receiving half, so I think we’ll have to let the market sort out the average deal size.

Three parts of the equation are controllable if everyone (vendor and customer) is willing to do their part.

Time is a big lever. With a similar sales team and win rate, a company with an 18 month sales cycle will spend twice as much on sales as a percent of revenue as a company with a 9 month sales cycle. There are tons of pockets of wasted time throughout the sales/purchase cycle but the first order problem is this:

People are free to waste what is not their own. So vendors frequently waste the customer’s time, and customers frequently waste the vendor’s time.

Some ways vendors waste the customer’s time:

- Avoiding describing what the product or service actually does in favor of abstract marketing and positioning statements like “end to end” or “best in class.”
- Reluctance to disclose product weaknesses.

If you’re a large purchaser of technology, go to one of your vendor’s account managers the day after New Year’s and say:

“Whatever quota you’ve been assigned for me for this year, I’m guaranteeing you’ll make it. Now I just guaranteed your income so you work for me. You will be my savvy shopper. I want to get precise descriptions about what your products do. I want to know about their issues and weaknesses before anyone else does. I want to have access to your company’s expertise as fast, or faster, than anyone else. If you fail to do these things I can ensure you get kicked off this account and probably fired.”

Some ways customers waste the vendor’s time:

- RFP’s. Everything in moderation, but most book-sized RFP’s are huge time & resource drains for vendors with low probability of success.
- Concentrating purchase authority in the hands of one or two people who take months to get access to.

If you work in sales management for a large technology vendor, pulls a customer aside at the end of your first meeting and say:

“On average my company spends 12 months with customers before they reach a decision on our product. If you are willing to commit to a yea or nay decision on my company’s product within 6 months, I will discount the price an additional 7% in addition to whatever discounts you regularly negotiate.”

Sales costs are roughly 25% of revenue so by cutting them in half the customer and the vendor can share the savings equally at a 7% discount.

Win rate is another big lever. If a vendor won 100% of the deals it pursued, its sales & marketing costs would be half that of a vendor that won 50% of the time. This is a big reason why the #1 vendor in a software market typically makes 80% of the profits in the market. If #2 vendor wins half as much as the #1 vendor, their sales & marketing costs as a % of revenue are higher than that of the leader, and this causes them to starve R&D to fund additional sales & marketing. Of course this further reduces the win rate, sending the #2 or #3 vendor into a vicious cycle.

It’s in the technology buyer’s power to increase win rates industry wide, reducing vendor sales & marketing costs. If you’re a shopping for software, how many vendors do you typically evaluate? When do you cut most of them loose so you’re down to the likely two?

Cost associated with the sale is yet another lever. Over a 12 month sales cycle, the airfare, meals and extraneous expenses can add up. I’ve personally never seen a compensation plan that rewards salespeople for saving the company money. I’m not sure why this is but perhaps someone can explain to me why this would not work. A sales manager tells his salespeople:

“On average our company spends 3% of revenue for a sale on travel & miscellaneous expenses (this is a total guess on my part). If you come in below the company average, you can have half of the savings.”

Just as in product development, there’s no silver bullet to reducing sales and marketing costs. But the prize (in the form of increased profits, more money ploughed into R&D, and customer savings) is so great, it seems crazy not to try. So let’s light a candle rather than curse the darkness. Has anyone attempted these or any other approaches to streamlining the enterprise software sales and marketing machine?

Startup fad diets

Just got through reading this article on Appirio in Forbes online.

Essentially Forbes holds Appirio up as the new paragon of startup thrift. The founder’s taken such overhead reducing steps as:

1. No physical office space except for a rented cube.
2. A team distributed throughout the country, mostly in low-ish cost US states like Arkansas
3. The company owns no hardware. Everything is by the drink from Amazon ECC
4. The company spends no money on PR. Everything is word of mouth.

For all this, Appirio is able to bid for projects at 20% less than competitors (which seems like an underwhelming cost advantage after all that fasting) and often does fixed bids.

O.K.

Let us all agree that being thrifty is good.

Let us also agree that advances in technology and business practices allow startups to run leaner and meaner than they could have 7 years ago.

But some of Appirio’s stuff is just shortsighted, and by the way, it’s been tried before.

Consulting/software hybrid businesses. So many failures in this regard it’s hard to count all of them. ICG Commerce comes to mind as one good example.

Fixed fee consulting projects. This works when you’re a small company but falls apart as you grow because of underbidding which either burns out consultants or creates perverse incentives to under-deliver to clients so they might hit the target budget. Cambridge Technology Partners is a good example.

No physical office space, just a distributed team. A nice over-head saver but typically these sorts of companies have very little cohesion and turnover becomes rampant, especially as you get into crunch time on one of those fixed-fee projects that you underbid. A notable failure example here would be Gemini Consulting that tried to go 100% virtual with just one physical office in New Jersey.

No hardware. Well, this is a matter of degrees in my opinion. Clearly the old days of buying hundreds of thousands of dollars worth of Sun servers is over. But are you so hard up you can’t spend $10,000 on a couple of Dell boxes? Or at least some dedicated servers from a hosting company? The difference is a couple of hundred dollars a month for some added consistency and reliability. Isn’t a business worth at least this much?

No PR. Hard to argue with this one, I don’t recall ever getting much value out of the money I’ve spent on PR.

It seems like every startup era, the business press profiles some startup that takes the current zeitgeist to the perverse extreme like some sort of fad diet.

I recall articles in 2000 during the dot com boom where they’d profile a startup that raised $20 million in the series A and bought a Superbowl ad the next day. Get big fast and build the brand immediately. THAT’S the future of the startup.

A few years later I was reading articles of startups that threw everything to India except a skeleton crew in the US. Quotes from VC’s saying “I’m not interested in any business plan that doesn’t have an India strategy.” Go to India. THAT’S the future of the startup.

Now it’s “buy nothing, own nothing, hire no-one” future of startups.

Every era a number of businesses get weaned on the new fad diet, but just like fad diets, they typically last for a couple of years before becoming dysfunctional and flabby.

P.S. - From when I started writing this post we're apparently already moved onto the new "don't fund anyone over 40" diet.

What are you willing to pay for availability?

Dan Farber writes up an interesting piece on Salesforce.com's rather extended scheduled downtime. In the process, Dan quotes a fellow Enterprise Irregular Charlie Wood who says:

Does anyone think PayPal could have hours of scheduled downtime and get away with it? Of course not! Why not? Because payment processing is a mission-critical, 24×7 function. Shouldn’t sales and support be no different?

In fact it should be different. People are prone to forget that sales force automation has very little to do with actually securing revenue. If your SFA is down, you may not be able to enter some contact information or update your pipeline, but this is hardly life threatening for a few hours. By contrast if your order entry & fulfillment system goes down for a few hours, you are likely to experience some serious commercial consequences.

None of this is really a SaaS topic. It’s more a matter of not paying for mission-critical availability for a non-mission critical system. For an extra $5/user/month I imagine Salesforce could substantially reduce downtime. But for most customers would prefer to save the money and do without a contact management and pipeline tracking system for a few hours a week. If you were making this same decision for a manufacturing execution system or an order entry system or a telecom OSS system, you’d make a different decision.

There have actually been mission critical systems available as a service for decades now. Payroll through ADP is one example. Also many small community banks get their highly mission critical payment systems as a services from larger banks that can afford to maintain the infrastructure. They just come with mission critical prices.