For SaaS companies seeking potential capital, a major key valuation is growth. Growth is a function of how effective your sales model is or the return on your sales and marketing spend. In our recent webinar, Private Equity Perspectives on B2B SaaS Investing, we asked leading investors to identify three key ratios they focus on to assess the health of a company’s sales and marketing efforts. Their answer ―customer acquisition cost (CAC), lifetime value (LTV), and sales efficiency.
Having delved into the importance of lifetime value and customer acquisition in our recent blog, The Importance of LTV:CAC for SaaS Businesses, we will focus on the sales efficiency ratio and why it’s an important indicator of future growth prospects.
How does a SaaS executive evaluate the efficiency of their sales and marketing efforts?
For SaaS businesses, sales efficiency ratio not only provides historical views of how effective your sales spend is, but also provides insights on whether to increase spend or re-evaluate sales and marketing efforts.
Sales Efficiency Calculation
Sales efficiency can be calculated in two ways. Gross sales efficiency looks at incremental revenue generated over a fixed period while net sales efficiency offsets the incremental increase in revenue by any loss in customer revenue due to churn over the same timeframe.
Calculating sales efficiency requires an understanding of subscription revenue from new customers as well as upsell or cross-sell revenue from existing customers.
Gross Sales Efficiency = New ARR / S&M Expense*
(New ARR = Ending Quarter ARR – Beginning Quarter ARR)
To calculate new annual recurring revenue in any quarter, subtract out any recurring revenue from the prior quarter and divide that number by the current quarter’s sales and marketing expense. Sales and marketing expense includes any costs related to those endeavors, including salaries, benefits, commissions, software, and advertising expenses.
Net Sales Efficiency = Net New ARR / S&M Expense*
(Net New ARR = Ending Quarter ARR – Beginning Quarter ARR – Lost ARR)
To calculate net new annual recurring revenue in any quarter, take new annual recurring revenue and subtract lost ARR during that quarter. Sales and marketing expense should remain the same. In cases where there is ARR churn, net sales efficiency will be lower than gross sales efficiency.
|Quarter||ARR||Lost ARR||S&M Expense||Gross Sales Efficiency||Net Sales Efficiency|
Using Sales Efficiency to Set Future Sales Strategy
If sales efficiency is less than 1.0x, you may want to revisit your sales and marketing strategy, including opportunities to better upsell or cross sell. When sales efficiency is greater than 1.0x, you are in a strong growth position. Assuming the total addressable market is there, consider adding more resources to sales and marketing given the high return on your sales dollars. Sales efficiency can also be used to assess individual sales productivity when looked at more granularly.
Sales efficiency is an important indicator of how effective your sales and marketing efforts are and how quickly your organization can grow. Actively reviewing and recrafting sales strategy to boost efficiency is an important aspect of managing your growth and maximizing your valuation.
If you have any questions about calculating sales efficiency, please don’t hesitate to reach out.
*Sales & Marketing Expense is the same quarter as New ARR or Net New ARR.