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How to
establish a clear cause and effect relationship between promotional
expenditure and sales …
and how
to fast-track the growth of your business in the process.
Over lunch, a CEO recently admitted to
me that his financial controller was using his organisation’s profits to build
quite a substantial commercial property portfolio.
When I asked if this was best use of
his organisation’s free cashflow, he smiled, "How did I know you’d ask
that question?
"The fact is," he continued,
"the availability of capital is not currently a constraint on our
growth."
"It might not be a constraint on
your organic growth," I argued, "but I still think that money
could be better invested in new client acquisition."
We spent the rest of that lunch
scribbling on napkins. Together, we discovered that a dollar invested in
promotional expenditure was actually providing this CEO’s organisation with a
better-than 900% return on investment!
By the time coffee was served, we’d
agreed that his organisation’s sales process could provide a much more
favourable return on capital than even the bluest of blue-chip commercial
property investments.
In our experience, this holds true for
most organisations. Unfortunately, most are reluctant to invest in their sales
processes because (unlike other business processes) it’s impossible to
calculate a return on investment.
Science versus art
If you’re a follower of our Relationship-centric
Marketing methodology, you’ll know that a sales process has inputs and
outputs — just like any other business process.
You’ll know that a sales process (as
the word process implies) consists of a sequence of simple, interrelated
steps — just like any other business process.
And you’ll know, at least in theory,
that each step in a sales process can be measured, managed and optimised —
just like any other business process.
This article explains the science (and
more importantly, the mathematics) behind sales process management. It will show
you how to take control of your sales process and use it to fast-track the
growth of your organisation.
If you didn’t pay much attention to
mathematics at school, you may find this article tough-going at times. But
please be sure to persevere.
I’m sure you’ll discover that your
sales process is harbouring significant growth potential!
Management by numbers
If you think about it, the word management
presupposes measurement. The fact is, if you can’t measure it, you
simply can’t manage it.
So, to manage a sales process (or any
process for that matter), we need to know what to measure. Generally speaking,
we will measure inputs, outputs and time. Specifically, we’ll
measure:
-
Throughput (output/time)
-
Productivity (output/inputs)
We’ll measure these key
performance indicators (KPIs) for the process as a whole, and then we’ll
break the sales process into its key components (sub-processes) and devise a set
of KPIs for each component.
It’s worth remembering that your
sales process is actually a component of a much larger system: your entire
business. In the context of your business as a whole, revenue is a
measure of throughput, and gross profit is a measure of productivity. The
problem with these indicators is that they are trailing indicators: that
is, they tell you more about what you have done in the past than they do about
what you should do in the future.
Because your sales process is the
first step in your entire organisational process, the information you collect
from monitoring these performance indicators can be used to enable real-time
process optimisation.
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As we dissect and analyse the
sales process, we’ll make references to a fictitious company we’ll call Correlex.
Correlex is an engineering firm that consults to property developers. Correlex’s
clients all pay a retainer of $450 a month to access its consulting
services. References to Correlex will appear in indented sections,
with a green sidebar, just like this one.
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Measuring the process
as a whole
The objective of your sales process is
obviously to generate sales.
This process must be designed and
managed to ensure that it delivers a sufficient volume of sales in exchange for
a commercially realistic investment.
For simplicity’s sake, we’ll
assume that the objective of our sales process is to acquire new clients.
But don’t worry, we will be sure to take follow-on sales (and even
referrals) into account.
Accordingly, the two global indicators
in which we’re most interested are:
-
Client acquisition rate (new
clients per month).
-
Client acquisition cost (cost per
new client).
When we’re measuring client
acquisition cost, we’re dividing the amount we invested in the acquisition
of relationships by the number of clients acquired as a result of that
expenditure.
When we calculate this figure, we only
take into account the variable costs associated with the promotional campaign
that acquired each particular client relationship. With a promotional campaign,
variable costs are typically media costs. We do not factor in the fixed costs
associated with that promotional campaign (the cost of creating the campaign).
Nor do we include the fixed costs associated with the rest of the sales process
(e.g. the cost of managing the relationship with the potential client).
We ignore fixed costs because these
are the cost of operating your sales process, rather than process inputs.
Our client acquisition cost is
most useful for monitoring the performance of our relationship acquisition
campaigns. It’s important to remember that, unless you have a very short sales
cycle, client acquisition cost tends to be longer-term performance
indicator. (The term sales cycle refers to the average time span between
the acquisition of a relationship and the consummation of a sale.) We’ll uncover a
short-term indicator when we examine the relationship acquisition step of
the sales process.
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When the CEO of Correlex reviews
his organisation’s sales process, he discovers that, averaged over the
last 12 months, Correlex acquired two new clients each month.
To determine his average client
acquisition cost, he divides his total variable promotional costs by the
number of clients he acquired over this period.
In the last 12 months, Correlex
had advertised in the Financial Review, and in a number of specialist
publications. It had also run 4 direct mail campaigns. Accordingly, its
variable promotional costs consisted of the cost of media for the
advertising campaigns, and the cost of mail processing for the direct mail
campaigns.
In total, Correlex invested
$9,600 in order to acquire 24 new clients: an average client acquisition
cost of $400.
$9,600 / 24 = $400
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Optimisation
It’s obviously important to know how
many sales your organisation is making. It’s also nice to know how much each
sale is costing you in promotional expenditure.
But, in isolation, this information is
not particularly useful.
What you need to be able to do, is
compare your actual performance with your optimal performance.
A common mistake in process
management is to establish absolutes as targets. For example, it would be
tempting to assume that the objective of your sales process is to generate
as many sales as possible, for the lowest possible promotional expenditure.
The reality is that sales and
promotional expenditure are interrelated. (You can’t have one without the
other.) A singular focus on either maximising sales or minimising
promotional costs is likely to sub-optimise the performance of your
sales process. The key is to determine the optimal relationship
between promotional expenditure and sales.
Accordingly, you now need to determine
the optimal figures for each of your global KPIs.
Client acquisition rate is
easy. Obviously, your optimal figure is determined by the capacity of your
production and distribution processes. (There’s little point generating sales
that can’t possibly be fulfilled.)
However, your client acquisition
cost requires a little more thought.
As the graph below illustrates, as
your promotional expenditure increases, the number of clients you acquire should
also increase. However, with the increased promotional expenditure, the
profitability of each client relationship suffers.
In theory, your optimal client
acquisition cost is the point where these two lines intersect.
In practice, it will take some
experimentation (and careful measurement) to calculate your optimal
acquisition cost.
The starting point for this
calculation is the determination of the lifetime value of a client. (Your
optimal client acquisition cost will be a percentage of this figure.)
It is difficult to overemphasise the
importance of performing this calculation. Without an understanding of the
dollar value of a client, it is simply impossible to effectively manage your
sales process.
In our experience, because most
organisations have no way to value a client relationship, most grossly
underestimate the amount that they are prepared to invest in client acquisition.
This under-investment in client
acquisition seriously retards the growth of many organisations.
The publishing industry is one
industry that does understand the concept of lifetime value.
Typically publishers of magazines and other periodicals are prepared to
invest at least 100% of the first year’s subscription revenue in order to
acquire a new subscriber!
Valuing a client
relationship
In financial terms, a client
relationship is simply an annuity income stream.
It follows that you can value a client
relationship, just as you can value any other kind of annuity (income-producing
investment).
You value an annuity using a net
present value calculation. (Net present value is the sum of a series
of future payments, discounted for the cost of capital.)
To calculate the lifetime value of
a client, determine the gross profit you earn in an average year from an average
client, then multiply this by the figure in the annuity table below that
corresponds to the number of years you retain this average client.
This table shows how much a
series of $1 payments, to be paid at the end of each year for a
specified number of years into the future, is currently worth, with
interest at different rates, compounded annually. In other words, the
table shows what you should be willing to pay, today, in order to
receive a certain series of future payments of $1 each.
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As you already know, Correlex sells
a consulting service for $450 a month.
To calculate the lifetime value
of an average client, it must multiply the gross profit in a transaction
by the number of times Correlex transacts with an average client over
the lifetime of the client relationship.
On average, Correlex retains
a client for three years. Its gross profit is 70% (or $315).
It chooses to account for cost
of capital at its overdraft rate, 9%.
Correlex calculates
the net present value of a client relationship by first calculating
its annual gross profit, and then multiplying this figure by the appropriate
multiplier from the table above:
Average annual gross profit:
$450 x 12 x 70% = $3,780
Net present value: $3,780 x
$2.53 = $9,563
The CEO of Correlex is
surprised to see just how valuable a client relationship is.
Prior to performing this
calculation, he was considering reducing his promotional expenditure ($400
per client seemed like a lot — especially for an engineering firm).
Now, however, he suspects that he
has been underspending on client
acquisition!
Accordingly, he decides to set his
optimal client acquisition cost at a (conservative) $900. He also
resolves to watch his KPIs carefully and review this figure in six months’
time.
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As explained, your optimal client
acquisition cost will be a percentage of the lifetime value of a client. The
actual percentage will depend on the fixed costs associated with your sales
process (and your sales volume). It will almost certainly be more than 10%. It
may even be as high as 50%.
(While the idea of investing 50% of
the lifetime value of a client in client acquisition may seem
ludicrous, it’s important to remember that, once an organisation has passed
its break-even point, it’s effectively enjoying a 100% return on this promotional
expenditure. Try earning that in the bank!)
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Before he can finalise his global
performance indicators, the CEO of Correlex must determine his optimal
client acquisition rate. A quick call to his operations manager confirms
that Correlex is capable handling four new clients a month.
These indicators provide Correlex’s
CEO with an overview of the relationship between his sales process’s
inputs and outputs.
His suspicion that he is
underspending on promotion is supported by the fact that Correlex is
growing at 50% of its optimal rate.
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Because your global KPIs are
longer-term indicators, they do not enable you to manage your sales process on a
day-to-day basis.
To do this, we need to divide your
sales process into its key components, and then devise a set of performance
indicators for each.
You’ll remember that a sales process
consists of three components:
-
Relationship acquisition
-
Relationship management
-
Opportunity management
Let’s start with the final component
of the sales process and work backwards.
Opportunity management
The objective of your opportunity
management process is to convert sales opportunities into sales (remember, we’re
assuming that a sale is a new client). This process will generally involve
salespeople, operating either in the field, or from a call centre (or both).
A sales opportunity is typically an expression
of interest in a specific product or service, generated as a result of your
opportunity management process. (Sales opportunities are often called leads.)
As with your sales process as a whole,
we are primarily interested in the throughput and the productivity of your
opportunity management process.
Accordingly, we will begin by
measuring:
-
Client acquisition rate (clients
per month)
-
Opportunity conversion rate
(sales/opportunities x 100)
Of course, the throughput of the
opportunity management process (client acquisition rate) will be
identical to the throughput of your sales process as a whole.
Your conversion rate is the
percentage of sales opportunities that convert into sales.
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The CEO of Correlex already
knows his client
acquisition rate.
What he doesn’t know, is how
many sales opportunities his consultants require in order to make each sale.
A survey of his consultants’
sales figures indicates that, on average, his consultants convert one in
every 2.9 sales opportunities into sales. (Accordingly, his conversion
rate is 35%.)
But these sales figures also
reveal an interesting phenomenon. Correlex’s CEO observes that
conversion rates vary considerably from consultant to consultant. He also
notices that there seems to be an inverse relationship between acquisition
rate and conversion rate for individual consultants.
In other words, the consultants
who acquire the most new clients tend not to have the highest conversion
rates, and visa versa.
He wonders why …
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Optimising conversion
rates
Contrary to popular belief, the
primary influencer of conversion rate is not the skill of salespeople.
Rather, it is the design of the
opportunity management process.
In our experience, opportunity
management processes are best designed with a view to minimising the time
between the emergence of a sales opportunity and closure of that opportunity (a
sales opportunity is closed when it is won, lost or abandoned).
Increasing the throughput of a
sales process may result in lower conversion rates, but this is not necessarily
a bad thing!
Sales managers typically manage
their salespeople as if a conversion rate of 100% is achievable.
In reality, 100% is rarely an
optimal conversion rate. The reason is that, as conversion rates go up,
throughput goes down.
Ask yourself, which would you
prefer: a salesperson who conducts 5 appointments a day, with a 40%
conversion rate; or a salesperson who conducts 3 (highly qualified)
appointments a week, with a 95% conversion rate? (Hint: salesperson A
generates 10 sales a week, where salesperson B generates less than
3.)
You can take the following steps to
increase the throughput of your sales process:
-
Break the opportunity management
process into a number of logical steps.
-
Ensure all sales opportunities
follow the same process.
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At each step in the opportunity
management process, be sure to up-sell to the next step.
-
Actively manage open opportunities.
You can manage individual (open)
opportunities with a simple tabular report, like the one below. Normally, a
sales team will work through this report in its weekly sales meeting. The key
indicators to watch are the number of open opportunities and average
days open. (If you sell a number of products with different price points,
you may prefer to monitor the dollar value of opportunities).
[click
to enlarge]
Most CRM systems produce such a
report; alternatively, you can create your own in Excel.
You can also use the weighted value
and target close data from this report to produce sales forecasts.
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Correlex’s CEO
reviews his consultants’ differing opportunity management processes. He
identifies the consultant with the most efficient process and resolves to
benchmark this process and make it the organisational standard.
This new benchmark calls for a conversion
rate of 25% and an average days open of 45 days.
From these figures, he calculates
that, at any one point in time, his organisation should have one and a half
months’ worth of open opportunities:
Optimal monthly sales: 4
Opportunities required to make
10 sales: 4 / 25% = 16
Average days open: 45 (1.5
months)
Optimal open opportunities: 16
x 1.5 = 24
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Relationship
management
The objective of your relationship
management process is to generate a steady stream of sales opportunities from
your relationships under management.
We do this by creating an automated
communication program. This is a sequence of ongoing communications, where each
communication is designed to add value to these relationships.
A typical communication program will
consist of a monthly e-mail newsletter and bimonthly seminars or workshops.
We tend to take an indirect
(longer-term) approach to the generation of sales opportunities. Our experience
is that, if you can design the relationship management process to position your
organisation as the leader in its particular field, sales opportunities will be
forthcoming.
Events and other activities can be
used to stimulate the flow of activities, but on many occasions, these
activities will simply time-shift the emergence of opportunities —
rather than creating opportunities you wouldn’t otherwise have received.
You need to balance your need for
sales opportunities against the requirement to add value to the relationships
under your custodianship. There is a danger that, if you design your
communications specifically to maximise the flow of sales opportunities, you may
compromise the integrity of these relationships.
As with our other processes, we are
primarily interested in monitoring throughput and productivity. Accordingly, our
KPIs are as follows:
-
Opportunities per month.
-
Opportunity realisation rate
(monthly opportunities/relationships).
Opportunity realisation rate advises
you of the correlation between the number of relationships you have under
management (the size of your database) and the number of sales opportunities
these relationships produce each month.
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Correlex has
1,500 contacts on its database. Because all of these contacts are recipients
of Correlex’s monthly e-mail newsletter, it referrs to them as subscribers.
On average, Correlex receives
12 sales opportunities a month from its subscriber database.
These 12 opportunities represent
an opportunity realisation rate of 0.8%:
12 / 1,500 x 100 = 0.8%
In order to increase the flow of
sales opportunities to the 16 per month required, Correlex’s CEO
realises he must acquire an additional 500 subscribers:
16 / 0.8% = 2,000
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Relationship
acquisition
The objective of your relationship
acquisition process is to acquire a steady stream of relationships with
potential clients and centres of influence.
The input into this process is the
investment in your relationship-acquisition campaigns (remember, we’re only
tracking variable costs). The output is obviously the relationships (or
subscribers) you add to your database.
The precise management of this process
is critical for two reasons:
-
The flow of inbound opportunities
is the key determinate of the throughput of the process as a whole.
-
In the absence of an objective
performance measure, there is a high probability that you will either
under- or over-spend on promotion.
Our performance indicators for this
process are:
-
Relationship acquisition rate
(relationships per month).
-
Relationship acquisition cost
(cost per relationship).
Relationship acquisition cost is
calculated by dividing the variable cost of promotional campaigns by the number
of new relationships acquired by those campaigns.
As with our global KPIs, these
indicators don’t mean much until we can compare actual and optimal figures.
Optimising your
relationship acquisition process
The calculation of your optimal relationship
acquisition rate is easy. This figure is determined by:
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Your target database size.
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Your availability of promotional
funds.
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The capacity of your relationship
acquisition process.
The calculation of your optimal relationship
acquisition cost requires a little more thought.
The amount that you are prepared to
spend in order to acquire a new relationship must obviously relate to the value
of such a relationship.
But how can you value one more name on
your database?
The solution is to value relationships
using exactly the same methodology we used to value clients.
Your database of subscribers provides
you with a flow of sales opportunities.
You can value a sales opportunity by
discounting your optimal client acquisition cost for your conversion
rate. (In other words, if your conversion rate is 10%, a sales opportunity is
worth 10% of your optimal client acquisition cost.)
Accordingly, to value one new
subscriber, all you have to do is calculate the odds of that subscriber becoming
a client over the life of their relationship with you.
While you can easily calculate the
life of a client relationship, it’s a little harder to calculate the life of a
subscriber. In our experience, it’s rare for subscribers to unsubscribe
from our automated communications program.
For this reason, we arbitrarily choose
to value subscribers over the same lifespan as clients. Accordingly, if the life
of an average client is three years, we value subscribers over this same period.
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The CEO of Correlex is
prepared to invest $900 to acquire a new client.
Because his optimal conversion
rate is 25%, a sales opportunity is worth $225.
$900 x 25% = $225
He knows that his automated
communication program provides him with an opportunity realisation rate of
0.8% per month. Or, to put it another way, for each subscriber on his
database, he will receive 0.8% of a new sales opportunity each month.
Because he arbitrarily decides to
value subscribers over a three-year period (36 months), Correlex’s CEO
can calculate that there is a 28.8% likelihood of a new subscriber turning
into a client over this period.
0.8% x 36 = 28.8%
If 28.8% of subscribers become
clients, it follows that a new subscriber is worth $64.80:
$225 x 28.8% = $64.80
Therefore, this $64.80 is Correlex’s
optimal relationship acquisition cost.
Correlex’s CEO
decides to set his optimal relationships acquisition rate at 85 per
month. This will allow him to easily hit his target of 2,000 subscribers
within 12 months. (Even accounting for a particularly conservative unsubscribe
rate of 42 a month.)
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The knowledge of your optimal
relationship acquisition cost enables you to manage your promotional
activities with pinpoint accuracy.
You do this by using our activity
by source report below.
This report enables you to track the relationship
acquisition cost for each promotional activity, and then compare your
average acquisition cost over a given period with your optimal
cost.
This report also factors the benefit
of referrals into your calculations. Because referrals have a $0 acquisition
cost, each referral pulls your average acquisition cost down, and has the
effect of increasing your promotional budget. (Each referral you receive
effectively doubles the amount that you can afford to spend to acquire your next
relationship.)
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[click to enlarge]
Correlex’s CEO
can see that Correlex has underspent on relationship
acquisition.
It may have saved money on
promotional expenditure, but his relationship acquisition rate has
suffered as a result.
Of course, the downstream impact
of this under-expenditure is that the future growth of Correlex has
been handicapped.
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The real value of
promotional expenditure
As promised, this scientific approach
to sales process management enables you to establish a clear cause and effect
relationship between your sales process’s inputs (promotional expenditure)
and its output (sales).
The benefit of this approach is best
demonstrated by taking one last look at Correlex’s sales process:
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The CEO of Correlex is
delighted to discover a direct correlation between promotional expenditure
and sales — and, accordingly, business growth. (Like many CEOs, he had
previously regarded promotional expenditure as a necessary evil.)
Now that he has discovered this
cause and effect relationship, he’s curious to calculate the return that
he will receive on future promotional expenditure if his sales process
performs at the optimal levels he has determined.
He grabs a calculator and a clean
sheet of paper and starts with the assumption that he invests $1,000 in a
(typical) promotional campaign.
Because his acquisition cost
is $64.80, this campaign generates 15 new subscribers.
$1,000 / $64.8 = 15
His 0.8% relationship
realisation rate means that, over the next 36 months, those 15
subscribers will provide him with 4 sales opportunities.
15 x .008 x 36 = 4
A conversion rate of 25%
will obviously result in one of those sales opportunities converting into a
client.
And the lifetime value of this
client (net present value) is $9,563.
Correlex’s
CEO grins like a Cheshire cat as he calculates his return on investment:
$9,563 / $1,000 x 100 = 956%
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Correlex’s CEO
should be excited to discover that promotional expenditure can produce such a
return.
But what should excite him even more
is that, as a result of this exercise, his sales process is now as measurable,
manageable and as scalable as his other key business processes.
If you liken his business to a
profit-generating machine, he’s just taken the controls!
[Agree? Disagree? Please
drop me a line and let me know.]
[I'll try and answer your
question for a bottle of Glenfiddich!]
[What's the question
again?]
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