Why Your Cost of Sales Generally Doubles As You Scale

One of the biggest things first-time founders intuit wrong is how much sales efficiency plummets … just as it is getting good.

Usually, most SaaS start-ups follow a pattern where the CEO starts off doing founder-led sales. Then, after she hires a few sales reps, and makes a few mistakes. At first, those reps struggle to even close anything. But then, by trial-and-error, learning, and better training … eventually, the CEO gets the company to two trained, scaled sales reps that are pretty darn good.

That structure often looks something like this around $500k in ARR or so:

Awesome! Look at the final row: your sales team is efficient at $500k – $1m in ARR. Your sales reps are closing 4.0x what they are paid. The model seems to be working at that rate, the reps are happy, and things are good.

And then you go to scale. And then these numbers break. Why?

First, you’ll need to add a VP of Sales. And that will be a cost center, for modeling purposes at least. Most, but not all, founders get that, and sort of budget it in.

Second, you’ll probably want to add SDRs if you haven’t yet. SDRs aren’t as expensive as sales reps, but in the model at least, they’ll also be cost centers. These days, most folks are aiming for a 1:2 coverage model (1 SDR: 2 AEs). In theory, an SDR should be able to help an AE close more. But in practice, it will take you time to fully yield all those efficiencies. You can raise everyone’s quotas. But they may not really achieve those raised quotas for quite a while.

Third, you’ll need to start hiring a bit ahead. You can’t just hire 1 rep at a time anymore after $1m in ARR or so. That means the more you hire, the more reps you have that will be in their ramping phase. That inherently drives down efficiency numbers.

The impact of just these 3 factors alone can sneak up on you. Watch your sales efficiency be cut in half in just a quarter or so, from 4.0x to 1.7x:

The next phase then adds more costs, and more scaling:

  • You’ll need a sales manager for every 8 AEs or so and maybe 10 SDRs.
  • You’ll need to add sales ops by the time you have 10-15 sales professionals, or it will be just too much for your VP of Sales to handle.
  • You’ll need to tolerate more mid-pack reps to scale effectively, while will bring down attainment a bit more.
  • You’ll need to hire even faster.

You’ll get some efficiencies here, but they’ll be balanced out by the increased costs and overhead of hiring ahead and managing the team.

In this model, efficiency again dips at $5m ARR, although only a smidge:

You may see somewhat different results, but the trend will almost certainly be similar. You can play with this simplistic model here.

In the end, this likely means once you add in marketing costs, you’ll lose money in Year 1 on every sale as you pass seven figures in ARR. You probably know this is coming, but aren’t quite sure why in the early days, when everything finally gets … efficient.  Balancing this out a bit over time will be renewals (much lower sales and marketing costs, but take a while to kick in and become material) and if you have it, account expansion.

But almost no matter what, sales efficiency will drop materially once you finally first have it figured out and dialed in.  Plan for it.

Published on March 18, 2019

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