Losing Money on Sales
Put Sales Leverage to Work for You

Companies live or die on whether users invest with their time and customers invest with their wallets. We’ve all seen companies that spend more on every sale than they make. Their refrain, as the old joke goes, is, “We’ll make it up in volume!”

It’s funny to read about but no laughing matter when it’s your own bank account. Rare is the entrepreneur who has profitable sales out of the gate. But the successful entrepreneur turns the model around and makes its scalable. A scalable sales model depends on sales that are profitable, repeatable, and efficient. Profitable, efficient sales come from knowing how much a customer or user is worth combined with a highly leveraged way to reach them. Repeatability comes from users or customers buying the same thing from you over and over again. How do you turn your sales model around and really make the engine hum?

When Customers Cost More Than They’re Worth

Company M targeted small businesses with its content-hosting solution. The company acquired customers primarily through online advertising and search-engine optimization. I’ve changed the details, but the numbers are illustrative of the acquisition cost versus customer value challenge Company M faced.

Each month, the company spent about $21,000 on online advertising through Google AdWords. The company’s cost per click (CPC) ranged from $3.73 to $4.56, with an average CPC of about $4.15. The company was able to convert around 1% of potential customers that clicked its ads, resulting in a cost per acquisition (CPA) of $415 per customer. (Out of 100 people who clicked at $4.15 per click, one converted to become a paying customer. Thus it cost $415 to acquire a customer.)

The founder of Company M was excited. He had found an acquisition channel that appeared to scale. He started spending.

Company M sold its product at multiple price points, but the most popular was its $19.95 per month Bronze offering. At that price, it would take about 21 months for the company to break even on its CPA. The company would have to lay out $415 up front and wait 21 months before it started making a profit on that customer—and that was to cover its marketing costs, not taking into account other costs such as hosting and customer support. What’s more, each customer would have to continue using Company M’s product for more than 21 months—if any churned out, Company M would lose money.

Some customers did churn out. In fact, some 20% of Company M’s customers churned out—many liked the product, but, being small businesses, they simply went out of business.

After more than a year of spending, watching his customer churn rates, and managing down the CPA, the founder of Company M realized the two lines—his CPA and his customer lifetime value (CLV) weren’t going to converge quickly enough. He laid off most of his staff and reduced his marketing spend. Only time will tell whether he can rebuild the business.

Ultimately, It’s About Acquisition

If you can’t acquire users or customers profitably and repeatedly, you may be able to survive for a long time on capital from investors, but ultimately you can’t build a sustainable business. Frankly, as heretical as it may sound, you may be able to make a lot of money building an unprofitable business. Many entrepreneurs and investors have made plenty of money building businesses that lost money hand over first and weren’t sustainable.

That’s because when it comes to tech companies, the capital markets tend to reward growth, and sometimes even just the potential for growth, over profitability. Alternatively, a startup that is unprofitable may be profitable when rolled into a larger company that has a more efficient way to reach the market. Or a larger company may simply want to acquire a startup for its people or technology, netting the founders and investors a handsome profit in the process.

Of course, far more of these unprofitable companies go out of business along the way. If you want to build a sustainable business or control your own destiny, you have to figure out how your company can make money. Making money requires you to acquire users profitably. Simply put, that means monetizing users or customers for more than it costs you to acquire and serve them.

Understand Customer Lifetime Value

CLV measures how much revenue a customer generates over the time they remain a customer of your company. Revenue can come directly from the customer, but it can also come from third parties; this is common for businesses that monetize via advertising. By determining CLV across a number of customers, you can figure out how much you can afford to spend to acquire a customer.

For example, if a customer is expected to generate $100 in revenue over their lifetime, you can in theory spend up to $99.99 to acquire and serve that customer and still be profitable on each customer. Of course, you’re generating only one cent in profit for every customer! That likely isn’t enough to pay for all your other costs—your own salary, that of your management team, and the costs of software development, for example.

However, if it costs you $10 to acquire and serve a customer, and you can monetize that customer for $100, you make $90: a far more appealing proposition. That should be more than enough to cover all your other costs and leave you with a nice profit.

What if you have to spend the $10 up front, but you collect only $1 each year for 10 years? That situation creates a cashflow problem. That is, you don’t have enough cash to spend on acquiring new customers because you’re being paid back far too slowly. Clearly, to become a profitable company, you must not only be able to acquire customers profitably but also do so in a timeframe that supports your cashflow requirements and growth objectives.

When companies start out, the amount they spend to acquire a customer often far exceeds the amount for which they can monetize that customer. That is the nature of new companies—while they’re figuring out the most efficient way to acquire customers, every new customer is a learning experience. That learning is expensive but pays back its cost many times when you determine how to acquire customers or users in a repeatable and scalable manner.

Many startups get trapped in continuing to invest large amounts in customer acquisition, only to discover that they can’t get the cost of acquisition down. Every “sale”—that is, a new user or a new paying customer—is a one-off. These companies are unable to move from learning to scalable execution.

Churn is another common challenge that companies face. When companies have high churn, it means customers or users are showing up to use the product—and then going away. Having high churn is like trying to fish with a sieve: you may occasionally catch a fish, but most of them swim on through.

If you have high churn, it may appear that your company is growing rapidly, especially if you can generate new users or customers more quickly than you lose them. But because those new users don’t stick around, you’re fighting a constant battle; ultimately, your apparent growth falls off, and you haven’t built a growth engine that can truly scale.

Users and customers leave for a variety of reasons. If you’re selling to small businesses, given their high failure rates, a lot of them simply go out of business. If you’re building a consumer product, users may like the promise of your offering, but once they try it, see no reason to continue using it. You’re failing to engage your users, so you can’t retain them.

And in all cases, if you don’t have a compelling and sticky offering—an offering that locks in the customer and makes it hard to switch while solving the customer’s needs—a competitor can swoop in and take your customers. In that case, you’re spending a lot of marketing and sales dollars educating customers, only to have someone else monetize them.

Remember: Products Are Bought, Not Sold

People are fond of talking about selling, but really we should all talk about buying. That’s because your product is bought, not sold. Of course, you’ve probably let yourself be talked into buying something you didn’t need or made an impulse purchase because an item seemed like a good deal. But when it comes to the very best products, people want to buy them.

Consider the lines in front of Apple Stores the day before a new iPhone goes on sale. Think about concerts that are so popular they not only sell out but have scalpers selling tickets for far more than they originally cost. Or recall the last time you tried to go on vacation during a holiday season, and the associated cost of airfare and hotel rooms.

What do all these products have in common? They’re in demand, and they’re scarce. Scarcity and demand obviously go hand in hand. More often than not, they don’t come about naturally: they must be created. This is why so much marketing today refers to demand generation rather than sales.

Certainly, the sales pitch, nowhere more artfully demonstrated than in episodes of Mad Men, still exists. But with the amount of information now available on the Internet, transparency around price and quality has increased significantly. From sites like Yelp and TripAdvisor for restaurant and hotel reviews to Amazon for product reviews, information about products is widely available. As a result, great products are a must.

So is demand creation—because if your product seems undifferentiated, people will simply go for the lowest price. And there are many ways to differentiate—from the product itself to how you position and deliver it. Great service is a differentiator too.

Fight Inherent Bias

Ask an enterprise sales executive how they would solve a sales-execution problem, and the answer will most likely be, “Put in place a sales methodology, set a quota, and hire the right sales people.”

Ask a product person how they would solve a sales problem, and the answer will most likely be, “Remove any friction in the way of product adoption, and make it easier to buy.”

Ask someone who’s been 100% focused on online marketing, and the answer may well be, “Spend money on Google AdWords and a variety of other online lead-generation mechanisms.”

Ask a consumer Internet entrepreneur, and the answer will be, “Go viral.”

Which of these answers is correct? They all are—from the point of view of the person answering the question! They may not be the right answer for your startup, however. The issue you face is that people bring inherent biases with them. They tend to go with what they know and with what has worked for them in the past. Big enterprise sales execs go with big enterprise sales models. Online marketers go with online marketing. Those who have built brands for big companies in the past want to spend lots of money on marketing and brand building.

Everyone is susceptible to this kind of bias—even your most experienced board members. They may be the most susceptible, because they’re using pattern matching as the basis for their advice based on companies they previously invested in that worked (or didn’t work).

But what worked in the past may have depended as much on a particular market or market conditions as on the startup itself. What’s more, if you push someone to market and sell in a way that’s not natural to them—say, suggesting that an enterprise sales executive market and sell only via a light-touch Internet approach—you set up that person to fail.

How do you fight bias like this? Although it’s difficult, the best solution is to look at the data. But realistically, no matter how much you do that, you’ll probably turn over your sales team a few times before you get one in place that works. It may feel like a bad thing when it’s happening—and it certainly feels painful to the organization—but it’s the nature of a startup’s evolution.

Reduce Sales Team Turnover

It’s almost a given that in every startup, sales executives are turned over more than just about anyone else in the company. That was the case with Company X, which went through three VPs of sales in 12 months. The first head of sales was a channel executive who knew a lot about setting up partnerships but very little about running an actual sales organization and “owning the number.” He lasted almost two quarters before the board leaned on the CEO to fire the exec and get someone more familiar with direct sales.

The second head of sales was the real deal. He had a track record of helping companies grow from the low millions of dollars in revenue to $50 million, $80 million, and over $100 million in revenue. Sales model discovery followed by scaling was his sweet spot. He didn’t enjoy working in really big organizations, but he did enjoy tuning the sales model and then putting a team in place to execute on it.

Although Company X was, as he put it, “a little earlier” than he was used to, he joined because a good friend of his was on the board and encouraged him to take the job. He was at one board meeting and gone before the next. A savvy individual, he quickly figured out that the company wasn’t a little earlier than he was used to—it was a lot earlier. In fact, Company X was still a long way from finding product-market fit. Of course, the CEO of Company X blamed the sales executive, saying he had turned out not to be a good fit for the company.

The third sales executive went through a number of lengthy interviews with the board members, all of whom had previous operating experience. Having been through two sales executives in rapid succession, neither the CEO nor the board was eager to hire another mismatched executive. The decision to hire the third sales executive was unanimous—as was the decision to make him CEO a few months later.

He came right out and said the one thing no one else had been willing to: it wasn’t a question of sales execution that was killing the company. It was a lack of product-market fit. While other companies in the space were having great success, Company X continued to struggle. Perhaps the third sales exec had more on the line than the second one, or perhaps he wanted to prove he could make it work—as CEO. Given the choice between him becoming CEO and losing sales executive number three, the board decided to make him CEO.

Failing fast is one mark of a great startup. But making the same mistake repeatedly isn’t. Don’t hire senior executives and staff up before you’re ready for them. Doing so just wastes time and capital. And, as I talked about in the last chapter, great sales operations are no substitute for product-market fit.

Get Sales Leverage

Sales leverage is all about reaching customers efficiently. Pivoting doesn’t just apply to your product strategy; it also applies to your go-to-market strategy. If you feel you have product-market fit, but you’re not reaching your potential customers and your business isn’t growing the way you want it to, it’s time to pivot your model.

The Traditional Way

The most cost-effective way to get new customers or users, of course, is for your existing customers or users to recruit them for you.

Historically, companies run advertisements, do PR campaigns, and then put “feet on the street” to sell their products. Drug company representatives go door to door to meet with doctors and educate them about new products.

Traditional software companies have account executives (AEs) who meet with big customers in person. Sales engineers (SEs) then install the software and perform any configuration—and sometimes, costly customization—of the software for the customer’s environment. Some software products are so complex or need to be customized to such an extent that the customer pays professional service fees on top of the cost of the base product. Teams from the software maker itself or from a third party install and customize the software.

Enter the Cloud

Today, most software is in the cloud. This means instead of the product being installed on premises—that is, on the customer’s servers at the customer’s location—and managed by the customer’s employees or a designated third party, the software is run at a data center external to the customer. The vendor manages and updates the software. Although this model existed before Salesforce.com, that company was the first to make Software as a Service (SaaS), software delivered via the cloud, a widely accepted practice.

Delivering software this way has transformed the way software is sold, enabling a variety of innovative new business models.

The Freemium Model

Well-known tech companies like Dropbox, Evernote, LinkedIn, Skype, and others have implemented the freemium model with much success, and you can too. In this model, a company gives away the basic product for free and then charges for premium services.

Business-to-business (B2B) companies are using this innovative model to disrupt classic business software models. With freemium, your customers don’t pay you up front—they get to try the product for free. The idea is to get them hooked, so that they decide to pay to keep using the product or to take advantage of premium features.

To be clear, the freemium model comes in two flavors. In one case, customers get to use the complete product free of charge during the trial period, and then they must convert to paid to continue their usage. In the second case, your base product (perhaps a personal edition to be used by one or two users only) is free, but customers pay for premium features or higher-end packages that include business capabilities like more storage, more email, or multiple-user support.

The freemium model itself isn’t new—shareware programs of the 1980s and 1990s used a similar model, where customers could use the product for free and then pay if they wanted to continue to use the app. These applications came in the form of installed software, with the user bearing any associated computing and storage costs. With hosted, web-based services, the costs of bandwidth, storage, and processing are borne by the company. Historically, this was expensive, and it meant that supporting a user for free was equally expensive, preventing freemium from being a viable approach for hosted services.

But the decline in the costs of these infrastructure services, and the ability to rely on them being delivered by Amazon Web Services, for example, means that the incremental cost of supporting an additional user is very low. As a result, many companies have been able to implement the freemium model successfully. They can afford to take on new users for free, and they view the costs of supporting such users as their marketing cost—and frequently that’s a lot more cost-effective than paid marketing.

Although the model can be used for all kinds of services, it’s especially useful when users create or upload their own content, as is the case with Dropbox, Evernote, and others. Once users upload their content, they want ongoing access to it. This makes them more likely to convert to paying customers and stick around, because although it’s possible for them to switch to another service, transferring their content requires a significant investment of time and energy.

The risk with freemium is that customers may decide your product is nice to use if it’s free but not worth paying for if it isn’t. You may end up with tons of users using the free version of your service but have limited success converting them to paying customers. Users who abuse the service or fail to convert cost you money and hurt your margins. Supporting them also costs time and money. If there are too many of them, you have implemented the dreamium model, not freemium.

Given that freemium plans typically see a conversion rate of 1% to 5% from free to paid (with 5% being incredibly high), you must have a lot of users for freemium to work. Looking at Evernote, Dropbox, LinkedIn, and others, the common theme is that they all have millions, if not tens of millions of users.

Their products appeal to a very broad base of potential users, who are all signing up for their products individually. Although businesses or employees may ultimately pay for products like LinkedIn and Dropbox, it’s millions of individuals who sign up for the service. If your service doesn’t potentially appeal to millions of individuals, freemium probably won’t work for you. It may look good at the outset, but there won’t be enough users for it to work at scale. In that case, you should turn off your free option and charge for your product.

Zero-Cost User Acquisition

Pioneered by consumer Internet companies, especially social networks like Facebook, zero-cost user acquisition is literally just that: it costs nothing to acquire another user. It’s the most highly leveraged and efficient model of all.

Zero-cost user acquisition is easiest when your users are your content—their pictures, words, files, and activities are what make your product what it is. Your product provides the framework for them, but they (and their associated digital media and actions) are the content.

The more your users are the content, and the more the benefit of the product is a result of them sharing their content and actions with others, the closer you are to zero-cost user acquisition. That’s because your users will naturally want to invite friends and colleagues to the site, because the more friends and colleagues are on the site, the more benefit the original inviter derives from the service.

Word of Mouth

But you don’t have to be building a social network to implement some of the approaches of zero-cost user acquisition. Zero-cost user acquisition also comes in the form of word of mouth. This is perhaps one of the most powerful forms of marketing (and sales) ever.

Consider online shoe seller Zappos, known for its excellent customer service. Other companies sold shoes on the Web for years before Zappos showed up. But Zappos introduced free two-way shipping and incredible customer service. Customers loved it—they reviewed the company positively online, and they told their friends. Word spread like wildfire, and Zappos became so successful that it was acquired by Amazon for more than a billion dollars.

Of course, Zappos spent money on advertising. But more important, the company became known for one thing: its industry-leading customer service. People loved talking about their Zappos’ experience. By developing a reputation for doing one thing—customer service—better than any other company, Zappos revolutionized its category and became successful through word of mouth.

Figure out the one thing you can be better at than any other company in your category, become known for that, and you can put word of mouth to work to grow your business, too.

Partnering

One often overlooked path to sales leverage is via partnering with a larger company that already has an efficient channel to the market. Of course, this approach comes at a cost: partnerships are notoriously difficult to come by, plus you give up a portion of your revenue to the partner.

The risk with partnering is that you become so dependent on the partner that you can’t acquire customers without them. But some companies and their platforms have so much reach that paying them the tax to acquire customers may well be more effective than trying to acquire those customers directly.

Many companies are acquiring users by developing mobile applications and listing them in the Apple App Store or working with partners like Salesforce.com that already have large and efficient customer reach. When you consider that ultimately you need to spend money on customer acquisition one way or another, these kinds of relationships can be an important component of a broader acquisition strategy.

Repeatedly Monetizing Your Users

One of the best sources of revenue you can come by is revenue from existing users. If someone is using your product, you’ve already paid the cost to acquire them. As a result, any more money you can get them to spend with you is revenue that goes straight to your bottom line.

This is called farming your existing user base. The reality is, existing, satisfied users want to spend more money with you! You just have to give them a way to do so. You can upsell them on a more expensive offering, sell them new features, or charge them for usage (of storage, for example). Or, in the case of ad-supported businesses, you can get them to spend more time on your site, which should result in them seeing, and ultimately clicking, more ads.

Of course, it’s also possible to over-monetize your users. Web sites that put too many ads in front of their users, for example, can detract from the core user experience. Social network MySpace suffered from ad burnout—users of the site saw so many ads that they tuned them out. Finding the right balance is key.

Making the Engine Hum

There are plenty of tactical items that, when all put together, can clog up a sales engine. Ineffective sales people, bad contracts, pricing that’s a complete mismatch for the value customers perceive they’re getting, lack of good process, and a sales funnel that acts more like a leaky bucket can all destroy sales execution. Let’s take them in order.

Ineffective Sales People

Ineffective sales people are a form of lack of product-market fit. Instead of the product being your actual product, the product is the sales person, and the market is the individual customer looking to make a purchase. I recall a sales team where calls were routed randomly to the inside sales representatives. They didn’t get to choose which customers they talked to; they simply picked up the phone when it rang. Yet in one month, the best performer sold five times more than the worst performer.

The CEO, who was new to managing a larger sales operation, figured that his VP of sales could coach the worst performers to do better. The company and the worst performers both invested many months, yet the resulting improvement was minimal. Ultimately the CEO decided to focus the company on its strengths.

After moving the VP of Sales to another role and taking over the job himself, the CEO laid off his worst-performing sales people and hired more people like those who were successful. The strategy worked—and the rest of the organization was overjoyed. Having the non-performers on the team for so long had started to take its toll and demoralize the other employees.

Bad Contracts

Bad contracts can limit a company’s upside and cost you a lot of money. Pressured to get deals done by its board, Company Z cut sweetheart deals with its customers. Although the deals looked great on paper, they restricted Company Z’s ability to get more revenue from the customers as the company expanded its product’s reach in its customers’ organizations. You often need to discount aggressively to get early customers. But contractually limiting your upside can come back to bite you later.

Painful as it was, ultimately Company Z had to go back to these customers and tell them it couldn’t afford to service them as customers under the agreed-on contracts. Some customers reacted very negatively. Many, however, responded with, “We couldn’t understand how you could afford to charge us this little.” Were they happy about renegotiating? Certainly not. But they needed the product enough that they didn’t want Company Z to go out of business.

Mismatched Pricing

Pricing that is a mismatch with a customer’s expectation of value can also kill a company. This frequently happens when startups introduce products that compete with those from larger companies. I have heard the refrain, “But [big company X] charges tens of thousands of dollars for a product like ours, and our product is a lot better” more times than I care to remember. Yes—but you’re not big company X.

Bad Sales Process

Bad sales process and a leaky funnel go hand in hand. Many startups have potential customers or users coming in that they aren’t taking care of. In an ideal world, every sale would be a self-serve sale. Customers would come to your web site, put in their payment info, and buy your product. Or, in the case of a consumer web site, they would register and become ongoing, active users. The reality is often quite different.

Hard as it may be to believe, your site may make it too difficult for customers to sign up and pay you. Customers may have questions about your product because you haven’t refined the information on your site to the point that they can find the answers. Or, they may want to speak to, chat with, or email a human being just to make sure you’re “real.” This is especially true in the early days of a startup.

The bad news about a clogged engine is that missed opportunities may be chewing up your potential profits—and your reputation, if word spreads that you’re unresponsive to your customers.

The good news is that you can solve the leaky-bucket problem with data and attention to process. For web sites, you can instrument your site and know exactly how many people who come to the site convert into leads and paying customers. Consumer companies can track how many users turn into registered users and then remain as active users. They can figure out the specific actions taken by users who stick around, and then focus on getting more new users to perform those same activities.

Summary

Pivoting doesn’t just apply to your product strategy. It applies to your go-to-market strategy too. Keep refining your go-to-market strategy until you have a highly leveraged model:

• Develop a reputation for being better at one thing than any other company in your category.
• Use innovative new sales models to accelerate your growth.
• Figure out how much your users or customers are worth to you, and then run the numbers to determine how much you can spend to acquire and serve them.
• Sales team turnover is a natural part of company evolution.