Is your sales organization burning cash to chase growth? Or is your sales model structured for long-term success? Part of that answer starts with sales quotas.
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The “5X rule” for setting quotas is a surprisingly useful rule of thumb. But don’t rely on it without understanding the connections between quota, sales efficiency, and building a sustainable go-to-market model.
Part of my role as Operating Partner is working with Scale’s portfolio companies to accelerate their growth as they scale. Founders often want to know whether to use the “5X rule” for setting sales rep quotas at 5 times their On Target Earnings. The short answer is that yes, it can be a good starting point. But there’s a lot more to it than that.
Data Shows Reps Are More Expensive and Less Productive
We analyzed trended quotas and compensation levels from 2012 through 2019. The results were eye opening. During that period, compensation increased by nearly 50% while quotas only increased by 24% according to data from The Bridge Group. The fact that quotas haven’t kept up with compensation increases raises flags as to how sustainable these go-to-market models are in the long run.
Quota levels need to align with a company’s operating model, especially when Sales & Marketing often represents more than 50% of total Operating Expenses. I created a Quota <> Sales Efficiency tool that makes it easy to see the connection between quotas and efficiency using a few data points about a sales organization’s expense structure. It’s a quick way to measure whether sales productivity and expenses are contributing to sustainable growth. Headcount, compensation, staffing, and overhead all need to be considered before you can say for sure.
The Link Between Sales Efficiency and Sales Model
Sales efficiency measures a company’s return on Sales & Marketing spend. It’s an incredibly useful metric that investors and companies alike use to gauge the effectiveness of a particular sales model. It’s also one of Scale’s Four Vital Signs of SaaS, our framework of key operating metrics.
For the sake of simplicity, I’ll use Net Sales Efficiency here as it requires just two inputs: one quarter’s Net New ARR and the same quarter’s total Sales & Marketing expense.
What’s a “good” Net Sales Efficiency? The Scale Studio dataset of SaaS companies shows that Net SE stays right around 0.75 to 0.8 for 50th percentile companies all the way up to $50M in sales. Keep that figure in mind as you examine your own company using the quota tool. All things being equal, improvements to rep productivity has a linear relationship with sales efficiency.
There’s a lot more to say about other relevant sales metrics, including the Magic Number, which uses annualized GAAP revenue as the basis for comparisons between companies. We’ve also written about the tooth-to-tail metric, a headcount-based approach to sales capacity planning.
Using the Quota <> Sales Efficiency Tool
Big picture, using the tool starts with recording inputs about your sales team (salaries and headcounts) and sales model (fully burdened costs, Marketing expense, etc.). The tool then outputs a big picture look at your company’s Quota / Net Sales Efficiency relationship, as well as functionality to examine how your sales model responds to different Quota targets or Net Sales Efficiency goals.
Here are some details about what information to provide and how best to use the tool.
Sales Organization Details. Start by adding the On Target Earnings (OTE) and headcount for your sales team’s personnel, including QBSRs as well as support and management personnel like SDRs, Sales Engineers, and VPs. This section captures direct sales personnel expense.
Organizational information. This section uses allocation estimates to adjust compensation expenses upwards to arrive at a fully burdened total for the entire sales organization. By adding everything from benefits to Marketing to real estate, you arrive at a much more accurate picture of the real cost of your sales org.
ARR and Churn. Enter starting ARR and churn for the quarter you’re interested in. Note that the output tabs will use Total Allocated Quota as a proxy for Net New ARR. The tool assumes that you’re hitting your aggregate quota goal, meaning the sum of quotas = gross new ARR. What we don’t take into account is the level of over-assignment in your quotas. In general, higher Quota/OTE leads to higher Net SE — so be sure your quotas are reasonable and attainable!
Scenario testing. The final two tabs in the tool allow you to target specific Quota multiple or Net Sales Efficiency to examine how your sales model responds to changes. By adjusting inputs, like increasing Marketing spend or adding new sales reps to a particular segment, you get a sense of what impact those changes will have on your operations.
Note that we’ve excluded Customer Success from the equation for the sake of simplicity. CS naturally contributes to the efficiency of the business, but there is so much variance in deployment models for Customer Success and its contribution to revenue expansion and upsell. Use the Quota tool as a starting point for a deeper analysis that includes the impact and cost of your company’s CS activities.
The real value of linking sales quotas to sales efficiency is ensuring that your sales model is sustainable over the long term. This makes sense of course: quotas are the key incentive driver for individual QBSRs, and thus play a big role in the overall sales organization’s performance.
It’s eye opening to see just how big a swing different quota multiples can make. Take a typical company with a 5X quota level and a 0.75 Net SE. When you adjust their Quota/OTE multiple downwards to 4X, the company’s Net Sales Efficiency drops to 0.59. At 6X, the company’s Net Sales Efficiency jumps to 0.91. That’s a big swing.
This has implications to a company’s valuation as well. Assuming an investment of $10M in Sales & Marking in the next year and forward revenue multiple of 7.5x, the more efficient company would have created an additional $24M in value just from higher sales efficiency. In reality, however, higher sales efficiency means higher sales growth, for which investors will pay a higher revenue multiple–and so the difference in valuation would be even greater than this simplified example implies.
Keep the Quota <> Sales Efficiency tool handy as you grow. Used in conjunction with Scale Studio’s benchmarking reports, it’s a great way to verify every quarter that your quota capacity is scaling in line with your top line. Maintaining that balance is the very definition of a sustainable sales model.