By Eric Mersch
The typical Small and Mid-Market SaaS company will use a portfolio of sales strategies designed to fit the average Annual Contract Value (ACV) of the sale. The most common strategies are Direct Sales, Inside Sales, eCommerce Marketplaces, and Partnerships. Some SMM companies may use all four depending upon their business model, but the main strategy employed is Inside Sales.
Direct Sales is a valuable GTM strategy if the company can deploy an enterprise grade product and sell it at a premium. But, as we discovered in the Direct Sales economics discussion, the price point needs to be at least a $50,000 ACV to make this strategy profitable. Therefore, companies with an Average Selling Price (ASP) below $50,000 will rely on an Inside Sales strategy.
Unit Economics of an Inside Sales Strategy
The term Inside Sales refers to the process of closing deals remotely without the live, face-to-face engagement of the direct sales approach. The onset of the 2020-2021 COVID pandemic made all selling remote so this is no longer an accurate distinction. Today, the better definition is to describe Inside Sales as the use of lower cost sales strategy leveraging people who do not need the selling skills of Account Executives and whose efforts are combined with a robust digital marketing lead generation program.
Marketing campaigns generate contact information of potential customers who demonstrate interest through some behavior such as attending a webinar or responding to a call-to-action message. The objective of these marketing campaigns is to increase brand awareness and further customer education to move respondents closer to a sale. The Inside Sales Representative (ISR) then reaches out to each interested customer and attempts to move them to a paid subscription. The Inside Sales strategy is successful if the combination of the digital marketing campaigns and the Inside Sales Representative results in greater sales efficiency than either a direct-sales or an all-digital marketing strategy.
The average ISR has 2 years of work experience. They work for an average base salary of $63,000 with an average On-Target-Earnings (OTE) of $126,000. The mix between base and variable is roughly 50/50. The average quota for an account executive is $760,000 in ACV with 66% productivity. The typical productivity ramp is 4.5 months and average tenure is 2.4 years. The average ACV generated by ISRs is $28,000.
The ISRs work is far more predictable and regulated than that of an AE. Each day the ISR has a set of targets to accomplish. These include sending emails and making phone calls to potential customers on contact lists. Each month the ISR is measured on opportunities created and opportunities converted to paying customers. Variable compensation is often based on meeting daily and month activity targets, and sometimes in lieu of commission on new deals.
On average, ISRs are expected to send 30 emails per day and make 20 phone calls. These activities should lead to 10 meaningful conversations per day with about 1 in 20 conversations becoming Sales Qualified Leads, of which 15% convert to paying customers. Under these assumptions, an ISR closes 6.7 deals per quarter. At the company’s average ACV of $28,000, each ISR can generate $760,000 in total ACV per year.
Case Example: Calculating the Inside Sales Contribution Margin
Analyzing the profitability of a single deal using the data above will help illustrate the parameters required for this Go-To-Market (GTM) strategy to generate sales efficiency. Let’s start with the average metrics for an Inside Sales Representative (ISR) above.
We will assume that our ISR has an OTE of $126,000 with a 50%50% base salary to variable mix. This average ISR will have an annual target quota of $760,000 and productivity or achievement rate of 66%, which, when combined, gives a $500,000 expected quota for planning purposes. We will assume that the average Annual Contract Value is $28,000, which is in the middle of the range for SMM SaaS companies. The ACV and expected annual quota assumptions imply that the average ISR needs to close 71 deals per year or just under 6 per month. By closing these deals at a $28,000 ACV, the ISR will achieve 5.6% of expected annual quota. For the company the acquisition cost of a new customer after the Inside Sales Representatives variable and base compensation is $7,033.
From here, we will calculate the Contribution Margin as defined by all of the variable costs associated with acquiring a new customer. The Contribution Margin concept is a unit economics approach in which the unit is defined as a specific operating activity. For this specific analysis, we define the Contribution Margin as the average theoretical Inside Sales profitability for acquiring a new customer.
In our example above, the $28,000 ACV contract generates 78% in gross margin, or $21,840 in absolute dollars. As estimated above, the average ISR salary and commission cost for the contract is $7,033. Of course, we need to increase this amount by 25% to account for taxes and benefits and get to a fully-loaded labor cost of $8,792. The sales commission plan for Inside Sales team allocates 3% of the ACV to the sales management; this adds $840 to the sale cost. The sum of all sales activity costs is $9,632.
We also need to account for the marketing expense associated with the new customer acquisition. For this analysis, we will add in an estimated Cost per Lead (CPL) as well as the rate at which the leads convert to a paying customer. The CPL depends upon the mix of channels used to acquire new customers. For this analysis, we use a $300 CPL, which is typical for an Inside Sales GTM. As discussed, the ISR is responsible for nurturing marketing leads to acquire a paying customer. Conversion rates vary widely depending upon product pricing versus market demand, marketing campaign effectiveness, and the ISR’s skill in nurturing the lead to close. We can use 6% for this analysis with the caveat that this is a representative number and not a typical number. So, with a $300 CPL and 6% conversion rate the marketing cost associated with the sale is $5,000. The sum of the sales and marketing cost is $14,632, and this number accounts for 52% of the ACV. Combined with hosting and connectivity costs associated with the Subscription revenue, the sales and marketing activity produces a 47% profit margin. Tracking performance at this level will give insight into the effectiveness of Inside Sales as a GTM strategy.
We will now take this exercise one step further, highlighting the pros and cons of the Contribution Margin concept. The benefit to this approach is to layer on additional costs associated with this customer. The next logical step is to estimate the direct costs of onboarding the customer. The Cost of Revenue component used above only relates to the Subscription Revenue, e.g., the hosting and connectivity as well as some customer support, which is minimal for SMM SaaS companies. But we did not account for the professional services work to onboard the customer. This expense is typically much lower than that for Enterprise SaaS and may even be zero if the product allows for self-provisioning. In this case though, we will estimate onboarding costs in an overly simplistic approach. Typical Professional Services revenue when the company is at scale makes up 20% of Total Revenue and 25% of Subscription Revenue. A good Professional Services team can generate 40% gross margin, again at scale. So, 60% of 25% of the ACV gives a $4,200 onboarding cost. The result of taking this next step in the calculation of Inside Sales CM is that the Contribution Margin is reduced to just 11%.
This example highlights the caveats when using the Contribution Margin approach to judging the value of Inside Sales. The first problem is that the assumptions are not static. For example, extending a discount equivalent to 38% of the ACV brings the Contribution Margin down to zero. All ISRs need to generate sales at the assumed level. Lower ISR productivity of 50% versus 66% also makes the sale breakeven. An additional 40 person-hours of implementation time above budget similarly consumes up 11 points of margin. A 60% increase in CPL or a 2.25 point drop in conversion rate will send contribution margin below zero. Thus, the margin of error for missing the target Contribution Margin is thin.
A final problem with the Contribution Margin approach is that you may not be seeing the whole picture. It’s easy to exclude relevant costs because they are missed or not well understood or, worse, an organizational bias that prevents decision makers from fully embracing the true story.
The Small/Mid-Market SaaS business model has advantages in that the time and expense to launch products are much lower. Success requires an Inside Sales Go-To-Market strategy to ensure sales efficiency and preserve operating dollars for continued product development. Tactically, CFOs must track the key metrics associated with the Inside Sales channel such as Contribution Margin (among others) and continually test and evaluate each operating assumption versus actual performance. This insight truly enables the CFO to serve as a business partner to the CEO, the Board of Directors, and the C-team.
 The Bridge Group, Periodic Table of Inside Sales Metrics, https://blog.bridgegroupinc.com/hubfs/resources/Periodic_Table_Inside_Sales.pdf
 The 40 hours referenced is from a simplistic calculation assuming a cost per hour of $75 for a Professional Services person earning $157,500 per year at full utilization.