So you’re getting your ass handed to you by a technology solution that sells direct to merchants, are you? The first thing you need to do is recognize that software investors play for keeps, and if you’re content running a lifestyle business things are only going to get worse.
But if you’d like to learn about where and how you can compete then this article is for you. What follows is the math that venture investors use when deciding to back companies. What will hopefully become apparent is that selling direct to merchants is very, very expensive, and few companies can really justify raising a ton of capital to sell direct.
For everyone else, the channel makes the most financial sense. Yet if you too move slowly even the most innovative software companies that use the channel as their means of distribution will find their marketshare being hoovered by companies that conquer direct distribution.
Speed matters.
We should start with the basics of sales. There are ostensibly three different roles involved in the sales process: BDR, AE, and CS.
BDR, or business development representative, is responsible for generating and qualifying leads. Sometimes these leads come in from marketing, but in our world let’s relegate this to direct outreach by the BDR. The BDR spends his or her time creating lists of targets, calling/emailing those targets, and moving a target to a prospect at which point they need a product demo.
When booking the demo the AE, or account executive, takes over. The job of the AE is to close the deal. For more complex deals there can be SE, or solutions engineers, to talk through particular features and benefits that an AE might not be as equipped to answer. We will ignore them for our purposes since any solution requiring an SE is already much too complicated for a brick and mortar merchant.
Lastly there’s CS, or customer success. The goal of CS is to prevent churn in the business by identifying when a customer is upset and remedying those problems before they cancel the contract. CS is also instrumental in cross-selling other solutions to their accounts, often discovering new product opportunities and reporting on those opportunities to the product team.
If you’re thinking this sounds expensive, you’re right. The average BDR salary is $70,000, the average AE salary is $110,000, and the average CS salary is $125,000. This includes commission and OTE – on target earnings – though not the fringe benefits which should be budgeted as another 30%. If you pay much less than this you won’t be competitive and will attract lower caliber people who are prone to high churn.
How do you determine how much you can afford to pay? There are some rules of thumb.
The first is that a sales employee’s compensation should be 50% base and 50% commission. For an AE making $110,000 that means a guaranteed base of $55,000 and another $55,000 of potential commission. How is commission determined? It’s typically a percentage of quota.
So second, an employee’s quota should be 4-6x their expected OTE. The 4x number is for earlier stage companies that lack marketing support, whereas 6x can be expected for more mature companies where sales are generally easier. For an AE making $110,000, that means their annual quota should be between $440,00 and $660,000.
Lastly, CS should cover about $1M-$2M in ARR, or annual recurring revenue. So if you have one customer that pays you $1M a year, then you’d dedicate one CS rep to that account.
Now this is where things get interesting, and how the math can make certain business models really challenging. BDRs are people, not machines, so there’s clearly a finite number of prospects that they can send to AEs. This determines the ratio of BDRs to AEs, and therefore your cost structure. The average ratio of BDR to AE is 1:2.5, but for SMB it can skew the other way in a hurry as the number of leads put through the funnel grows dramatically.
Let’s start with our magical $100/mo/store SMB product to show what we mean. This means the average deal is worth $1,200 a year. To reach $440,000 in annual quota the sales team would need to close 367 deals per year and for $660,000 in annual quota that number swells to 550 deals.
Okay, well there are only ~250 working days in a year. That means the sales team would need to close between 1.5 and 2.2 deals per day. Assuming a 5% close rate, that means the team would need to source between 30 and 44 leads per day. That is really going to strain a BDR and probably burn them out, especially considering the average BDR can qualify 15 deals a month while the average AE closes 3 deals per month. Not only that, but your CS employee will be managing between 80 and 160 accounts – not an enviable amount of work by any stretch of the imagination.
How does one change this? Increase the ACV, or annual contract value. Instead of selling the tool for $1,200 a year, how about we sell it for $8,000 a year? Now, through the magic of math, that sales team only needs to close between 55 and 83 deals per year. That’s closing a deal every 3-5 working days. Oh, and if the customer can afford $8,000 per year they’re likely churning less and have additional budget for other tools, making the job of CS much easier too.
The only way to make smaller AVCs work is through marketing (though merchants don’t self-discover as is the problem with POS app stores) or through… channel. Via channel an existing relationship is leveraged to create a sales win.
The channel is the best way for lower ACV solutions to make it to market in a reasonable time period. It’s a symbiotic relationship: the sales engine of the software can often not go direct without increasing price and the channel needs valuable solutions to sell. Much has been written on this topic and usually products with an ACV lower than $3,000 need to rely on channel and inbound to work.
But if the channel cannot or will not sell these solutions at a meaningful pace then both the smaller ISV (independent software vendor) and the channel should expect a dwindling marketshare as ISVs with larger AVCs monopolize the stack. And in the world of cheap money, that’s definitely a greater threat than it’s ever been.
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