In previous posts I've discussed revenue growth rates of IPO-bound internet companies, as well as how much these companies spend on sales and marketing. In this post, I will discuss 'sales efficiency', a metric typically used to describe SaaS companies, on our same peer set.
There are many variations of the sales efficiency metric, sometimes called the magic number in SaaS, but the basic premise is to provide some sense of incremental revenue generated by sales and marketing spend. For example, if a SaaS startup invests $1M in sales this quarter and generates $2M of incremental annual revenue, less the cost of providing the service, the sales efficiency would be 2.0. The inverse of this metric is payback period, and in the previous example the revenue reimburses sales costs in 1/2 year, or 6 months. Generally, a sales efficiency of over 1.0 is a good thing since it implies that you are at least breaking even on your sales cost for the year.
While the calculations in the above example are useful, it is difficult to make the same calculations for consumer internet companies for several reasons. First, the go-to-market strategies for consumer companies don't necessarily involve traditional sales organizations (inside sales, enterprise reps, account managers, etc), which is where sales efficiency metrics are most useful. Second, the business models and margins of internet companies are highly variable which makes apples-to-apples comparisons difficult. Third, internet businesses often have diverse customer acquisition strategies such as organic growth, content marketing, referral programs, direct response advertising, online paid acquisition, and so forth.
Regardless, I thought it would be interesting to do a very basic sales efficiency calculation for our universe of internet companies to see what we can learn. Using my usual index of companies across Social, Marketplaces, Ecommerce, Digital Media and Travel, I've plotted generic sales efficiency in the years leading up to IPO. For example, Facebook went public in 2012 so their sales efficiency that year is 2012 revenue minus 2011 revenue, divided by 2011 sales and marketing costs.
Note: You would normally take into account gross margins, but I wanted to keep the analysis simple and so just used revenue. If we were to drill deeper, we would most certainly take into account gross margins. We would also calculate sales efficiency on a quarterly basis rather than on an annual basis as I did here.
Facebook, LinkedIn and Twitter have all experienced a ton of viral growth throughout their history so naturally their sales efficiency metrics are incredibly high. As businesses mature, sales efficiency tends to decrease and the Social category is no exception. LinkedIn and Twitter are trending to 1.0 today, but Facebook is still over 3.0 which is superb. Gross margins for these companies are very high (SaaS-like) and so the above metrics are probably pretty close to the true sales efficiency.
In marketplace-land, some of the most efficient companies from a sales and marketing perspective are Etsy, Lending Club, GrubHub, Just-Eat, Zillow and Trulia. If you think about it, those also happen to be some of the most profitable and successful marketplaces. In their IPO filing, Etsy boasted that 90% of their customers to date have been organic, a terrific feat. At the bottom of this list you'll find companies such as Care.com, Angie's List, TrueCar and Yelp, businesses that have had to pour on sales and marketing to generate ever-decreasing amounts of top-line growth. Gross margins for these businesses also tend to be very high, so the revenue sales efficiency we are using should be relatively accurate.
Ecommerce is all over the place. Some of these companies, such as Groupon, Zulily, and Fitbit, tend to explode out of nowhere as viral phenomena. Hence they spend very little on sales and marketing and drive astronomical revenue growth, at least in the early days. Groupon was quite literally off the charts but they quickly dropped down to 1.0 sales efficiency, and they are now well below that since the business is struggling. Fitbit went public just last year and they have seen incredible sales leverage since they have locked up a ton of retail distribution which happens to be a very efficient channel. Other ecommerce companies tend to be in the 1.0-3.0 range leading up to IPO, but many have fallen off considerably post-IPO, i.e. RetailMeNot, Coupons.com, and GoPro.
The Ecommerce category is where my sales efficiency calculation starts to break down. Ecommerce businesses tend to have very low gross margins and so the numbers in the above chart are inflated. And, since there is a lot of gross margin variability between companies, it becomes difficult to make apples-to-apples comparisons between companies using my metric. JD.com is the starkest example, their sales efficiency looks incredible, but in actuality their gross margin is just 5%, so you can basically divide the above numbers by 20 and find that JD.com has mediocre sales efficiency. Again, I purposely chose to use a revenue sales efficiency metric rather than gross margin as a thought exercise. One takeaway of this analysis is that it is clearly very easy to warp the sales efficiency metric and mask what is really going on in a business.
The Digital Media category also has quite a bit of variance. These metrics are also inflated since gross margins here are lower than SaaS, though they are still generally higher than Ecommerce. Google, as you would expect, exhibited really strong sales leverage through their IPO. Mobile gaming companies Zynga, King, and even Glu Mobile showed incredible sales efficiency when they were experiencing rocket ship growth from their hit games, but all three eventually hit ceilings and experienced flat to negative growth (which crushes the sales efficiency metric).
Given the unique history of companies in the travel category, I prefer to plot their metrics chronologically rather than indexing around IPOs. The above chart really tells the story of the age old travel wars. The battle for customers in travel is fierce and the dominant players have massive war chests. Priceline and Expedia are willing to push their sales efficiency down to the point where they are barely break-even on acquiring customers because they are huge companies and can justify the spend due to the monopolistic characteristics of the online travel market. It's all about market share, consolidation and squeezing smaller players out. The above metrics for travel should be pretty accurate since gross margins are very high.
This analysis is a good "finger in the air" approach to understanding sales efficiency for internet companies. However, this analysis would look very different if you were to dig into an individual company. Go-to-market strategies for Internet companies vary significantly and so it is important to figure out the true structure of the sales and marketing function within a company. Measuring metrics on a quarterly basis, properly attributing sales and marketing costs to revenue, looking at new business vs expansion of existing business and churn, taking into account gross margins - these are some of the points worth understanding in regards to sales efficiency.