This week we’ve covered many flavors of margins and how to calculate them. But the margins we’ve discussed so far are based on products and services. What if you want to understand how efficient individual functions or departments are in your business? Let’s look at an example.
As with any business, I’m sure your company spends a lot of money on marketing and sales. How do you know if you are getting a return on that investment? Sales Efficiency (also known as Sales & Marketing Efficiency) is a measure of how much revenue you generate for every $1 you spend on sales and marketing.
To calculate your sales efficiency, you divide the amount of new business you generated in a set time period (e.g. January) by the total sales and marketing cost for the same time period. For example, if you spent $10k on sales and marketing in January which generated $15k in new customer revenue then your Sales Efficiency would be 1.5.
If your Sales Efficiency is above 1 it means your sales and marketing are generating more cash than they consume and you should spend more! If the value is lower than 1 it means that you are burning capital and you need to watch your bank account.
Just like margins, Sales Efficiency is a great metric to track over time to understand if your sales team is becoming more or less profitable as your business grows. It also allows you to compare yourself to other businesses regardless of differences in revenue and product pricing.
Okay, that sounds too easy. What is the catch?
You are right, that does sound too easy! As with any advanced metric, Sales Efficiency can be difficult to calculate for a number of reasons:
- It can be hard to determine how much of your revenue is due to sales and marketing spend. If a customer returns to your site and spends more money, is that because they had a great experience previously or because you spent money to reach them again? What about subscription businesses where you might not know how much revenue you generated in January until September?
- It can be hard to classify expenses as sales and marketing! Advertising is easy to classify as marketing, but what about promotional discounts? What about channel partnerships where you provide wholesale pricing?
- If your business experiences seasonal swings, it can be hard to have a consistent measure of efficiency. E-commerce businesses boom around the holidays which can influence the Sales Efficiency calculation.
Even with these complications, Sales Efficiency is a great example of how you can extend the idea of margins to various parts of your business. Understanding the relationship between revenue and profit will make sure you always know the fundamentals of how your business operates.
Recommended Reading: “A Diamond in the Rough – Warren Buffett Talks Jewelery” This article analyzes Warren Buffett’s winning strategy in the jewelry business, which is based entirely on margins.