Almost any leader in any industry should care about return-on-investment (ROI). If a dollar is spent in any part of a business, whether it’s people, technology, or research, the leaders of that business likely would want to know the impact of that dollar spent. Furthermore, can that impact be quantified? And if it can be quantified, is the impact greater than the dollar spent by some multiple? As a matter of fact, you could argue that most people in the world care about ROI no matter what one does for a living. If someone is going to invest one hundred dollars in the stock market or a savings account, don’t they expect some return from that investment over time? Or if you’re going to invest several thousand dollars in home improvement projects, wouldn’t you expect that such investment would increase the value of your house by a multiple of what you originally spent? Seeking an appropriate ROI is Corporate Finance 101 in the business world; yet, the authors argue that in certain respects, it can be elusive.
Take sales and marketing for example, which will be the main subject of this article. Do all business leaders at companies big and small pay strict attention to the ROI they are getting from their companies’ sales and marketing programs? This is most likely far from certain. If every single company had a handle on how effective (or ineffective) their sales and marketing program was, there wouldn’t be such an enormous industry built around consulting, outsourcing, and agency work in this area. The fact of the matter is, many companies struggle with sales and marketing. After all, roughly 50% of businesses fail after five years of being in business (and if all businesses were amazing at sales and marketing, it’s tough to believe half would fail). Not only do many companies have a hard time marketing and selling; many companies struggle with identifying whether their sales and marketing program is working, and if it appears to be working, how well it’s working. The purpose of this article is to provide guidelines for what an appropriate ROI should be on a sales and marketing program, explore whether any differences exist among industries or company sizes, and determine whether there’s a higher standard for outsourced solutions versus internally built programs.
The authors of this article each have over a decade of experience in business, touching essentially all areas of sales and marketing. Jonathan is currently the Chief Financial Officer at FullFunnel. Prior to FullFunnel, Jonathan held a number of accounting and finance leadership positions at companies ranging from a high growth startup to one of the largest financial services companies in the world. Jonathan is a certified public accountant and holds an MBA from Boston College. Jason is the Lead Portfolio Manager of Impact Investments at MassMutual. Jason also has extensive experience in sales, marketing, and customer success in the SaaS, enterprise software, marketplace, and healthcare IT industries. Jason earned a J.D. from Northeastern University School of Law and a master’s degree from Harvard Divinity School.
This may seem obvious, but it’s worth setting the table here and establishing what we’re referring to when we say sales and marketing program. First, note that we will refer to sales and marketing as one entity with one goal, which is to generate revenue. This is not to say that sales and marketing are done by the same people or even under the same leader. Rather, in order for a company to be set up for success, these functions truly should be aligned in their mission and have a willingness to work as a unit in order to achieve the underlying goal of generating revenue. With that said, let’s walk through what a typical program looks like.
Based on the authors’ experience, a sales and marketing program consists of the overall mix of staffing, training, technology, paid advertising, events, travel, and other related costs that are required to handle the entire lifecycle of a buyer journey, from initial impression to close. Your typical high growth company may think of their sales and marketing program as the Head of Sales, Account Executives (AE), Sales Development Representatives (SDR), Sales Operations, Head of Marketing, Marketing Managers (e.g. digital marketing, content marketing, field marketing), Marketing Operations, the payroll costs associated with these folks (including commissions and bonuses), and all other expenses required for customer acquisition. The team will also have a go-to-market strategy that dictates how they generate new leads, move buyers through the sales process, and set measurable goals.
FullFunnel identifies four key aspects of a sales and marketing program: platform, people, process, and performance. Each of these is critical, yet neither one by itself should be considered a silver bullet for nailing your sales and marketing program. Instead, all four components need to be humming along in a cohesive manner to maximize ROI.
There are different schools of thought for this, which of course is why this article is being written. If you’ve read the many sales blogs or listened to podcasts that address this, you might have heard that the well-known benchmark for high growth companies is to achieve a customer LTV that’s at least 3x greater than the company’s CAC. Legendary investor David Skok from Matrix Partners has written about this extensively, at least as it pertains to software-as-a-service (SaaS) companies. Skok defines LTV as the average revenue per customer * average lifetime of a customer, minus COGS. This same article defines CAC as the total cost of sales and marketing in a period, divided by the number of deals closed in that period.
So why is 3x a good benchmark? This certainly does not need to be a catch all for every company that’s ever opened its doors. That being said, when a company is getting three times more value from a new customer than the cost to acquire that customer, it should have plenty of money left over for expenses not related to customer acquisition (e.g. R&D or that expensive CFO who can tell you whether or not your sales and marketing program is working). There’s likely a range for acceptable multiples depending on how efficient a company is with its spending elsewhere. Companies with little overhead might get away with 2x or 2.5x LTV-to-CAC and still have a very profitable business. On the other hand, more capital-intensive companies may need a 4x multiple.
Additionally, we can take this 3x goal in the relatively small scale of this article (a company’s sales and marketing program) and extrapolate to other widely known industry benchmarks. In private equity, our experience has shown that the model of most funds is to buy a company, help to turn it around through increased revenue and/or more efficient spending, and sell the company for at least a 3x multiple of what it paid. Even more mainstream is stock market investing. Based on historical trends, a typical investor expects to generate a roughly 7-10% gain per year on their investments. Over say a 20-year horizon of investing, an investor should more or less triple the amount they’ve invested. In other words, if you recently had a child and opened up a college savings account for them, investing $150 a month for the next 20 years ($36,000 invested), at an 8% annual return, would net you about $90,000 in your account, or 2.5x of the amount invested.
An important thing to note here is the aspect of time horizon. This is important because most companies don’t have the time horizon of an individual investor socking away money for retirement or their kids’ college funds. If it took 10 or 20 years for a company to get 3x return on its sales and marketing program, rest assured it probably wouldn’t live to see that day come to fruition. On the other hand, it’s probably not reasonable to think that a company will get 3x return in a couple months. Depending on the stage of a company in its lifecycle, it typically takes 12 to 24 months to recover the investment made in sales and marketing – this is referred to as CAC payback. As an example, if a software company spends $1 million on sales and marketing over a 12-month period, and during that 12-month period they sold $1.25 million in new annual revenue, at 80% margins this $1.25 million in revenue would bring the company $1 million in gross profit over a year. Therefore, the CAC payback period is 12 months. Furthermore, if this company expects the average life of these customers to be 3 years, the total LTV is $3 million, and the ratio of LTV-to-CAC is 3x.
The example above makes an important distinction between revenue and gross profit. The benchmark of 3x assumes that the unit of measurement is gross profit (in line with Skok’s article). When LTV is defined only in terms of revenue, and not in terms of gross profit, a more appropriate benchmark may be 5-6x or greater depending on a company’s gross margin percentage. Let’s now go deeper and start to explore how industry differences may play into this benchmark.
Let’s say you run a professional service firm where the main product is human capital – think law firms, accounting firms, consulting firms, or marketing agencies. Due to the nature of these businesses, the cost of labor (i.e. the product) brings down gross margins relative to software companies that benefit from economies of scale. This isn’t to say that professional service firms are unprofitable; rather, the cost structure is skewed more towards cost of revenue and less so R&D. A profitable, well-run professional service firm may strive for gross margins in the 50-60% range, as opposed to a software company’s 80-90%. This naturally raises the bar for ROI. According to David Skok’s definition of ROI, a company should strive for 3x greater LTV created than CAC incurred, where LTV takes into account the cost of revenue. So, if a service firm with 50% margins wants 3x return, they actually need to deliver 6x more revenue compared to their CAC, whereas the software company with 80% margins only needs to deliver 3.75x revenue.
Continuing with the example in the previous section, the software company needs to generate $3.75 million in new revenue * 80% to get $3 million in lifetime value and a 3x multiple on its customer acquisition costs of $1 million. However, if this same company pivoted to focus primarily on services and saw its gross margin slip to 60%, they would need to generate $5 million in new revenue * 60% to get $3 million in lifetime value and the same 3x multiple. This of course assumes that costs “below the line” (e.g. all other operating expenses not directly associated with producing revenue) are the same in both scenarios. If a company with lower margins is more efficient with managing their operating expenses or overhead, then in theory they wouldn’t require as high of a return from their sales and marketing program to deliver strong bottom line profits.
How about differences among the size of companies that are targeted in a sales and marketing program? Should companies focused on selling to startups or SMBs expect the same ROI as companies selling to Mid-Market or Enterprise? The authors argue that expectations should be consistent regardless of whether a company is selling to startups or enterprise customers. In other words, don’t try to solve for only CAC or only LTV; rather, strive to optimize both of these as they relate to one another, i.e. the ROI. Companies have built extremely successful businesses on maximizing value from selling to small customers (high volume, high value), as well as enterprise customers (lower volume, still high value). The trick here is tailoring the cost structure (i.e. your CAC) according to the type of business you’re selling to.
Brian Halligan, CEO of HubSpot, points out that it only costs them $1,000 to acquire a new small customer (2-20 employees) and they expect that customer to deliver $5,000 in LTV (assuming he’s referring to LTV here in terms of revenue; if it’s in terms of gross profit then more power to HubSpot) – 5x ROI. Going slightly up-market to medium customers (20-200 employees) costs them $4,000 to acquire and they expect about $20,000 in LTV – still 5x ROI. Lastly, selling to large customers (200-2,000 employees) costs HubSpot $50,000 to acquire and they expect about $250,000 in LTV – once again, 5x ROI. What Halligan is ultimately trying to optimize at HubSpot is not just the CAC or not just the LTV in a vacuum, but the total ROI.
The last concept we want to explore in this article is the comparison of outsourcing versus building a program internally, and whether the ROI bar is higher in either scenario. Building a team internally sounds like a straightforward endeavor, yet many companies have tried and failed to do this, some of them repeatedly. Over the course of a company’s lifecycle, this process may look something like the following:
With an internal team, the company is making a very big and generally very costly investment, so the expectations are of course quite high. That said, a CEO may tend to have more patience with the internal team because it truly is an investment that takes time to fully realize its value. An internally built sales and marketing program could have a leash as long as a year (and sometimes two) to “figure it out” and get the company to a place where it’s generating strong revenue growth and ROI. The same likely cannot be said about an outsourced team.
When outsourcing anything, company leaders should expect at least a similar level of production versus building internally. But there are two key differences that raise the bar for an outsourced team: cost and time. On the matter of cost, outsourcing is generally going to be a less expensive option than hiring an entire internal team of folks; this is primarily the reason business leaders consider it an option in the first place. When outsourcing a function like bookkeeping for example, the main benefit of this is that it’s cheaper than hiring a controller or an internal accounting team. However, the cost of an outsourced firm is more likely going to be viewed as an expense rather than an investment. This is a tough bar to clear for outsourcing firms, as one would expect it’s much easier to part ways with your bookkeeping vendor than it is to fire your staff accountant who’s involved in building the company culture and is physically there each day. And on the matter of time, it’s quite simple – outsourced firms are expected to deliver results faster. Usually when a business leader considers outsourcing a key function, it’s either because they want to save some money, get things done faster, or probably both.
In terms of ROI, the matters of cost and time create an interesting paradox. Let’s go back to the example of the software company spending $1 million on sales and marketing to generate $3 million in new customer LTV. If instead this company hired an outsourced sales and marketing firm, they might be able to cut the cost down to say, $300,000 over the course of a year. There are two key questions now: 1) will the CEO of this company have the patience to wait a year or more for the outsourced firm to “figure it out” and deliver results? And 2) will the CEO still expect to get that $3 million in LTV from the outsourced firm? It’s fair to say that it depends on the CEO’s style and amount of patience, but you could argue that most business leaders are going to have a much shorter time horizon for an outsourced firm to deliver similar results. This raises the bar tremendously when outsourcing sales and marketing.
The best way to approach a relationship with an outsourced sales and marketing firm is to set expectations early in the process. Write them down, put them in the contract, make a pretty slide presentation… whatever it is, ensure that the firm and the company hiring the firm are on the same page. Hiring a firm for $150,000 over six months is a big expense for many companies – before the contract is even signed, the CEO and the outsourced firm need to establish what success looks like. Depending on the length of the company’s sales cycle, does the CEO expect a high volume of deals to close in that first six months? If so, they may be looking for that 3-5x return right off the bat. If the CEO is dealing with a longer sales cycle, say 9-12 months, what does success look like after 3, 6, and 10 months? Perhaps it’s a certain amount of pipeline generated that makes the CEO feel good about being on track to hit 3x ROI in the timeframe that’s acceptable to them. In any case, these expectations need to be set as early as possible, and over-communication will be key during this relationship to ensure total alignment at all times.
Given the above discussion on ROI benchmarks, we’re going to conclude by pointing out some levers that a company can pull to maximize ROI. And in fact, there’s really only three: raise prices, improve margins, or keep customers longer. Raising prices can be a relatively quick fix, so long as everything else is held constant (i.e. you don’t lose customers by raising prices). After all, if you spend $100 on sales and marketing to acquire a customer that spends $150 a year for two years, raising prices to $175 a year will increase the ROI from 3x to 3.5x. Improving margins is less of a quick fix and more a function of the overall business model. That said, a software company that improves its gross margins from 70% to 80% can expect a nice uptick in ROI because fewer dollars are spent on the cost to serve those customers.
By far the most difficult, most impactful, and most fulfilling way to improve ROI is by keeping customers longer. This is not as easy as raising prices by 10% or negotiating lower hosting costs to improve gross margins. We don’t claim to be customer success gurus, nor do we have any more room in the article to dive deeper into this topic. But rest assured, delighting your customers and minimizing churn will do wonders for LTV, ROI, and the success of your business as a whole. We can talk all day about metrics and benchmarks, yet if there’s one thing you can take away from this article, it’s to stop reading and go find ways to make your customers love you.