The Economics of a Direct Sales Strategy

The capacity of the Direct Sales approach can be illustrated with a unit economic analysis for a single new customer. We’ll start with a review of the unit economics on a range of Annual Contract Values from $100,000 to $250,000 to show how Direct Sales works for the Enterprise SaaS company, and then show how it becomes more difficult at lower ACV deals. The key component of the Direct Sales GTM strategy is the Account Executive, or AE. The Account Executive is the key customer-facing member of the Direct Sales team, responsible for working one-on-one with potential customers in closing deals to create new customers. An AE earns a base salary and a commission on the sales of the company’s product. The sales commission compensation is designed to generate 50% of the AE’s total earnings if the AE meets a specific sales target, called a Sales Quota. The Sales Quota is almost always an annual target. If the AE exactly meets the Sales Quota, then the total earnings are referred to as On-Target-Earnings, or OTE. At OTE, 50% of the total compensation comes from salary and 50% from sales commission. The OTE is a key metric because the annual quota is set at a multiple of 4 to 6 times OTE. This ratio is important because it drives the main cost component in sales and marketing, as we’ll see below. 

For this theoretical exercise, we assume:

• The contract has a $125,000 ACV.

• Each contract has a Subscription Gross Margin of 78%.

• Base Commission Rate of 10% with an additional 6% for overhead, i.e., sales leadership, sales support, and administrative activities. 

• Sales representative On-Target-Earnings split 50%/50% sales commission and base salary, with the sum grossed up by 25% for taxes and benefits, i.e,. fully loaded. 

• Onboarding cost is equal to the cost of Professional Services, which is assumed to generate revenue at 40% of Subscription Revenue and operates at 40% gross profit margin.

• Cost Per Lead (CPL) of $208 and a 6% Lead to Close conversion rate

• Each sales representative carries a $1,500,000 annual ACV quota and has On-Target-Earnings of $300,000. At a $125,000 ACV, the AE needs to close one deal per month to make their yearly quota. This new customer acquisition pace is typical for Enterprise SaaS companies.

A new customer at a $125,000 ACV generates $97,500 in annual profit and costs $30,000 to onboard. The AE’s salary expense for this specific deal can be estimated by dividing the ACV of this deal by the AE’s quota. So, by closing on a $125,000 ACV contract, the AE retires 8.3% of the annual quota. So, we allocate 8.3% of the AEs' annual base salary to this deal. Our Base Commission Rate (BCR) assumption results in a $12,500 commission on this deal. 

Allocating the AE commission and base salary to this contract results in a total unloaded cost of $8,000 for salary and $8,000 for commission, totaling $ 16,000. The fully-loaded cost, including taxes and benefits expenses, is $31,250. The Direct Sales team leadership and supporting staff earn commissions on this sale. This overhead commission rate equals about 6% of the ACV in aggregate. This overhead costs $20,625 for this sale. 

The result is that the Direct Sales model costs the company $85,342 or 68% of ACV in Sales and Marketing expense and produces $12,158 in contribution profit or 9.7% in contribution margin to fund the company’s other operating expenses. By repeating this exercise for the full ACV range from $100,000 to $250,000, you will find that the contribution margin is consistent with this result. 

We can check our analysis by calculating the Customer Lifetime Value to Customer Acquisition Cost (CLTV/CAC) metric. A $125,000 ACV deal with a 78% gross margin, assuming an 18-month average customer lifetime, divided into $85,342, gives a 1.7x CLTV/CAC ratio. Thus, this specific deal generates $1.70 for each $1.0 in Sales and Marketing investment. So, again, the Direct Sales model can deliver a respectable sales performance for this level of ACV.

The second part of this analysis is to look at the Contribution Margin for deals with an ACV below $100,000. Our annual sales quota assumption begins to break down with deals priced between $50,000 and $100,000. Specifically, a product priced at $50,000 would require the AE to close 2.5 deals per month to meet a $1,500,000 annual quota, and this is an unreasonable number of deals to expect one person to close. The upper limit on new yearly customer count for one AE is around 15. The number of deals at a $50,000 average ACV means an annual Sales Quota of $750,000. The AE would make $195,000 in this arrangement, but the theoretical Contribution Margin falls to just 3.6%. Any change to the negative would easily make this strategy unprofitable. At these lower price points, Enterprise SaaS companies need to incorporate more sales-efficient strategies. 

Note: This article is an excerpt from my book, Hacking SaaS - An Insider's Guide to Managing Software Business Success.