Want to immediately identify yourself as a total sales/revenue noob? Make the following statement while talking to an investor (or a peer, the postman or your dog) about how your derived your revenue projections:
“We estimate that we can capture X% of the current market which will generate $YYY millions.”
Gut check moment….do you know what is wrong with that statement? No? Here it is, plain and simple. True sales projections are derived as a result of understanding how many opportunities a sales person can close in a given year. This includes online marketing/sales efforts. Even if a sales person is not directly contributing to a sale (like converting a website member to a paying account), there is a metric that one needs to derive to form the foundations of revenue projections. You need a formula based in reality.
By saying that all your company needs to do is capture a percentage, you are telling the other party that you have not gone through the thought process of how opportunities will be generated (above the funnel), how they will be converted (in the funnel), how long it will take to convert, what revenue will be generated per account, and when you will lose that customer (below the funnel).
This is the difference between a ‘Top-down” and “Bottom-up” strategy. Top-down strategies are basically WAGs (Wild Ass Guesses) stating some unrealistic percentage of market as a revenue number. Bottom-up strategies use reality to derive a revenue figure. When the VP of Sales conducts an annual sales meeting with his/her team, the individual sales people in the room don’t commit to sales figures based on a percentage, they think about the cycle of “bagging and tagging” a new customer. They also think about attrition rates and incremental revenue from their existing customer base. They consider all the factors that lead to a sale and then, based on lead generation, provide a projection that is a reflection of reality.
For example, Dr Suess starts a new company selling moss covered credenzas. He hires a marketing person to start generating inbound sales leads and then finds a sales person to close them (I am overly simplifying this, so go with it!). Dr Suess asks the sales person how much revenue he can “close” this year. The sales person pauses and thinks to himself;
“It takes me 2 weeks to get a meeting with a new lead, another month to ship them a sample, then a couple more months for them to decide. The first order is normally 10 units at $1000, assuming a first time buyers discount of 50%, which will take another month to run a credit check, set them up in our system and get the actual order from the customer. So it will take me about 4 months to close each new account, generating $10,000 per customer. I think I can find and handle about 10 sales over the course of the year so that makes $100,000 in revenue.”
He then tells Dr Suess he can generate $90,000 (giving himself a little wiggle room) in the next year. Dr Suess nods approvingly and writes down this number as the sales persons commitment. Let’s just assume the cost of living in Whoville is VERY low and profit margins are high.
The thought process the sales person went through is Bottom-up. It is based on his real experience selling credenzas and is therefore more realistic. If he had taken the Top-down approach the number might be completely unattainable. If the market was $100,000,000 and he made the noob mistake of saying he could close 0.5% of the market, he would have signed up for a revenue figure of $500,000. Given the sales cycle, what are the chances this sales person would close 50 account in a year? Slim to worse-than-dead.
This is why, when people talk about potential sales as a percentage of market, most people think they are just throwing out a mentally-lazy number and haven’t done the math. Someone with experience would state a number and maybe talk about how that number was derived. The beauty of a Bottom-up approach, especially when seeking investment, is this level of understanding helps the entrepreneur also deal with the wonderful question, “If you doubled your sales staff, how much more could you make?” Translation, “I am interested and might be inclined to give you more money because I trust your analysis.” Not a bad problem to have.