The Start-up Dilemma - How Much to Spend on Sales and Marketing

“… a problem offering two possibilities, neither of which is unambiguously acceptable or preferable.”

Definition of Dilemma from Wikipedia

Planning for Long-term Growth: Sales vs. Marketing

“I like your suggestion. But I invested all my funds in product development and have nothing left to put towards sales and marketing.”

As a sales leader and an entrepreneur, those are the last words I want to hear. And yet, over the past years, I have had a number of conversations with founders that almost verbatim included this statement.

Every business is different. And if you are starting a tech business, then you know that without venture capital investment in engineering and development there is no product to sell. But this is not a chicken-or-egg-type dilemma. It is part of the continuous entrepreneurial challenge of where to spend limited funds. And as you write – or re-write – your business plan, there are best practices to rely upon and not get caught in a dilemma.

Marketing

Marketing budget refers to all costs for marketing, advertising, public relations, promotions, and anything else you might blanket under that very wide-cast net called 'marketing' on a day-to-day basis: for example, Google AdWords, social media, print ads, sponsorships, collateral, and events.

The U.S. Small Business Administration recommends spending 7 to 8 percent of your gross revenue for marketing and advertising if you're doing less than $5 million a year in sales and your net profit margin – after all expenses – is in the 10 percent to 12 percent range.

Some marketing experts comment that, start-ups and small businesses usually do allocate only between 2 and 3 percent of revenue for marketing and advertising. Still, other marketing experts suggest a wide range between 1 and 10 percent and more depending on how long you've been in business and how competitive your market is.

A 2016 survey of 168 Chief Marketing Officers revealed that marketing budgets can account for as much as 40 percent of a firm's budget, with a median of 10 percent of the overall budget and a mean average of 12 percent. When shown as a percentage of total revenue, the mean was 8 percent, and the median was 5 percent.

And as a final data point in this context, Abby Pearson has the following recommendation: “… as a general estimate, it is recommended that young companies spend around 20-25% of their revenue on marketing costs, while this figure is in the range of 10-15% for more established companies. The answer will depend on your company's unique circumstances, like product, target market, location, ...“

Clearly, these numbers are all over the place. And while some may be self-serving, the 7 to 8 percent of gross revenue from the SBA seems to be a good benchmark. Now, what if you are pre-revenue? Apply the above percentage to the projected revenue in your business plan.

Sales

As an entrepreneur, your main job is selling. Your small business can make a lot of demands on your time and money, but you must ensure you devote enough time and resources to sales, or your other business activities will be meaningless. Sales expenses include salaries, bonuses, overhead, and administrative costs.

Every business is unique when it comes to sales as a percentage of revenues. A manufacturing company, for example, must spend money to make products, whereas an e-business that sells information can focus on selling without worrying about physical product manufacture and storage.

According to Steve Smith, Head of Sales for Encoding.com and former top salesperson for Yelp, companies like Google pay as much as 40 percent to affiliates, while Amazon pays very little in sales expenses because of its online presence and dominance in its field. High-growth technology businesses spend 25 to 45 percent of revenues on sales. A new product launch can boost these costs to 30 percent for a small business, while ongoing 10 to 20 percent of revenues is more typical.

The average is much higher for (successful) SaaS companies, where many spend more than half their annual recurring revenue (ARR) on sales and marketing costs. According to Tomasz Tunguz, a partner at Redpoint Ventures, during their first three years, SaaS companies often spend anywhere from 80 to 120 percent of their revenue on sales and marketing. It then plateaus around 50 percent from year five on.

Again, these numbers vary. The consistent element is the significance of sales cost as a percent of revenue or projected revenue.

The point of spending on sales and marketing is not for the sake of spending, but to develop an effective strategy. It serves a purpose; it serves to achieve the goals set in the business plan.

Rodrigo Martinez emphasizes investment overspending when it comes to sales and marketing: “What I mean by investing in sales and marketing is about your goal and approach to it. You’re investing … when you’re in a “trial and error” mindset:

· You try to experiment to see what works and what doesn’t to attract and convert customers. You must try to get your whole team into this mindset. Involve everybody in the team in thinking how to further grow the business. Great ideas can come from everywhere!

· Try to get some sense of how those channels will scale and understand their scalability and when they would saturate.

· Document those things so new people who join can get up to speed quickly.”

Moving beyond a simple percentage of revenue, there are more complex metrics that venture capital firms consider when assessing a start-up: Customer Lifetime Value (CLV) and Customer Acquisition Cost (CAC) are two of those. Both can also be used by founders to determine how much of their spending has to go toward sales and marketing in order the make the business develop and grow according to plan.

Customer Acquisition Costs (CAC) are all actual or projected expenses incurred in acquiring new customers. Costs like wages for your sales and marketing team, digital and other advertising expenses, and any other expenses to do with onboarding new customers.

In order to understand the total cost you incur to acquire a customer, you calculate the unit cost by dividing the total expense over the number of new customers.

Customer Lifetime Value (CLV) is a way to predict the future profit you will make over the entire relationship with a customer. It’s a formula to help you quantify what a customer is worth to you in financial measures so you can understand if they are worth acquiring (via sales and marketing) in the first place!

Customer Lifetime Value can be calculated with varying levels of sophistication and accuracy; and if done in the context of a start-up using projected cost and revenue numbers, it requires solid documentation of all assumptions. The simple version of the formula is CLV = Annual Gross Profit per Customer times the average number of years.

Whatever approach you take, build a business plan that includes investment in sales and marketing. There is no dilemma in a successful business.

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Abby Pearson – How much should marketing costs be for my start-up?

Jason Andrews – How Much Should my Business Spend on Sales and Marketing?

Rodrigo Martinez – INVEST in Sales and Marketing!

Photo by Anne Gosewehr