FREQUENTLY ASKED QUESTIONS
This page is dedicated to answering frequently asked questions about:
Understanding details about the Commercial Ratio
Why its important and how it can be applied
Details about techniques and how to do things are covered in our how to section.
How do you calculate commercial ratio?
1) Find your Revenue Growth by subtracting the previous period revenue from the current period revenue.
2) Divide your Revenue Growth by the Sales & Marketing Expense for the current period.
Periods can be any unit of time as long as they are the same (annual, year, month, quarter, etc.). We prefer to use year and annual periods in our calculations.
Why are you only using revenue Growth?
The primary reason you have Sales and Marketing functions is to drive revenue growth. The goal is to constantly focus the combined efforts of everyone involved in Sales and Marketing to drive revenue growth. While it is true some Sales and Marketing resources are invested to help renew existing business (think about account manager roles who up-sell existing accounts), the goal of the Commercial Ratio is to look at spending in the aggregate. Rolling up all Sales and Marketing spending into one metric allows companies to evaluate:
1) The focus on Sales and Marketing resources (helps track the effectiveness of execution)
2) How well activities are prioritized (helps manage random acts of sales support)
3) How well resources are aligned (helps evaluate the ratio of headcount to results and if they are deployed effectively)
Is this ratio only Valuable for Saas Companies?
Today, the executive management team of over 50 companies are using the Commercial Ratio as their primary metric to evaluate the productivity of their Sales and Marketing efforts (commercial process). It's true, most of them are subscription-based technology businesses.
However, the metric is designed specifically to measure B2B businesses. Think about the following industries (or the B2B elements of them):
Hospitality (repeat business travel due to align programs with procurement and traveler loyalty)
Manufacturing (repeat business to industrial clients; think Caterpillar)
Financial services (driving employee benefit loyalty for programs making switching costs harder)
Transportation (locking in constant routes and shipping with big clients through delivery and service)
The purpose of the metric is to provide a north star and a standard comparison for like businesses.
How does Cost of Revenue (Cost of goodS sold) Relate?
As more and more businesses move towards subscription-based business models, many are changing their accounting practices to move from Cost of Goods sold to Cost of Revenue. This means professional services, training costs, even account management expenses all go into the Cost of Revenue category. These expense are deducted from Total Revenue to get at Gross Margin.
Many companies are exploring ways to use their professional services groups to drive subscription based or renewal product sales. For example, an office furniture manufacturer uses professional services to help its customers envision space optimization strategies that lead to furniture sales.
As customers increasingly need help to envision a new way of working so they can anticipate the change management required to fully buy into their supplier's vision, understanding the different between revenue driving and revenue retention work is increasingly important. Without a top-down metric that management teams are held accountable to, making these intelligent resource allocation decisions is increasingly more difficult.
What expenses are accounted for in Cost of revenue?
"The cost of revenue is the total cost of manufacturing and delivering a product or service to consumers. Cost of revenue information is found in a company's income statement and is designed to represent the direct costs associated with the goods and services the company provides. The service industry often favors using the cost of revenue metric because it is a more comprehensive account of the various costs associated with selling a good or service." Source: www.Investopedia.com
What kinds of costs are included?
Software licenses fees or other third party expenses required to deliver on the service
Hosting fees or other costs that are directly related to delivering on the agreement
Professional services and training headcount costs
Data communication expenses
Website development and support costs (for your product delivery)
Customer support and account management costs
While in practice these activities and people create iterations with customers that could drive renewed revenue (which one could argue is the responsibility of a Sales and Marketing role), these costs are not accounted for in that way. It is very important to make sure all of the spending is properly categorized to make sure "apples to apples" comparisons are being performed.
What is a sales channel?
A sales channel is a way to bring products and services to market for different customer types.
Sales channels normally include:
a scope (handle companies of a size)
a structure (defined job roles and how they are organized)
and coverage model (how territories are defined, how many salespeople are in the channel, and where they are deployed)
There are many different types of sales channels (some companies call them segments but that creates different problems with you think about revenue segmentation).
Common sales channels include:
Strategic accounts (sales executives assigned to 1-5 large accounts)
Original Equipment Manufacturers or OEM (partnering with other businesses to embed your products into theirs)
Strategic alliances (partnering with other businesses who have complimentary offerings to target specific markets)
Named accounts (a sales territory with a list of specifically named accounts)
Vertical teams (either as overlay specialists or specific named accounts)
Geographic accounts (sales territories assigned by states, zip codes, or area codes)
Indirect or partner sales (using partners who either resell or add value your product our service)
Inside sales (either inbound or outcomes sales teams that handle volume type sales of individual transactions)
Digital sales (high-volume transactions processed on websites or other electronic or self-service ways)
What is a revenue Segment?
Revenue segments are an organizational tool to identify either geographic or business unit gaps that are preventing revenue growth.
The bigger an organization gets, the more combinations of products and channels to drive revenue it will have. What typically happens is a company will organize around both business units (which are normally designed around related product sets) and also by sales channels (mostly by geographic regions like: North America, Europe and Middle East, Asia Pacific, and Latin America). Setting revenue targets by both business units and geographic regions creates coordination problems.
These common organizational structures create common problems.
From a business unit perspective:
Providing integrated capabilities across many different regions for multi-national organizations creates big growth opportunities for business units. However, misalignment across a geographically deployed sales organization doesn't work.
From a sales channel perspective:
A named account sales team will want to provide integrated solutions across the whole portfolio to C-level buyers. The internal business unit structure creates unnatural barriers to drive cross-selling.