The Difficulty Ratio
A fundamental principle in SaaS sales is that the size of a deal must be large enough to justify the effort required to close it.
There are many ways to win in SaaS. Some software companies target enterprise customers, while others focus on SMBs. Some concentrate on industry verticals, whereas others focus on horizontal needs across industries. However, all successful SaaS companies share a trait in common: the size of their deals is commensurate with the time required to close them. We call this the Difficulty Ratio (deal size/cycle time). Larger deals can take longer to close; smaller deals must close quickly.
This chart illustrates the concept:
There are four quadrants:
Bottom right: Sales cycles are long, but they are rewarded with high annual contract values (ACVs). This is the classic Enterprise sales model, which typically involves proactive identification of high-value accounts. Common lead generation strategies include account-based marketing (ABM) and outbound sales.
Top left: ACV is low, but velocity is high, so lots of small deals add up to a big number. This is the SMB model, or sometimes selling to individual teams within larger companies. This model is usually fueled by product-led growth (PLG) or inbound marketing. Targeting SMBs through outbound sales is challenging due to their sheer number.
Top right: This rare and coveted quadrant features both high deal sizes and high deal velocity. This exceptional model can occur when a SaaS company has won its category and benefits from order-taking. Or it can be found when a PLG company matures and begins to close enterprise deals. In that case, bottom-up adoption by employees precedes the sale, compressing the sales cycle.
Bottom left: This is the only quadrant that doesn’t work. Deals are both small and slow. For example, a startup that takes 6 months to close a $25k deal is not sustainable. However, during a startup’s first year, closing $25k enterprise deals is acceptable as a proof of concept (POC). Just understand that a real enterprise deal doesn’t materialize until you renew for at least $100k+/year.
In summary, a low-ACV model can succeed if it has high velocity, and a high-ACV model can afford to have low velocity, but low ACVs with low velocity spell disaster.
How do I get out of the losing quadrant?
Suppose your average deal size doesn’t align with the appropriate cycle time. In that case, you need to focus on moving right (to higher ACVs) or moving up (to quicker sales cycles). Here are some suggestions:
1. Push ACVs higher
Reevaluate your pricing model: Ensure your pricing model aligns and scales with the value you’re providing. Consider monetizing usage instead of seats (or vice versa), and implement tiered pricing to capture more value from different customer segments.
Improve your product: Enhance your product with additional features, integrations, or customizable solutions that address more valuable pain points or that help you engage new budget holders. Make sure that your features appeal not just to end users but to decision-makers who have the budget and authority to buy your product.
Target larger customers or verticals: Shift your focus towards larger customers with bigger budgets or specific industries that can derive more value from your solution. If you’re a horizontal app selling small deals to departments, consider verticalizing and targeting a particular industry to drive more value for a more defined set of buyers (leading to larger deals).
Expand within accounts: Identify opportunities to land and expand or upsell existing customers to higher value plans or cross-sell complimentary products or services.
2. Increase velocity
Conduct an audit of your sales engine: Assess your sales team setup, pipeline availability for your reps, lead qualification processes, and the definition of when a lead becomes an opportunity. Evaluate whether reps can create the necessary urgency to drive deals across the finish line. Find the compelling event that makes your product an immediate need to some buyer.
Track the time a prospect spends in each stage of your sales process: While most SaaS startups have accurate data around their ACVs, they often lack good data on deal closing times because they don’t properly classify when an opportunity enters the top of the sales funnel. Tracking cycle time will help you identify bottlenecks or inefficiencies that slow down deals.
Implement lead scoring to prioritize high-quality leads: Focus your sales efforts on leads that are more likely to convert quickly to shorten the sale cycle.
Consider how you might introduce PLG into your distribution model: Freemium offers can compress cycle time and drive more top-of-funnel activity.
Either a high-velocity, low-ACV or high-ACV, low-velocity sales motion can work as long as all the pieces – including the type of customer, lead gen strategies, and sales processes – are aligned. Go-to-market strategies that take a long time to close small deals are prohibitive. If you’re in the losing quadrant, you must determine whether tactical improvements (getting better at sales, changing pricing, or improving efficiency) can solve your problem or if your situation requires a pivot. If things are trending in the right direction, keep going. If you’re in the losing quadrant and don’t see progress, it’s time for a deeper discussion about your product-market fit.
Thanks for reading Bottom Up by David Sacks! Subscribe for free to receive new posts and support my work.