When choosing sales models, coaching reps, or even deciding on tactics for a particular deal, do you consider what the cost of your decisions might be? Not the actual costs, but the alternative cost – the value which could be achieved with alternative decisions. If you were to do that, rather than this, how much more, or less, value would you create? And how does that influence the choices you make?
The concept is one of those ideas dreamt up by economists. Given their track record in guiding our economies through the recent storms, the real world sales manager could be forgiven for dismissing anything they suggest about how to make business work better. Economists are primarily academics, and rarely understand people who have to make things happen, to earn a living. They can afford theories, whereas business people have to get results, regardless of whatever that takes.
And anyway, the concept contradicts principles sales managers have followed ever since factories made stuff which needed selling.
The traditional model for sales management assumes sales peoples time is cheap, and profit from any sale is substantial. Opportunity cost looks at that formula from the other direction, where sales peoples time is expensive, and profits from sales are low.
In which case, this academic theory might make for an interesting discussion, but has little relevance to territories, activity rates, and sales skills. Those are the factors which make for successful sales operations. Aren’t they.
Where the selling effort is expensive, as in sales people backed up by Marketing, Technical Support and Customer Service, the opportunity cost is fundamental, not just to sales operations, but to the very success of the business.
This is why Reengineering Sales Management focuses so hard on strategy, and process, including qualification. It’s all about spending less time on deals which won’t come in, and spending more time on those which will, given enough attention and effort. The opportunity cost of chasing a sales deal which is ultimately lost is the value of the deal which would have been won, had that been worked on instead.
The Opportunity Cost In Any Sale gives simple examples of how this works.
With the way traditional models work using sales funnels, the opportunity cost seems meaningless. When the sales team pitches 10 contacts with its proposition, knowing 3 will ask for a proposal, and of those 1 will buy, the actual cost of pitching the 9 who don’t buy is simply a cost of doing business. We can easily understand the total cost of sale for the successful deal is the cost of trying to sell all 10. Where each cost of sale is $1 and the profit on a successful sale is $100, who cares about the cost?
It’s a different story when the cost of trying to sell each deal is $10, of course. Thats the way most deals turn out these days, now customers are sophisticated, informed and demanding. In that case, the total sales cost wipes out all the margin on the one successful sale. But when we consider the opportunity cost, this approach looks to be really bad business.
Just looking at the actual cost, the funnel pitching 10 at a cost of $10 each in order to make a single sale worth $100 appears to be break even. Reduce the cost of each sale by $1, or increase the value of the successful sale by $10, and the business model starts to make sense. Not much sense, but at least its profitable.
But with opportunity cost its a very different story. Assuming a failed sale costs the same as a successful sale, and each successful sale is worth $100, the opportunity cost of operating the sales funnel model is $900 – value which would have been achieved had different choices been made.
In which case the sales funnel model is obviously crazy.
If, instead of the sales team working on a deal which ultimately fails, it would work on one which succeeds, the total value of all the deals is $1,000.
The sales manager who builds a strategy, and selects an operating model, which stops her guys selling to people who aren’t going to buy, wastes a lot less of her resources than the one who does it the old fashioned way. Meanwhile, the same sales manager also makes her resources very much more effective, increasing profitability and harvesting a host of other benefits.
That’s what management is about, isn’t it? And its why every sales manager, and sales professional for that matter, should understand what the economists describe as opportunity cost.
Why doesn’t the traditional approach to selling and sales management work so well any more? What can the modern sales professional do to stay relevant in today’s customer driven markets? Check out our eBook Reengineering Sales Management for ideas on how to embrace the new order of customer driven buyer/seller relationships.