What’s this document about?
This document is meant to be a basic introduction to the sales funnel. It will help you understand your company’s sales pipeline from leads creation to deals closed, as well as the sales cycle, capacity planning and the key metrics to keep in mind.
The Sales Funnel
The sales funnel starts with leads created, contact information of prospects who have been in touch with or have somehow shown interests in the product. The sales funnel ends with deals closed, a result of pursuing those leads at every stage of the process. But, pursuing every single lead to the end would not be a good use of the sales representatives or account executives time. Those leads need to be qualified as a potential customer before getting a lot of attention. Opportunities are a critical interim step of qualified leads that have been vetted as worth chasing and are more likely in becoming a paying customer. They’re the transition point between leads to closed deals.
To measure the quality and relevance of the original leads to business, sales teams use a conversion rate. The conversion rate is the number of opportunities created from leads over a specific period. For example, if your sales team creates 100 opportunities out of a 1000 original leads in a single month, the conversion rate is 10%.
Once opportunities are created, they will be moved throughout the Sales process until they’re either Closed Lost or Closed Won. The win rate is another funnel metric that measures the quality of opportunities and the sales team’s success rate at winning them. The win rate is the ratio of all closed won opportunities to all the closed opportunities.
The sales cycle is another frequently used term in pipeline planning. The sales cycle is the average time it takes for a lead to turn into an opportunity and for the opportunity to be closed.
To help the sales team achieve a certain sales target, you’ll need to calculate the number of deals they need to close. We can use a simple formula for that:
In this case, the Average Order Value (AOV) is the historical average of the deals dollar value closed; or the expected average value of opportunities. So, if the sales target for a certain period is $1M and the historical value of the deals have been $10k, the company needs to close 100 deals to meet the target.
Now that we have the sales target, with a backward or top to bottom approach, we can project the number of opportunities and leads needed to meet the target. From the historical or expected win rate, the number of opportunities can be easily calculated:
Similarly, number of leads can be calculated using historical or expected conversion rate:
So, by moving backward from Sales Target to number of leads, we have quantified every step of the sales funnel. The only thing left to figure out is time between lead creation to lead conversion (or opportunities creation) and opportunity close. To meet the sales target in a particular month e.g. February, the sales team needs to know by when to create and convert their leads. If the sales cycle is on average a month long, the leads and opportunities created in January will be closed in February. So, the sales team should build enough leads and opportunities pipeline in January to meet their sales goal in February.
Now if we break the sales target formula to its smaller component, we will have the sales funnel overall formula:
This formula can be used to project and forecast sales performance, as well as the current pipeline. For example, if the sales cycle is one month and in January we have 4,000 leads with a historical conversion rate and win rate of 10% and 40%, respectively, and the AOV of $10k, we can expect about $1.6M in sales bookings in February:
Capacity Planning refers to using sales funnel and pipeline projections to help plan for the number of sales reps or account executives (AE) needed through the sales cycle i.e. from leads creation to closed deals. For any sales target, a sales team needs to have a headcount capacity plan. The sales team should know how many AEs are needed to achieve the sales goal. Each sales rep has a target or quota they are expected to achieve. And the roll up of all the AEs goal achievement or quota attainment will be the sales team overall performance in the shape of new bookings. Ideally, the quota attainment is equal or even greater than the sales target. The following shows the relationship between the sales target and the sales team quota:
Ideally, the expected quota attainment rate should be 100%. But depending on the business and capacity planning assumptions, it might be lower. The overall quota of the sales team can be calculated by multiplying the number of AEs by the average quota per AE.
Once the sales target, individual target and expected goal achievement rate are known, number of AEs can be determined using the combination of the two formula above:
Finally, it’s important to remember that any new AE hire will require a ramp up period to become 100% productive – be sure to take this into account when planning the sales headcount.