Opportunity cost is the investment your company must make to achieve a sale, and it has a bearing on every company activity associated with a sales cycle. It is applicable equally on the higher level of entrepreneurship as well as at the level of the sales force—which of course includes sales reps and sales management.
Alice and the Opportunity Cost
Catching back up with our sales rep from the last article, Alice, there came a time when she took a good look at herself and her teammates and wondered about the expensive company cars, the lunches, and the trips in Business Class that were all part of selling at her company. Sure, sales were good, but wasn’t the company dishing out an incredible amount of money to bring in those deals?
Alice had a degree in accounting, and on her own time she started nosing around. She figured out the rough marketing costs. She averaged out all the travel expenses. She included in the costs of the SDRs, and other attached sales personnel. She figured in the average time it took to bring in a deal.
When she was done, she brought her figures to company management. They were shocked. While the average deal size was $10,000, the average opportunity cost was $16,500! Nobody had really sat down to totally figure it out. Needless to say, some major changes were made to the company’s business model. Fortunately, their services were in great demand, and within a year they began to show real profits.
The sales force is on the front line and is venturing risk on behalf of the company. Hence sales management should be acutely aware of all the costs associated with that opportunity. Opportunity costs should then be made transparent to the sales force in such a way that sales reps can act with them in mind.
Why should the sales force be so aware of opportunity cost? It’s simple: because sales reps are the ones actually making the deals. A sales rep must know the bottom threshold they must not go below in negotiating that deal. Without having opportunity cost data, a salesperson can close a deal for which the company will only break even or—worse—take a loss.
Profit Versus Opportunity Cost
As demonstrated with Alice’s company above, there are many situations in which the opportunity cost is not fully taken into account. For example, a deal might close for $8,000, but the total opportunity cost is actually $20,000. How many of those deals will be made before the company goes under?
In the VC-driven business world of the last few years, this practice has becomes incredibly widespread. Cash is just burned up in the interest of closing that deal and putting it on paper. This kind of business behavior is why something like 9 out of 10 businesses fail.
It is in the interest, then, of every business–and, really, every sales force–to completely analyze opportunity cost, for every one of the company’s offerings.
Breaking Down Costs
The cost of an opportunity, from sales standpoint, is the total costs involved with closing a deal.
At first glance opportunity cost might seem simple—for example the pay for salaried employees associated with a particular sales cycle and the cost of trialware or live product demonstration. There are also the ancillary costs associated with sales reps such as company vehicles, travel, entertaining of prospects, computing devices (if the company covers them), and even office space. A company will often offer free tech support to a potential client running trialware or otherwise involved in a limited-time trial of a product or service. The cost of that support and service should be taken into account as well.
But a deeper look reveals other costs that might seem “hidden” but are part of the opportunity cost as well. Opportunity cost must take into account the risk ventured by your company. A good portion of that risk is the time a salesperson spends learning about the prospect company, interacting with decision makers, isolating the potential client’s problems that your product or service will solve, paying personal visits, and everything else a sales rep will do to bring in a deal.
While a sales rep is most often paid strictly on commission so is not paid directly until the deal comes in, the time a salesperson is taking on that sales cycle is time not spent on other deals; some of these others may even have a higher probability of coming in or a higher profit margin. That is certainly part of the cost of an opportunity.
For longer-range deals it often happens that multiple salespeople are involved, and this can be a cost that is missed. In such a case you would have to take into account the items sketched out in the above paragraph for every rep involved with the sale. Also often for such deals it can happen that other personnel are brought in, such as consultants. There can be an actual monetary investment laid out, such as for special presentation materials put together just for that deal.
Behind all that is the infrastructure behind the rep, which is of course means the whole company. While that particular cost may be difficult to totally nail down, it is certainly something to bear in mind. A company is risking a portion of itself in the pursuit of every opportunity.
There are other factors that can figure into opportunity cost. For example, a company I do business with in Europe charges between $3,000 and $5,000 per year for their services. But when a contract is signed with them, it is for 10 years. Therefore they can figure their opportunity cost based on $30,000 to $50,000 per closed deal.
The real focus on opportunity cost may not be as important at a company’s startup phase. The importance of initially getting your products or services sold, in use, reviewed and publicly known may very well outweigh the importance of trimming costs, and in the beginning it probably should.
Shortly after a company is up and running with a client base, however, it should begin paying sharp attention to opportunity cost. It must be figured as precisely as possible, because it will have a direct bearing on your profit margin.
Knowing and operating from these principles as we do, at Pipeliner we have made sure our CRM solution makes it possible for a company to accurately calculate opportunity cost. The system is fully customizable, so that fields can be tailored for all parts of opportunity cost, so it can be accurately compared with the opportunity value.
It is evident that opportunity cost is an economic principle immediately applicable to entrepreneurs, the sales force and sales management—and, in fact, anyone engaged in business.
As shown, Pipeliner CRM makes it possible to accurately calculate your opportunity cost.Get your free trial of Pipeliner CRM now.