Refining Sales Projection Assumptions While Pivoting

This is the third of three articles on how to create a sales forecast when writing a business plan for a start up company.

In the first article we discussed the activities the create revenue. In the second article, we surveyed assumption-based techniques to create estimates of units you expect to sell in your start up company. In this article, we will focus on the pivoting process, i.e., as you run your company and realize that some of your assumptions are incorrect, how will you pivot [RIE11] and adapt?

Once you launch your company, you will learn much about what works and what does not work to attract new customers, and you will learn more accurate values for many of the assumptions for which you originally entered just estimates during planning. Let’s talk about the likely refinement processes that you will undergo for each sales model. (I will omit the wild ass guesses; once you start your company, you will need to replace these with more sensible sales models).

1. “Sales by Market Penetration” Sales Model

The primary value of a top-down sales model is to establish an absolute ceiling for your total available market; it is of little value in establishing sales estimates. If you insist on maintaining this model, you will be adjusting the market size as you learn more about it, and replacing estimated market penetration numbers with actual market penetration numbers as you determine them. However, this seems almost pointless because presumably you are learning what processes you are following to capture those sales, and as you learn those processes, you should be capturing them in a bottom-up sales model.

2. “Sales by Marketing and Sales People Effort” Sales Model

If you used this approach during the initial planning of your company to model the number of units, you likely guessed at how effective salespeople would be. As soon as the first few months in business, however, you should have a better idea of the Ratio of Employees to Units Sold, i.e., you will know how many units of each product each employee can sell in a month. What you won’t know, at least not initially, is whether those employees are still in the “ramp up” period, and thus not at their full potential, or whether they have already cleared that hurdle. To increase the Ratio of Employees to Units Sold, work on

  • Training salespeople
  • Improving fulfillment materials and website
  • Better pricing and promotions
  • Improved lead generation (i.e., better leads result in easier sales)

Improving the product and better alignment of the product with customers’ pains is a longer-term method to increase the Ratio of Employees to Units Sold.

3. “Sales by Marketing and Sales Dollars Spent” Sales Model

If you used this approach during the initial planning of your company to model the number of units you will sell, you likely guessed at how effective your marketing and sales budget would be in attracting sales. As soon as the first few months in business, however, you should have a better idea of the Ratio of Dollars Spent to Units Sold, i.e., you will know how many units of each product can be sold as a function of each dollar spent. This ratio captures many factors including the effectiveness of reaching the target market, the effectiveness of the message, as well as the effectiveness of the conversion of leads into customers. Thus this sales model starts off being fairly easy to use to create an early projection of sales, but is rather difficult to refine as you learn more about the effectiveness of the various components of the sales engines. Most entrepreneurs who start with this sales model, switch to the more detailed “New Customers by Marketing and Sales Dollars Spent” sales model soon after starting their companies. Nonetheless, to increase the Ratio of Dollars Spent to Units Sold, work on

  • Improving fulfillment materials and website
  • Better pricing and promotions
  • Improved lead generation (i.e., better leads result in easier sales)

Improving the product and better alignment of the product with customers’ pains is a longer-term method to increase the Ratio of Dollars Spent to Units Sold.

4. and 5. “New Customers by Marketing and Sales People Effort” and “New Customers by Marketing and Sales Dollars Spent” Sales Models

These sales models enable you to estimate sales initially and provide you with a solid basis for continuous improvement as you run your company and learn from experience. Whether you run the company and observe what happens or explicitly formulate and run experiments from which you will derive data, these sales models allow you start with initial conjectures concerning the parameters that drive your revenues and then refine those parameters as you learn. Those parameters fall into three categories:

  • The cost of acquiring customers as the result of explicit marketing and sales actions. Initially, you estimated how many resources (either labor or dollars) would be required to create one paying customer. As in the case of the two previous sales models, this is a composite of the effectiveness of reaching the target market, the message, as well as the conversion of leads into customers. As you run the company and tweak the product, prices, promotions, messages, targets, sales techniques, SEO, you will refine the values you entered for CAC and Ratio of Employees to New Customers Acquired to reflect reality. As you do so, financial projections will migrate toward reality as well.
  • Virality. Initially, you assumed that a certain percent of your current customers would draw a certain number of new customers each n days. Once the company starts, you now have real data to replace the estimates. However, don’t just accept the new data as fact. Work on improving the product and establishing new viral promotion campaigns to increase the viral coefficient and decrease the viral cycle. A leading indicator of the viral coefficient is the net promoter score (NPS). Quoting from [BES10],

Consumers are asked, “On a scale of 0 to 10, how likely is it that you would recom­mend our company to a friend or colleague?” Consumers offering a rating of 9 or 10 are anointed “promoters”, implying they are likely to promote the company to others. Those who give a rating of 7-8 are “passives”— they probably won’t discuss the company with anyone. Those . . . with ratings of 0-6, are dubbed “detractors,” since they might speak ill of a company and hurt its prospects with other potential customers. A company calculates its overall [NPS] by subtracting its percentage of detractors from its percentage of promoters. So, if 65% of an e-commerce firm’s cus­tomers rank as promoters, and 15% as detractors, the firm’s overall NPS would be 50.

  • Organic Growth. Initially, you assumed customers would spend a certain amount of money per month. Now that the company has started, replace that assumption with the real value. Next, initiate efforts to increase the Average Order Size, e.g., upsell, institute programs that reward frequent purchases. Improve product quality to reduce attrition. Listen to customers to find out what they want. Then reflect these improvements in the assumptions.

6. and 7. “Raw Materials Available” and “Manufactured Product Available” Sales Models

In both of these approaches, physical limitations constrain your ability to produce revenue. The only way that reality will differ from your projections is (a) to relax the physical limitations, (b) to create workarounds for the physical limitations (e.g., outsourcing, or finding alternate sources of raw materials), or (c) for you to discover that the limitation is not really a limitation, in which case you should switch to an alternative sales model. If “a” or “b” occur, change the assumptions in your model.

[BES10] www.bvp.com/sites/default/files/bessemer_top_10_laws_ecommerce_oct2010.pdf.

[RIE11] Ries, E., The Lean Startup, New York: Crown Business, 2011.

This article is extracted from my book published by Scrub Oak Press titled Will Your New Start Up Make Money?. Buy it at http://www.amazon.com/Will-Your-Start-Make-Money-ebook/dp/B00JOOZQNE.