Sales Forecasting: Supply & Demand

A common mistake made by sales leaders when building out a sales forecast is only considering the "supply-side" of their forecasting model.

That is, the model will include some version of the following inputs:

• # of Reps

• Quota

• Discount on quota

• Ramp-up time

• Rep turnover rate

They'll put all of those inputs into a spreadsheet and come up with a projection. 

This is a crucial step in the process. If you want to generate $100 million in revenue, you need a model that will tell you how many reps you'll need to hire; e.g what is the "supply" of reps you need to get to your number? 

But this is only half of the equation. The other half of the equation is the demand-side. You have enough reps to sell $100 million but is there enough market demand to sell $100 million? If there isn't enough demand, you now have two problems: 1/ you're not going to hit your number and 2/ you have too many reps.

To avoid that outcome, a sales leader must put an equal amount of energy into the demand-side of the model. Typically, that will include these inputs:

• Total addressable market (TAM): this is the number that you could hit if you sold to every potential buyer of your product in the current period.

• Serviceable addressable market (SAM): this is the number you could hit if you sold to every potential buyer in the markets that you serve in the current period. For example, if your product is only live in half of the U.S. market your SAM would be 50% of TAM. This could also be limited by specific verticals or buyer types that you’re currently servicing.

• Serviceable Obtainable market (SOM): this is the amount SAM that you can realistically obtain. Because of competition, delivery constraints, etc. you're not going to be able to sell 100% of SAM.

So, in order to be comfortable that there's enough market demand to get to $100 million, your SOM must exceed $100 million. There's no doubt that great salespeople and great sales teams can create demand that isn't there, but this doesn't scale and it’s a dangerous assumption to make. It’s crucial that sales leaders understand the actual market demand for the products they’re selling as it exists today.

The demand-side of the model is often more difficult to calculate than the supply-side because it's generally harder to understand and control — particularly in the early days. But there's a long line of sales leaders that made the mistake of not paying enough attention to demand and thus over-hired and missed their numbers. That’s the kiss of death for any sales leader. Applying equal rigor to both the supply-side and the demand-side of a sales forecast is the best way to avoid that outcome.

The Rule Of 40: Which Side Are You On?

In the early days, a company with solid product/market fit and a great team will grow extremely fast. Revenue growth can be 1,000+%. But as a company becomes established, things come back to earth. Tripling revenue when you have $50k in revenue is a lot easier than tripling revenue when you have $50MM in revenue. Over time, the company will eat up all the low hanging fruit. Competitors will enter the space and apply pricing pressure and reduce win rates. Scaling becomes even more difficult. Things just start to slow down.

This flattening of growth is nothing to be ashamed of. It's a natural curve for any product or company — even the iPhone's growth has flattened.

Apple iPhone worldwide unit sales from 2007 to 2018 (in millions)

The way to break out of this natural flattening is to innovate. As Jeff Jordan says, “to add layers to the cake.” But eventually, even the greatest companies will see their growth rates begin to level off.

To maintain a high valuation despite slowing growth rates, companies will often point their energy towards becoming profitable or increasing profitability. One of the biggest challenges of a maturing company is this: should we step on the gas and continue to grow like crazy, or should we shift our focus to profitability?

The Rule of 40 provides an excellent framework for how to think about this question. The Rule of 40 states that a company's growth rate + profit margin (EBITDA) should exceed 40%. Companies that can stay above 40 will continue to be on the high end of valuations — 10x, 20x, 30x revenue multiples. According to a study done by Bain, software companies that are above 40 have valuations that are double those that fall below the line.

So as growth slows, it's useful for executives to ask, what side of the Rule of 40 do we want to be on? That is, are we going to continue to achieve the 40% via revenue growth or do we need to begin focusing on profitability.

The Rule is just a framework; it shouldn’t be taken as gospel. But it provides an extremely useful framing for how to think about one of the most challenging questions high growth companies face.