What is the rule of 78, and how to use it in your sales plan
This article was originally published August 27, 2018 on our blog.
You may be familiar with the rule of 78 as a method of yearly interest calculations used by some lenders (particularly in the pre-computer age) — and if you didn’t know, now you do. But how useful is this rule in today’s world of sales?
For SaaS companies building out their sales plan, the rule of 78 can quickly estimate how much money a recurring subscription is going to bring in by the end of a 12-month period. Though the rule is not a hidden trick that will instantly transform your sales strategy, it can be a useful tool to understand, implement and get results.
The rule of 78, explained
In sales, the rule of 78 is all about recurring revenue. It’s most useful for businesses that are selling subscriptions, such as SaaS (software as a service) companies.
The other important thing to understand is that the rule of 78 is all about a 12-month revenue. The examples of the rule of 78 in action start with the beginning of the calendar year (January), but you can use the rule for any 12-month period you want. The calculation will let you estimate revenues for the next year from whatever month you choose.
Here’s how the rule of 78 works:
Imagine that you’re running a business that sells a monthly subscription for $50. Your company is rising very steadily and you add a new customer each month in addition to retaining all of the customers you’ve already gained. What’s the revenue for the next year?
A customer who subscribed in January will bring you 12 * 50 = $600 of revenue in a 12-month period. A customer who subscribed in February will bring you 11 * 50 = $550 of revenue. This continues all the way to the last month (December) — a customer who brings you 1 * $50 = $50 for that 12-month period.
Since revenue from each customer is recurring through a subscription, but you still convert a set number of new customers each month, your total revenue will be (1 * $50 + 2 * $50 + ….. + 12 * $50), which is equal to (1+2+3+..+12) * $50 = 78 * 50. So we have 78 * (monthly revenue per customer) * (number of new customers per month) to get the total revenue for the 12-month period, and hence the rule of 78
Here’s a helpful picture to understand how it works:
Basically, take the price of your product, multiply it by the number of customers you want to add each month and then multiply it again by 78 to get a ‘best case scenario’ idea of your revenue for the year ahead.
How to apply the rule of 78 for a better sales plan
You can use the rule of 78 to design sales quotas
How much should each member of your sales team bring in monthly for you to achieve your sales goal for the year? The rule of 78 makes it easy to calculate that number and set achievable quotas.
Let’s imagine that your sales team has five members and you want them to bring in $100,000 in a 12-month period selling $50 subscriptions. It’s easy to see that in this scenario each member of the team should bring in about $20,000 in a year.By dividing that goal by 78 we get $256 (let’s round it down to $250). This is how much revenue each member of the team should bring in each month by closing new accounts.
Want to know how many customers exactly? Simply divide $250 by $50 (the price of your subscription) and you get 5. This means that if each member of your sales team succeeds in bringing five new customers on board each month while retaining the customers they brought in the past; in 12 months you’ll collect $100,000 in revenue.
Adjust your quotas to allocate for lost customers
Obviously, in real life you’re never going to retain 100% of the customers you convert during the year. Some months will prove to be more successful than others.
That’s perfectly OK, but if you want to hit your sales goal for the year, you should learn to adjust your sales strategy accordingly. The rule of 78 can help with that.
In our previous example, we calculated that each member of our 5 person sales team needs to bring 5 new customers monthly in order to achieve the overall goal of $100,000 in revenue. But what if they lose some along the way?
Imagine that one of the members of your sales team lost 5 customers between March and April (while still converting 5 new customers). The rule of 78 tells us that the customers lost in April mean 8 months of lost revenue from their subscriptions.
Even if that person on your team continues to hit their quota of 25 new customers for the rest of the year, they won’t be able to recoup those 8 months of lost revenue. Which means that you need to readjust their quota for the next month.
If your sales rep brings 10 people instead of 5 in the month of May, your sales goal will be achieved.
One of the main ideas behind the rule of 78 is that customers you bring at the beginning of the year will be worth more to you by the end of the year than the customers you bring during the later months.
This basically means that if you lose 5 customers in April and convert 10 customers in May, your overall sales plan won’t change.
But if you lose 10 customers in March and convert 10 customers in June, you will lose a month worth of subscriptions.
To return to our example, if your sales rep loses 5 customers in April, their quota for May should be 10 new customers instead of 5 to accommodate for lost customers. But if they are not able to convert 10 additional customers in April, the quotas for the following months will get higher and higher.
For example, to accommodate for the customers you lost in April, by November your sales rep would have to convert 25 new customers instead of 5:
The rule of 78 is the reason why it’s so important to retain customers
The example above should illustrate how important it is to retain customers throughout the year. The more customers you lose, the more customers you need to convert with each passing month to hit your overall goal.
This basically means that as the year goes by, it becomes harder and harder to correct for your losses in previous months and regain lost customers.
A customer who registered for your $50 subscription in January will be worth $600 by the end of the year, if they stay. But if they drop the subscription in February, by December you’ll need to bring on board eleven new customers to accommodate for lost revenue.
If you’re having trouble retaining customers, your sales team will feel the pressure of expanding quotas. Look into improvements with your customer success team, revisit your onboarding plan and ask customers for feedback to remedy any issues.
Understand how important the beginning of the year is
The previous examples relate to the main idea of the rule of 78. The customers you bring at the beginning of the year are more important for hitting the yearly sales goal than the customers you bring in at the end of the year.
Use that knowledge to your advantage and design a sales plan along with a customer success plan that heavily invests in the beginning-of-the-year sales. At the beginning of your 12-month period, you should aim to overperform and get more customers than your sales plan suggests.
Promotions, sales, and discounts are a good way to do that. By bringing more customers on board at the beginning of the year, you’re giving yourself some space to lose customers and still hit your goal down the road.
Adjust the rule of 78 to become the rule of 21 or the rule of 300
The rule of 78 concerns the revenues you’ll gain in a 12-month period, but the same equation actually holds up for longer (or shorter) stretches of time.
If you want to work on a two-year goal, for example, use the rule of 300 (which will look like this on a spreadsheet). And if you need to build a 6-month sales plan, use the Rule of 21:
Both of these use the same principle as the rule of 78. Use them to experiment and adjust your strategy as needed. For example, consider building a sales strategy specifically for the next 6-month period and calculate your sales goal for that period with the rule of 21. If you hit it, consider expanding that plan for a 12-month or 24-month period.
Though the rule of 78 can seem a bit complicated at first, the ideas behind it are simple and the insights it offers are important. By letting you evenly distribute your sales quotas between team members and across a 12 month period, you can acknowledge your limitations, identify your opportunities, and build a more solid sales plan to achieve your goals.
Have an idea of what we should discuss next or a tip of your own? Share it with us in the comments section below!
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