I hope everyone had a great holiday season and a grand New Year. The calendar change typically includes the approval of a new budget (a favorite topic of mine) filled with assumptions, strategies and investments for growth. Speaking of growth, Clinipace has been expanding its sales organization and will be holding its annual global sales conference later this month. I thought I would memorialize the occasion, with my first blog of 2020 focused on measuring the returns from the investment in a new account director ("AD").
A successful sales career requires discipline, people skills, tenacity and the ability to not take losses personally. There is a reason why I started with a career in accounting and finance - I would have been terrible at sales. I consider myself more on the introverted side and am always amazed at how top ADs have the ability to engage current and potential customers with ease (I recommend the book Quiet: The Power of Introverts in a World That Can't Stop Talking). Relationship building goes deeper than engaging in meaningful conversation. Strong ADs are powerful advocates for the clients and navigate their CROs for the best possible teams/solutions. I was taught long ago that nothing happens in business until someone makes a sale - a great early lesson.
CRO growth strategies are usually organic (no acquisitions), acquisitive (growth via acquisitions) or a hybrid of both. Organic growth relies heavily on strong sales and service organizations. Job creation and job stability are by-products of sales success. Over the past 2 years, Clinipace has embarked on an organic growth strategy after several years of acquiring both a diverse skilled operations team and global footprint. Clinipace's Board of Directors typically challenge management (as they should) by questioning do we have enough sales staff, the right team, geographies to provide the sales necessary to sustain and grow the business I used to give typical industry metrics such as gross/net book to bills, along with a detailed buildup of sales by AD that reconciled to our global budget. However, I was asked a few nuanced questions at a recent Board Meeting:
Great questions - without clear answers, I needed to punt, do the work and report back. The answer is simple for billable staff - acceptable positive cash flow tends to occur when 80% utilization is met on a recurring basis (which can be immediate). Not so obvious for an AD. This blog lays out some of the analysis we ultimately presented.
Developing an AD pro forma income statement, provides a great methodology to perform a quantitative assessment. Before we dig into the numbers, a few caveats:
Successful ADs must have strong operational and administrative support. Poor operational delivery or weak proposal, financial or legal support would make it challenging for the most talented AD to achieve success.
The outputs are heavily driven by the inputs. CROs come in all shapes, sizes and have differing compensation structures reflecting those differences. I kept it simple and focused on the sales expectations for mid-size CROs (based on my personal experience).
I also made simplistic assumptions around items such as the backlog burn rate, travel expenses, etc... Again, these items can vary greatly, but I needed to make some assumptions to get started. I previously published a blog that discusses many of these metrics: "Simple Metrics That Clinical Research Organizations Should Utilize But Don't".
Cumulative Cash Return is the net cash generated by the CRO after netting our cost of sales, SG&A costs, account director expenses. capital expenditures and taxes.
Account director base Salary - $135,000
Fringe/benefits cost - 20% of base salary
Sales commission - 1% of revenue recognized (from sales)
Assume that new awards and change orders are included in the sales target
Travel costs - $20,000 per year
Revenue recognized (backlog burn rate) of 10% per quarter
Cost to deliver revenue - 60%
Cancellation component - 4% of the previous quarter's ending backlog
Marketing & administrative costs - 12.5% of revenue recognized
EBITDA (earnings before interest, taxes, depreciation & amortization) - Revenue - Cost to deliver revenue - Account director costs - Marketing & Administrative costs
Capital Expenditure costs of 2% of revenue
27% federal and state income tax rate
ADs do not technically begin generating cash at the point of sale, but when the sale starts generating revenue (and ultimately cash). To keep it simple, I've assumed that revenue immediately translates into cash (we know that payment terms are typically 30-60 days but I want to keep this to a blog rather than a short story). Below is a Backlog Rollforward Schedule schedule which shows the conversion of sales to revenue.
A few observations:
Sales don't commence until Q2 of year 1 (with a low amount of $500K). It is not realistic to expect a new AD to start winning large amounts of business immediately. I've layered in a gradual build as it takes time to get accustomed to a new organization. Plus the CRO sales cycle is typically longer than 3 months.
Revenue burns (i.e. is recognized) at a pace of 10% of the previous quarter's ending backlog. Q3 of Year 1 shows $50,000 of revenue off of $500,000 of ending Q2 Year 1 backlog.
Cancellations are also built in around the industry rate of 4% of the previous quarter's ending backlog. It would be folly to assume no cancellations - so their impact should be included. While the AD may not be the reason for the cancellation, the financial analysis would be incomplete without a cancellation factor.
Sale, revenue and backlog build over time - creating a successful franchise for both the AD and the CRO.
Base case is defined as a new AD hits all the development milestones and increases his/her sales output each year.
A few Base Case observations:
The cumulative cash return after 5 years is $5.83M - significant as it helps build cash that can be reinvested for additional capabilities or fuel future growth.
The investment turns cash positive in Year 2 - CROs should have realistic expectations that a new AD will not have a positive net return in Year 1.
AD total compensation continues to expand with revenue - Year 1 comp is $184K, Year 5 is $331K. Some CROs (like Clinipace) have a commission accelerator on which pushes total compensation even higher. Compensation will continue to climb year by year as the ADs "franchise" continues to grow.
The importance of operations (cost of sales) and administrative support (SG&A support costs) can be seen with their investments. Almost $11M is spent in by Year 5 supporting $14.9M of revenue. Under-investment in these areas would likely reduce the AD and CRO's chance at success.
Above is a great scenario for both the AD and the CRO - a great new hire achieving 5 year expectations. The Not So Great Case below is not nearly the same resounding success.
Not So Great Case
A few Not So Great Case observations:
The cumulative cash return after 5 years is $552K - more than $5M less than the Base Case..
The investment doesn't turn cash positive until Year 4 - waiting 4 years to generate cash is a long time for any investment, especially an AD.
One positive is that revenue is covering the cost of existing operational staff and SG&A overhead - a key benefit that shouldn't be overlooked (even with the subpar performance).
A Step Further
Below is a side by side comparison after 5 years - its not much of comparison - the Not So Great Case Really pales compared to the Base Case. The gap grows even more if you run out the remaining backlog after 5 years (Potential Future Cash Return). The Base Case would generate a whopping $12.9M of cash compared to just $1.7M for the Not So Great Case (a 7.5x difference).
Geographic sales territories play a part in the amount of annual sales an AD can expect to generate (its is also incumbent upon the CRO to make investments in the right territories). Below is a list of the top NIH funded states - biotech venture capital funding looks similar. Clearly the opportunity to generate significant cash is better in California and Boston than Ohio and Illinois (or other states not listed). CROs should set AD sales targets based upon detailed account plans including potential pipelines and reasonable win rates. Saturating a territory with too many ADs can also limit opportunities. Each territory is unique which is why a detailed territory analysis/account plan can help increase the odds of a successful year (for both the AD and CRO).
Conversely, poor performance in a territory such as California or Massachusetts could be devastating. Odds are if you aren't posting strong sales figures in key geographic markets, your business is likely losing overall market share. The Harvard Business Review has a good article (from 1975) on the impact of losing market share - needless to say it isn't good. Companies with declining market share tend to have less market power, a lower return on investment and less economies of scale. Providing adequate time for an AD to grow into their role is important, but employers would be wise to make sure ADs are displaying the tendencies that project future success. A poor performing AD can have a huge negative impact on a business as well. The entire organization can be adversely impacting by an ineffective AD.
Keep in mind that this article is simply a financial exercise - one should not use numbers alone to determine an ADs performance. Qualitative factors must be taken into consideration. I have have seen scenarios where an AD has gone from having the least sales to the most sales within a 12 month period. Operational support, training, a little luck and the ADs perseverance and character all make a huge difference. The numbers show that the right person with the right level of training and support can have a profound impact on a CRO.
Quantifying an AD's impact is more than just tallying up annual sales totals. ADs develop and maintain a customer portfolio and generate value by navigating their organizations and finding the right people/solutions (for their sponsors). Successful ADs can build a lucrative, professionally rewarding career by helping create happy clients (resulting in significant repeat business). Additionally, ADs can be a sponsor's initial interaction with a CRO - you only get one chance to make a great first impression.
I am grateful for every sales organization I've worked with over the past 25 years (I'm getting old) as their actions have brought stability and growth opportunities more often than not. I would not have my current role if I wasn't fortunate to work for several growth businesses during my career. I recommend to all ADs that next time you have an interview or a review session with your boss - let them know how your performance has translated into cash for the business (unless of course it hasn't) - a great opportunity to impress with your impact and business knowledge.
Jason Monteleone is CEO of Clinipace & President at Pivotal Financial Consulting, LLC. Clinipace is a global mid-size CRO with operations in the Americas, Europe and Asia-Pac serving small and mid-size pharma and biotech sponsors. Pivotal provides Divestiture Assistance, Acquisition Advisory Services and Strategic Planning to the Pharmaceutical Outsourcing Industry. Jason can be reached at firstname.lastname@example.org, email@example.com. Follow me on Twitter @JMPivotal. Sign up for Jason's latest blogs and updates at www.pivotalfinancialconsulting.com.