Sales Funnel

What is a sales funnel?

Sales funnel denotes the staged model that maps the path of potential customers from first contact to contract signing and measures the conversion rate for each transition. Because fewer prospects remain from stage to stage, the model is depicted as a funnel.

The funnel is a flow variable, that is, a variable that relates to a period of time. It describes how many prospects reach a stage in a month or year and what share of them moves on to the next. In this it differs from the sales pipeline, which as a stock variable shows the open sales opportunities on a reporting date. Illustratively, the funnel corresponds to the meter on a water pipe that measures a month's flow, whereas the pipeline corresponds to the fill level of a tank on a particular day.

Marketing and sales use the funnel to find bottlenecks, and management uses it for planning. Investors use it to check whether the revenue plan in the financial model is based on achievable volumes and rates.

Stages and conversion rates

The stages follow the company's sales process. In business with companies, a division into four to six stages is common:

• Lead: a contact with a first interaction from lead generation.
• Qualified lead (marketing qualified lead, MQL): The company fits the target customer profile, and the interest goes beyond a single interaction.
• Qualified conversation (sales qualified lead, SQL): Need, decision-making authority, budget range and time frame have been confirmed in the conversation with sales. From here, the prospect is managed as a sales opportunity in the pipeline.
• Proposal: A written proposal has been presented to the customer.
• Close: The contract is signed.

For each transition, it must be defined which verifiable event triggers it. The conversion rate of a stage is the share of prospects that reach the next stage; the overall rate is the product of all stage rates. In addition to the rates, the dwell time per stage is measured. It determines how long it takes until additional leads become revenue.

Measurement: period or cohort

Conversion rates can be measured in two ways. In the period view, the closings of a month are set in relation to the leads of the same month. This is simple but imprecise as soon as the sales cycle is longer than the measurement period, because the closings of a month come from leads of earlier months. With growing lead volume, the rates then appear too low, and with falling volume too high.

The cohort view (cohort analysis) is more precise: all leads of a month are followed through to their outcome, that is, to closing, rejection or the expiry of a defined period. This produces rates that can be assigned to a specific period and channel. The prerequisite is a CRM (customer relationship management) system in which the source, date of entry and stage changes of each contact are recorded.

The funnel in planning and due diligence

In the financial model, the funnel is calculated backwards. The planned new business yields the necessary number of closings. Using the stage rates, this yields the necessary number of conversations and leads, and from that in turn the marketing budget and the sales capacity. Because the sales cycle lies between lead and closing, the additional leads must arise earlier than the planned revenue by that duration.

In the current year, funnel and pipeline complement each other in the forecast, the regularly updated projection of the annual result. The pipeline supplies the expected closings of the next months, and the funnel the closings from leads that are not yet qualified or still have to be won.

In due diligence, the in-depth review before an investment or purchase, investors and buyers check whether the rates assumed in the plan correspond to the measured values. It must also be evident that the rates are stable over several periods and can be broken down by channel and segment. Plans that assume rising conversion rates and rising lead volumes at the same time without naming a cause are as a rule reduced to the measured values. The funnel is thus a central tool for demonstrating the plausibility of a revenue plan.

Worked example

A software provider with an annual contract value (ACV) of EUR 15,000 has measured the following funnel over the last twelve months, cohort-based and across all channels:

• 2,000 leads, of which 30% qualified = 600 qualified leads
• 600 qualified leads, of which 40% in a qualified conversation = 240 conversations
• 240 conversations, of which 50% with a proposal = 120 proposals
• 120 proposals, of which 40% closed = 48 new customers
• Overall rate: 30% × 40% × 50% × 40% = 2.4%
• New business: 48 × EUR 15,000 = EUR 720,000 annual contract value

The plan for the coming year provides for EUR 1.2 million of new business. That corresponds to EUR 1,200,000 divided by EUR 15,000 = 80 new customers. At unchanged rates, this requires 80 divided by 2.4% = about 3,333 leads, two thirds more than so far. At a cost of EUR 120 per lead, the lead generation budget rises from EUR 240,000 to about EUR 400,000. Sales must hold about 400 instead of 240 qualified conversations (3,333 × 30% × 40%).

Alternatively, a single stage can be improved. If the close rate on proposals rises from 40% to 50%, the same 2,000 leads yield 60 instead of 48 new customers, without additional budget. For the plan of 80 new customers, this alone is not enough. If both levers are combined, the additional requirement falls. The overall rate rises to 30% × 40% × 50% × 50% = 3%, and for 80 new customers 80 divided by 3% = about 2,667 leads suffice. That is one third more than today instead of two thirds, with a lead generation budget of about EUR 320,000.

In due diligence, it is therefore checked whether the financial model includes the additional budget, the additional sales capacity and the lead time of the leads. An assumed higher close rate must rest on a concrete measure, otherwise the plan is reduced to the measured 40%.

Distinction from related terms

• Sales pipeline: the stock of open sales opportunities with name, value and expected closing date on a reporting date. The funnel, by contrast, describes flow and rates over a period.
• Lead generation: the acquisition of the contacts that enter the upper stages of the funnel.
• Customer journey: describes the path from the customer's perspective with all touchpoints. The funnel measures the stages from the sales perspective.
• Retention and expansion after closing: are measured through retention and churn rates (retention rate). Some companies therefore extend the funnel beyond closing.

Common mistakes

• Only the overall rate considered. Without stage rates, it remains hidden at which point prospects are lost and which lever has the greatest effect.
• Blurred transitions. If everyone in the team qualifies by their own standard, the rates are not comparable and are unusable for planning.
• Period rates with long cycles. If closings and leads of the same month are set in relation to each other, the time lag distorts the rates as soon as volume fluctuates.
• Channels thrown together. An average across referrals and paid advertising conceals that the two channels have very different rates and costs.
• No deadline for lost prospects. Without a fixed rule on when a prospect counts as lost, contacts remain stuck in the stages and distort the rates.

Frequently asked questions

What is the difference between a sales funnel and a sales pipeline?

The funnel measures flow and conversion rates over a period, whereas the pipeline shows the stock of open sales opportunities on a reporting date. The funnel answers how many leads are needed for a revenue target; the pipeline, what revenue can be expected from the current sales opportunities.

How many stages should a funnel have?

In practice, four to six are common. Further stages increase the maintenance effort without providing additional insight, and they tempt teams to set transitions by judgement rather than by verifiable criteria.

Over what period should rates be measured?

At least twelve months, and additionally monthly where sales cycles are short. The period should cover several complete sales cycles so that cohorts can be followed through to their outcome.

Does the funnel end with the closing of the contract?

For new customer acquisition, yes. For company value, however, onboarding, renewal and expansion of the contracts also count. Many companies therefore measure these phases with their own rates following the funnel.

What do investors check in the sales funnel?

Whether the rates are measured and stable over several periods, whether they are available by channel and segment, and whether the financial model calculates with the same rates. Deviations between measured and planned rates must be capable of justification.

The Roemer Capital view

In the financial model, Roemer Capital derives new business from the measured stage rates and the lead time of the sales cycle. A growth rate thus becomes a volume calculation that shows how many leads, conversations and proposals are needed in which month and what they cost.

In the cautious case, Roemer Capital sets the weakest stage at the lowest value of the last quarters, and in the optimistic case only improvements for which a concrete measure is named. Investors thus see which assumptions support the plan and can compare them with the raw data in the data room.