Scott Maxwell, a VC who typically invests in expansion stage companies has just started a blog called Now What?. Only his third post and he has already hit a high-note with his comments on Funnel Economics:

Funnel Economics is essentially how much money do you spend on the funnel (in the form of sales and marketing expenses) vs. how much money (in the form of Gross Profit) drops out of the funnel? In this sense, Sales and Marketing is a money machine (remember that magic trick where you put a dollar in, turned the handle, and you got $10 out?) when done right (and a money sink when done poorly). from Funnel Economics-an Introduction

A few days ago Peter and Chris and I were talking about our accounting system and how hard it is to device good accounting for software businesses. In business school we talk a lot about variable and fixed costs, break even analysis, and other techniques developed over the years to help manage production-oriented businesses. But in a software business like ours there really are very few “variable” or “fixed” costs in the traditional sense.

To me, a software company has a certain set of expenses that are roughly fixed for a given number of users. This includes things like hosting costs, support, development, and overhead. Then you have your cost of sales—what you spend to acquire and retain your customers.

Your cost of sales is the money you spend on your sales funnel. You put money in to attract and close customers. The real trick is to get your sales funnel working so that you can put some money into it and have enough coming out of the bottom to cover both your cost of sales and overhead. That’s Funnel Economics. I would call it a Business Model.

Scott says you probably don’t need to think about these economics too much until you have a product or some customers. I think its worth at least taking a guess on how you expect your sales funnel to work when you first get started so you have some idea of whether your business will ever be able to turn a profit.

It’s also important to think about your funnel from the beginning because it will help you focus on what’s most important for a business in the end, which, as Scott points out, is tuning your funnel to turn a profit.

Anyway, Scott’s blog looks really promising. If he continues with these kinds of insightful postings, it will definitely be worth your time. Take a look