When I meet people for the first time and we start talking about what we do and I tell them about the new firm we founded, inevitably the first question people ask me is “Just what is the Rule of 78 anyway?” It’s a great question and I’m frequently surprised that more successful business owners, investors and operators aren’t familiar with the concept behind the Rule of 78.
The Rule of 78 is a mathematical proof that has remarkable impact for organizations that generate recurring billing. If your organization bills your customers on a monthly, quarterly or annual basis for services then you need to understand the power behind the Rule of 78 concept and make sure its working for you and your business. It is the single most important concept to rapidly expand your revenue streams.
Simply put, the Rule illustrates if you sell a consistent amount each month and bill on a monthly basis, what is both the Revenue you will generate that year as well as how much will your Monthly Recurring Billing (MRB) will increase. The chart below demonstrates how the rule works:
If you have just one sales person selling $1.00 of goods per month you will expect to see Revenue of $78 and a gross gain in your MRB of $12. To understand how your revenue will increase from any consistent level of sales, simply multiply the expected monthly sales by 78 to get your Revenue increase. To obtain your MRB gross gain multiply the sales level by 12.
This may sound intuitive but when you carry the process out for two or three (or more) years the compounding impact of the Rule of 78 becomes staggering and demonstrates how a tiny sales effort can lead to massive expansion of revenue. The reason for this is that in the second year of sales, your organization gets to start with the $12 in MRB that you created in the 1st year. You’ll bill that $12 in Jan and Feb and March and so on and so on (forever) for a total of $144 in revenue. In addition, you’ll generate an additional $78 from the work you’ll do selling $1/month in the second year. The graph below illustrates three years of results from just $1/month over three years:
Because of the compounding impact of the Rule of 78, after three years, $1 of sales per month will result in $366 in revenue and $36 in MRB. Still not convinced or understand how this can be impactful? Let’s look at another example with some more realistic sales targets. Lets assume you have a sales force of 10 people and they will sell $500/month each of your service every month. The graph below shows the impact of this output after just three years – again – this is just 10 salespeople selling $500/month:
Pretty remarkable! 10 sales people will generate $1.8MM in revenue and after just three years you’ll have $180k of MRB. In almost no time at all you’ve generated a multi-million dollar revenue stream and your cost structure has remained flat. In my last business we paid 5x commission to the salesperson for their sales. Under my commission structure, my total cost for my sales remained flat at $300,000 ($500 x 10 salespeople x 5commission x 12 months). By the third year in the example above, I would have nearly $1.5MM in profit after my entire sales costs. I’m literally printing money!
Understanding the Rule of 78 and how to apply it to your salesforce, salesmanagers and teams is without a doubt the most important concept you can master.
Written by Bob Boyd – Co-Founder Rule of 78, previously President & CEO of Agility Recovery Solution and board member & coach for numerous successful selling organizations.