the saas business model and metrics
TRANSCRIPT
The SaaS Business Model & Metrics
David Skok, Matrix Partners
Before we get started, there’s one useful concept to discuss…
3 STAGES OF A STARTUPAnd how the CEO should manage the company
Search for Product/Market Fit
Scaling the Business
Search for Repeatable & Scalable Sales Model
Conserve Cash Invest Aggressively
The SaaS Business ModelDavid Skok, Matrix Partners
What we were used to: Licensed Software
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What’s so different about SaaS?
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Cash Flow for a Single Deal
CAC (Cost to acquire the customer) Subscription payments * GM%
Cash Impact of a typical deal
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Negative Cash Flow
If cash flow is bad for one customer, what happens when we grow, and add many more customers?
Modeling a slow increase in the number of customers added every month
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Cash Flows
CAC
SubscriptionPayments
* GM%
Cumulative Cash Flow
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The SaaS Cash Flow Trough
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“The thing that surprises many investors & boards of directors about the SaaS model is that, even with perfect execution, an acceleration of growth will often be accompanied by a squeeze on profitability and cash flow.”
Ron Gill, CFO at Netsuite
What’s the impact of faster growth?
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$10,000,000
$15,000,000
$20,000,000
$25,000,000
2 moreCustomers/Month
5 moreCustomers/Month
10 moreCustomers/Month
What’s the impact of faster growth?
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2 moreCustomers/Month
5 moreCustomers/Month
10 moreCustomers/Month
Cash Flow Trough gets deeper
“As soon as the product starts to see some significant uptake, investors expect that the losses / cash drain should narrow, right?
Instead, this is the perfect time to increase investment in the business, which will cause losses to deepen again.”
Ron Gill, CFO at Netsuite
What typically happens…
Courtesy of Ron Gill, CFO at Netsuite
When your SaaS business is losing money at an increasing rate, how can you tell if the business is going to work eventually?
UNIT ECONOMICSA Powerful Tool
Unit Economics
Can I make more profit from my customers than it costs me to acquire them?
Unit Economics
Cost to Acquire a Customer Lifetime Value of a Customer
CACCAC LTVLTV
A Viable Business Model
CAC
CAC LTVLTV<
But surprising how many Entrepreneurs underestimate CAC
Computing the Customer Lifetime
Customer Lifetime = 1
Churn
How Churn affects LTV
1% 2% 5%$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
$100,000
$50,000
$20,000
LTV vs Churn RateLTV
Monthly Churn
Customer Churn vs $ Dollar Churn
Customer Churn vs $ Dollar Churn
Customer 1$1k MRR
Customer 2$5k MRR
Starting period
Customer 1$1k MRR
Customer Churn vs $ Dollar Churn
Customer 2$5k MRR
Customer 2$5k MRR
Customer 1 Churned50% Customer Churn
17% $Dollar Churn
Starting period A year later
Customer 1$1k MRR
Customer Churn vs $ Dollar Churn
Customer 2$5k MRR
Customer 1$1k MRR
Customer 2 Churned50% Customer Churn
83% $Dollar Churn
Starting period A year later
Customer 1$1k MRR
Negative $ Dollar Churn
Customer 2$5k MRR
Customer 2$7k MRR
Customer 1 Churned50% Customer Churn-16% $Dollar Churn
Starting period A year later
Negative Churn
Expansion Revenue
from Existing Customers
Revenue Lostfrom Churning
Customers>
Implies another part of the Sales Funnel
Expand, Upsell,
Cross Sell
Top of Funnel
Middle of Funnel
Sales
How do we get Expansion Revenue?
If we only have one SaaS product, what more can we sell
the customer?
Variable Pricing AxesA critical factor for expansion revenue
EnterpriseEdition
ProEdition
BasicEdition
Features
Users
EnterpriseEdition
ProEdition
BasicEdition
Features
Users
Depth ofUsage
Examples:- Mailing list size- Database size- Amount of storage used
EnterpriseEdition
ProEdition
BasicEdition
Features
Revenue from one group of customers (cohort) with no upsell/cross-sell
Time
$’s
Upsell revenuefrom the same cohort N
egat
ive
Ch
urn
Revenue from a single cohort
CRR and DRR
CRR: Customer Retention RateDRR: Dollar Retention Rate
Annual Numbers – expressed as a percentageLook at the year ago cohort
WHY CHURN IS SO IMPORTANT
Revenue Lost with 2.5% monthly Churn
Renewals
Lost dueto Churn
YEAR 3
$3m $7m
Becomes harder & harder to
replace this with new bookings
Renewals
Lost dueto Churn
YEAR 6
$30m $70m
Impact of Negative Churn
1 2 3 4 5 6 7
Jan 85% 75% 65% 62% 61% 58% 57%
Feb 87% 78% 70% 67% 63% 59%
Mar 88% 84% 79% 75% 71%
Apr 92% 89% 86% 82%
May 93% 89% 85%
Jun 94% 90%
Jul 96%
Months after starting usage
Coh
ort
Shows improving first month churnShows churn stabilizing
in fourth month
Cohort Analysis
CUSTOMER SUCCESSAn important new function
Customer Success
• Not just the responsibility of Customer Success department• Product
• Design• Quality (response time, bugs and downtime)
• Sales• Don’t over sell the product• Don’t sell the product to the wrong customer types
• Marketing• Marketing to customers, not just prospects
• But good to have single executive who has this as their top priority
Customer Success
Focusing on retention a
month before the contract
expires
Customer Success
Focusing on retention a
month before the contract
expires
Focusing on successful on-
boarding
CHI – Customer Happiness Index
• Find a way to predict the likelihood of churn
• Most common and simple technique: Usage
• More sophisticated:• Score usage of specific features higher than others
• E.g.• Commenting on someone else’s posts on Facebook = Low• Creating your own post = High
High Usage does not correlate with High Value
Usage
Business Value
Optimal
Worst
My Suggestion
• Consider a CHI score based on Business Value achieved, and find a way to measure automatically in the app• Example:
• How many new leads did you bring the customer?• How much did you improve the lead to customer conversion rate?
ANOTHER IMPORTANT VARIABLE
Time to Recover CAC
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Months to recover CAC: 6.3 Months to recover CAC: 12.5
Months to recover CAC: 18.8
Cumulative Cash Flow
Impact of Months to Recover CAC
6.3 monthsto recover CAC
12.5 monthsto recover CAC
18.8 monthsto recover CAC
Cumulative Cash Flow
Impact of Months to Recover CAC
6.3 monthsto recover CAC
12.5 monthsto recover CAC
18.8 monthsto recover CAC
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Months to recover CAC: 6.3 Months to recover CAC: 12.5
Months to recover CAC: 18.8
2x Deeper P&L trough2x longer to reach breakeven
3x Deeper P&L trough3x longer to reach breakeven
Two Guidelines for SaaS success
LTV CAC> 3x
Months to recover CAC < 12 months
Required for Capital Efficiency
What Metrics should we use to measure a SaaS business?
We care about recurring revenue
MRR Monthly Recurring Revenue
ARR Annually Recurring Revenue
Net NewMRR/ACV
Expansion MRR/ACV (Existing Customers)
Churned MRR/ACV(Lost Customers)
New MRR/ACV(New Customers)
Always ask to see Bookings over TimeEntrepreneurs always happy to show their MRR over timeBut this doesn’t tell whether their bookings are growing
Jan Feb Mar Apr May Jun
$(15.0)
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$-
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MRR Bookings
New MRR
Net New MRR
Expansion MRR
Churned MRR
Salesperson Unit EconomicsAnother valuable analysis
How Revenue Builds for a SaaS Salesperson(assuming no ramp up time)
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
$45,000
With Churn of 2.5%
Jan Custs Feb Custs Mar Custs Apr Custs
May Custs Jun Custs Jul Custs Aug Custs
Sep Custs Oct Custs Nov Custs Dec Custs
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
$45,000
With no Churn
Jan Custs Feb Custs Mar Custs Apr Custs
May Custs Jun Custs Jul Custs Aug Custs
Sep Custs Oct Custs Nov Custs Dec Custs
The Cash Flow Gap
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Net profit - New Sales Hire
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MRR vs Expenses – New Sales Hire
MRR
Expenses
CashGap
(Slightly later breakeven point, because Gross Profit is less than MRR)
11 months to breakeven
The SaaS Cash Flow Trough
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Cumulative Net Profit - New Sales Hire
23 Months to get back the investment
Total amount invested:
$110k
But a great return on
investment
Search for Product/Market Fit
Scaling the Business
Search for Repeatable & Scalable Sales Model
Conserve Cash Invest Aggressively
What happens at the company level when we add 2 new sales hires every month?
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$(250,000)
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Net profit
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Cumulative Net Profit
32 Months to get back the investment
Total amount invested:
$2.6m
First profitable month: 21
Worst loss: $190k in month 11
Comparison: hiring one versus two sales people per month
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Net Profit
1 sales hire a month 2 sales hires a month
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Cumulative Net Profit
1 sales hire a month 2 sales hires a month
The time to breakeven remains
the sameThe cash flow
trough is halved
Not adequately shown, but the acceleration after
breakeven is also halved
Salesperson Unit Economics
CAC
OTE LTVQuota<5x
On Target Earnings
A typical good ratio is around 6x in SaaS
Annual up-front paymentInstead of Monthly
What happens if we collect a year’s payment in advance?
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Cumulative Cashflow comparision - monthly
payments vs year in advance
Cumulative Net Profit
Cumulative Net Cash Flows
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Cashflow comparison - monthly payments vs
year in advance
Net profit Net Cash Flows
Eliminates the cash flow trough, and means $35m more cash in this
scenario
Looking at the whole company picture when hiring 2 sales people per month
MORE ON CACThe impact of sales complexity
Sales Complexity
FreemiumNo Touch
Self-Service
Light TouchInside Sales
High TouchInside Sales
Field Sales Field Sales with SE’s
How I assumed the two would relate
A rough estimate of CAC versusSales Complexity
FreemiumNo Touch
Self-Service
Light TouchInside Sales
High TouchInside Sales
Field Sales Field Sales with SE’s
$0-$40
$30 – $200
$300 - $800
$3,000 - $8,000
$25,000 – $75,000
$75,000 – $200,000
Rough Estimates of Cost of Customer Acquisition (CAC)
The relationship is roughly exponential
Clearly adding Human Touch dramatically
increases costs
Sales Complexity
CAC (logarithmic)
10x
10x
10x
Understanding Public SaaS companies
Example Operating Model
Revenue100%
CoGS24%
Sales & Marketing
51%
R&D15%
G&A13% Loss (6%)
Break apart Sales & Marketing
Revenue100%
CoGS24%
Sales & Marketing
51%
R&D15%
G&A13% Loss (6%)
Expansion &
Retention25%
New Customer
Sales26%
To make it comparable with a traditional software business, eliminate New Customer Sales, as those benefit the future
Revenue100%
CoGS24%
Sales & Marketing
51%
R&D15%
G&A13%
Profit20%
Expansion &
Retention25%
New Customer
Sales26%
CoGS24%
R&D15%
G&A13%
Loss (6%)
Expansion &
Retention25%
Profit20%
Expansion &
Retention25%
CoGS24%
R&D15%
G&A13%
Now look at DRR (Dollar Retention Rate):
• Example DRR = 123% (Zendesk’s number)
• The existing customer base with no additional revenue is growing at 23% annually
• So you have a business growing 23% year-on-year, generating 20% Profit
SUMMARY
Summary
• Expect to see the P&L / Cash Flow trough
• Use Unit Economics to evaluate the business
• Look for negative churn, (where DRR > 100%)
• Use SaaS metrics, not traditional metrics
The 3 Keys to SaaS Success
1 Acquisition
2 Retention
3 Monetization
APPENDIXSome more adanced topics
The Magic Number
• In general, I don’t like the Magic Number• Hard to explain and understand
• BUT – a public company may not give:• LTV:CAC ratio• Months to recover CAC
• So use Magic Number to calculate something roughly equivalent• First developed by the Josh James, CEO of Omniture• The key insight - if your Magic Number is:
• Above 0.75 – step on the gas• Below 0.75 – step back and look at your business • Below 0.5 – business probably not ready to expand
The Formula for Magic Number
• QRR[X] = Quarterly Revenue in the current quarter
• QRR[X-1] = Quarterly Revenue in the prior quarter
• Sales & Marketing Expense [X-1] = Sales & Marketing expense in the prior quarter
𝑀𝑎𝑔𝑖𝑐 𝑁𝑢𝑚𝑏𝑒𝑟=(𝑄𝑅𝑒𝑣 [ 𝑋 ]−𝑄𝑅𝑒𝑣 [𝑋 −1 ] )∗4
𝑆𝑎𝑙𝑒𝑠∧𝑀𝑎𝑟𝑘𝑒𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 [𝑋 −1]
𝑀𝑎𝑔𝑖𝑐 𝑁𝑢𝑚𝑏𝑒𝑟=𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛𝑄𝑢𝑎𝑟𝑡𝑒𝑟𝑙𝑦 𝑅𝑒𝑐𝑢𝑟𝑟𝑖𝑛𝑔 𝑅𝑒𝑣𝑒𝑛𝑢𝑒∗4
𝑃𝑟𝑖𝑜𝑟 𝑄𝑢𝑎𝑟𝑡𝑒𝑟 ′ 𝑠𝑆𝑎𝑙𝑒𝑠∧𝑀𝑎𝑟𝑘𝑒𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠
Expressed in a slightly more readable form:
Example Magic Number calculation
Q1 Q2 Q3
Revenue $1,000,000 $1,200,000 $1,500,000
Sales & Marketing Expense $800,000 $900,000
Magic Number 1.0 1.33
2008 Magic Number Graph