This blog post looks at the high level goals of a SaaS business and drills down layer by layer to expose the key metrics that will help drive success. Metrics for metric’s sake are not very useful. Instead the goal is to provide a detailed look at what management must focus on to drive a successful SaaS business. For each metric, we will also look at what is actionable.
Before going any further, I would like to thank the management team at HubSpot, and Gail Goodman of Constant Contact, who sits on the HubSpot board. A huge part of the material that I write about below comes my experiences working with them. In particular HubSpot’s management team is comprised of a group of very bright individuals that are all very metrics driven, and they have been clear thought leaders in developing the appropriate tools to drive their business. I’d also like to thank John Clancy, who until recently was President of Iron Mountain Digital, a $230m SaaS business, and Alastair Mitchell, CEO and founder of Huddle.
Let’s start by looking at the high level goals, and then drill down from there:
Key SaaS Goals
- Profitability: needs no further explanation.
- MRR Monthly Recurring Revenue: In a SaaS business, one of the most important numbers to watch is MRR. It is likely a key contributor to Profitability.
- Cash: very critical to watch in a SaaS business, as there can be a high upfront cash outlay to acquire a customer, while the cash payments from the customer come in small increments over a long period of time. This problem can be somewhat alleviated by using longer term contracts with advance payments.
- Months to recover CAC: one of the best ways to look at the capital efficiency of your SaaS business is to look at how many months of revenue from a customer are required to recover your cost of acquiring that customer(CAC). In businesses such as banking and wireless carriers, where capital is cheap and abundant, they can afford a long payback period before they recover their investment to acquire a customer (typically greater than one year). In the startup world where capital is scarce and expensive, you will need to do better. My own rule says that startups need to recover their cost of customer acquisition in less than 12 months.
(Note: there are other web sites and blogs that talk about the CAC ratio, with a complex formula to calculate it. This is effectively a more complicated way of saying the same thing. However I have found that most people cannot relate well to the notion of a CAC ratio, but they can easily relate to the idea of how many months of revenue it will take to recover their investment to acquire a customer. Hence my preference for the term Months to Recover CAC.)
- Months to recover CAC: one of the best ways to look at the capital efficiency of your SaaS business is to look at how many months of revenue from a customer are required to recover your cost of acquiring that customer(CAC). In businesses such as banking and wireless carriers, where capital is cheap and abundant, they can afford a long payback period before they recover their investment to acquire a customer (typically greater than one year). In the startup world where capital is scarce and expensive, you will need to do better. My own rule says that startups need to recover their cost of customer acquisition in less than 12 months.
- Growth: usually a critical success factor to gaining market leadership. There is clear evidence that once one company starts to emerge as a market leader, there is a cycle of positive reinforcement, as customers prefer to buy from the market leader, and the market leader gets the most discussion in the press, blogosphere, and social media.
Two Key Guidelines for SaaS startups
The above guidelines are not hard and fast rules. They are what I have observed to be needed by looking at a wide variety of SaaS startups. As a business moves past the startup stage, these guidelines may be relaxed.
In the next sections, we will drill down on the high level SaaS Goals to get to the components that drive each of these.
Three ways to look at Profitability
- Micro-Economics (per customer profitability): Micro-economics is the term used to describe looking at the economics of your business on a single customer level. Most business models (with a few exceptions such as marketplaces) are based around a simple principle: acquire customers and then monetize them. Micro-economics is about measuring the numbers behind these two essential ingredients of a customer interaction. The goal is to make sure the fundamental underpinnings of your business are sound: how much it cost to acquire your customers, and how much you can monetize them. i.e. CAC and LTV (cost of acquiring a customer, and lifetime value of the customer). In a SaaS business, you have a great business if LTV is significantly greater than CAC. My rule of thumb is that LTV must be at least 3x greater than CAC. (As mentioned elsewhere in this blog, your startup will die if your long term number for CAC is higher than your LTV. See Startup Killer: The cost of acquiring customers.)
- Overall profitability (standard accounting method): This looks a the standard accounting way of deriving profitability: revenue – COGS – Expenses. The diagram also notes that Revenue is made up of MRR + Services Revenue. Since MRR is such a critical element, there will be a deeper drill down to understand the key component drivers.
- Profitability per Employee: it can be useful to look at the factors contributing to profitability on a per employee basis, and benchmark your company against the rest of the industry. Expenses per Employee is usually around $180-200k annually for businesses with all their employees in the US. (To calculate the number take the total of all expenses, not just salaraies, and divide by the number of employees.) Clearly to be profitable in the long term, you will want to see revenue per employee climb to be higher than expenses, taking into account your gross margin %.
Drill down on MRR
MRR is computed by multiplying the total number of paying customers by the average amount that they pay you each month (ARPU).
- Total Customers: a key metric for any SaaS company. This increases with new additions coming out the bottom of the sales funnel, and decreases by the number of customers that churn. Both of these are key metrics, and we will drill down into them later.
- ARPU – average monthly revenue per customer: (The term ARPU comes from the wireless carriers where U stands for user.) This is another extremely imporant variable that can be tweaked in the SaaS model. If you read my blog post on the JBoss story, you will see that one of the key ways that we grew that business was to take the average annual deal size from $10k, to $50k. Given that the other parts of the pipeline worked with the same numbers and conversion rates, this grew the business by 5x. We will drill down into how you can do the same thing a little further on.
Drill down on Micro-Economics (Per Customer Profitability)
Our goal is to see a graph that looks like the following:
To achieve this, lets look at the component parts of each line, to see what variables we can use to drive the curves:
As mentioned earlier, customer profitability = LTV – CAC.
Drill down on LTV
Drilling down into the factors affecting LTV, we see the following:
LTV = ARPU x Average Lifetime of a Customer – the Cost to Serve them (COGS)
It turns out that the Average Lifetime of a Customer is computed by 1/Churn Rate. As an example, if a you have a 50% churn rate, your average customer lifetime will be 1 divided by 50%, or 2 months. In most companies that I work with, they ignore tracking the average lifetime, but instead track the monthly churn rate religiously.
The importance of a low churn rate cannot be overstated. If your churn rate is high, then it is a clear indication of a problem with customer satisfaction. We will drill down later into how you can measure the factors contributing to Churn Rate, and talk about how you can improve them.
Drill down on CAC
The formula to compute CAC is:
CAC = Total cost of Sales & Marketing / No of Deals closed
It turns out that we are actually interested in two CAC numbers. One that looks purely at marketing program costs, and one that also takes into consideration the people and other expenses associated with running the sales and marketing organization. The first of these gives us an idea of how well we could do if we have a low touch, or touchless sales model, where the human costs won’t rise dramatically over time as we grow the lead flow. The second number is more important for sales models that require more human touch to close the deal. In those situations the human costs will contribute greatly to CAC, and need to be taken into consideration to understand the true micro-economics.
I am often asked when it is possible to start measuring this and get a realistic number. Clearly there is no point in measuring this in the very early days of a startup, when you are still trying to refine product/market fit. However as you get to the point of having a repeatable sales model, this number becomes important, as that is the time when you will usually want to hit the accelerator pedal. It would be wrong to hit the accelerator pedal on a business that has unprofitable micro-economics. (When you are computing the costs for a very young company, it would be fair to remove the costs for people like the VP of Sales and VP of Marketing, as you will not hire more of these as you scale the company.)
When we look at how to lower CAC, there are a number of important variables that can be tweaked:
- Sales Funnel Conversion rates: a funnel that takes the same number of leads and converts them at twice the rate, will not only result in 2x more closed customers, but will also lower CAC by half. This is a very important place to focus energy, and a large part of this web site is dedicated to talking about how to do that. We will drill down into the Sales Funnel conversion rates next.
- Marketing Program Costs: driving leads into the top of your sales funnel will usually involve a number of marketing programs. These could vary from pay per click advertising, to email campaigns, radio ads, tradeshows, etc. We will drill down into how to measure and control these costs later.
- Level of Touch Required: a key factor that affects CAC is the amount of human sales touch required to convert a lead into a sale. Businesses that have a touchless conversion have spectacular economics: you can scale the number of leads being poured into the top of the funnel, and not worry about growing a sales organization, and the associated costs. Sadly most SaaS companies that I work with don’t have a touchless conversion. However it is a valuable goal to consider. What can you do to simplify both your product and your sales process to lower the amount of touch involved? This topic is covered at the bottom of a prior blog post: Startup Killer: the cost of acquiring customers.
- Personnel costs: this is directly related to the level of touch required. To see if you are improving both of these, you may find it useful to measure your Personnel costs as a % of CAC over time.
Drill down on Sales Funnel Conversion Rates
The metrics that matter for each sales funnel, vary from one company to the next depending on the steps involved in the funnel. However there is a common way to measure each step, and the overall funnel, regardless of your sales process. That involves measuring two things for each step: the number of leads that went into the top of that step, and the conversion rate to the next step in the funnel (see below).
You will also want to measure the overall funnel effectiveness by measuring the number of leads that go into the top of the funnel, and the conversion rate for the entire funnel process to signed customers.
The funnel diagram above shows a very simple process for a SaaS company with a touchless conversion. If you have a conversion process involving a sales organization, you will want to add those steps to the funnel process to get insights into the performance of your sales organization. For example, your inside sales process might look like the following:
Here if we look at the closed deals and overall conversion rates by sales rep, we will have a good idea of who our best reps are. For lower performing reps, it is useful to look at the intermediate conversion rates, as someone that is doing a poor job of, say, converting demos to closed deals could be an indication that they need demo training from people that have high conversion rates for demos. (Or, as Mark Roberge, VP of Sales at HubSpot, pointed out, it could also mean that they did a poor job of qualifying people that they put into the Demo stage.)
These metrics give you the insight you need into your sales and marketing machine, and those insights give you a roadmap for what actions you need to take to improve conversion rates.
Using Funnel Metrics in forward planning
Another key value of having these conversion rates is the ability to understand the implications of future forecasts. For example, lets say your company wants to do $4m in the next quarter. You can work backwards to figure out how many demos/trials that means, and given the sales productivity numbers – how many salespeople are required, and going back a stage earlier, how many leads are going to be required. These are crucial planning numbers that can change staffing levels, marketing program spend levels, etc.
Drill down by Customer Type
If you have different customer types, you will want to look at all the CAC and LTV metrics for each different customer type, to understand the profitability by customer type. Often times this can lead you to a decision to focus more energy on the most profitable customer type.
Drill down into ROI per Marketing Program
My experiences with SaaS startups indicate that they usually start with a couple of lead generation programs such as Pay Per Click Google Ad-words, radio ads, etc. What I have found is that each of these lead sources tends to saturate over time, and produce less leads for more dollars invested. As a result, SaaS companies will need to be constantly evaluating new lead sources that they can layer in on top of the old to keep growing.
Since the conversion rates and costs per lead vary quite considerably, it is important to also measure the overall ROI by lead source:
Growing leads fast enough to feed the front end of the funnel is one of the perennial challenges for any SaaS company, and is likely to be one of the greatest limiting factors to growth. If you are facing that situation, the most powerful advice I can give you is to start investing in Inbound Marketing techniques (see Get Found using Inbound Marketing). This will take time to ramp up, but if you can do it well, will lead to far lower lead costs, and greater scaling than other paid techniques. Additionally the typical SaaS buyer is clearly web-savvy, and therefore very likely to embrace inbound marketing content and touchless selling techniques.
From Alistair Mitchell, CEO of Huddle: “Just calculating CAC can be extremely complicated, given the numerous ways in which people find out about your service. To stop getting too bogged down in the detail, its best to start with a blended rate that just takes your total spend on marketing (people, pr, acquisition etc) and split this across all your customers, regardless of type or source. Then, once you’ve got comfortable with that, you can start to break CAC down by the different customer types and elements of your inbound funnel, and start measuring specific campaigns for their contribution to each customer type.”
Drill down into Churn Rate
As described in the section on LTV, Churn Rate has a direct effect on LTV. If you can halve your churn rate, it will double your LTV. It is an enormously important variable in a SaaS business. Churn can usually be attributed to low customer satisfaction. We can measure customer satisfaction using customer surveys, and in particular, the Net Promoter Score.
If you are using longer term contracts, another key metric to focus on is renewals. From John Clancy, ex-President of Iron Mountain Digital: “
Non-renewals add to churn, but they can have different drivers. We spent a lot of time examining our renewal rates and found that a single digit improvement made a huge difference. Often times the driver on a non-renewal is economic – the internal IT department has mounted a campaign to bring the solution back in house. SaaS businesses need to identify renewal dates and treat the renewal as a sales cycle (it’s much easier and less expensive than a new sale, but it deserves the same level of attention) Many SaaS businesses make the mistake of taking renewals for granted.”
A good predictor of when a customer is about to churn is their product usage pattern. Low levels of usage indicate a lack of commitment to the product. It can be a good idea to instrument the product to measure this, looking for particular features our usage patterns that are correlated with stickiness, or a likelihood to churn.
Another measurement tool that can be very useful in understanding churn is to look at a Cohort Analysis. The term cohort refers to a group of customers that started in the same month. The reason for doing this is that churn varies over time, and using a single churn number for all customers will mask this. Cohort analysis shows:
- How churn varies over time (the green call out below).
- How churn rates are changing with newer cohorts, (the red call out below) For example in the early days of your SaaS company, you may have serious product problems and lose a lot of customers in the first month. Over time your product gets better, and the first month churn rate will drop.
Cohort analysis will show this, instead of mixing all the churn rates into single number.
Here’s a comment on Cohort Analysis from Alastair Mitchell, CEO of Huddle: “I actually think this is more important than churn, for the simple fact that churn varies over the lifetime of a customer cohort, and just looking at monthly churn can be very misleading. Also, given the importance of payback in a year – you really want to look at churn over the course of a 12 months cohort. For instance, in the first 3 months of a monthly paying customer you will see high churn (3 is a recurring ‘magic’ number in all of retail), then reduced churn (sometimes even positive churn) over the next 3 months less and then probably more stable spend over the next 6 months. The number you really care about is the % of customers spending after 12 months (not necessarily on a monthly basis) as that’s what matters for your CAC payback calculations.”
Two variables that really matter
As we saw above, there are two variables that have a huge effect on a SaaS business: funnel conversion rate, and churn, and it is not a bad idea to graph them as shown below.
Drill down into ARPU (Average Revenue per Customer)
ARPU is often different for different customer categories, and should be measured separately for each category. It can usually be driven up by focusing on:
- Product Mix: adding products to the range, and using bundles, and cross-sell and up-sell
- Scalable Pricing: there are always some customers that are willing to pay more for your product than others. The trick is developing a multi-dimensional pricing matrix that allows you to scale pricing for larger customers that derive more value from the product. This could be pricing by the seat used (Salesforce.com), or by some other metric such as number of individuals mailed in email campaigns (Eloqua).
If you are using scalable pricing, it will be valuable to measure what the distribution is of customers along the various axes. You could imagine taking an action to do after more seats inside of existing customers as a way to drive more revenue. etc.
Drill down into Cash
We already discussed Months to recover CAC as a key variable. There is another way to affect Cash: which is using longer term contracts and incenting your customers to pay for 6, 12, 24, or even 36 months up front in advance. This can mean the difference between needing to raise tons of venture capital and giving away ownership, or being able to grow the business in a self-funded manner. Given the cost of capital, you can often calculate what discount makes sense. (If capital is cheap and freely available, it doesn’t make sense to give much discount.)
If you do use longer term contracts, it will be important to measure “Discretionary Churn”. Since some of your customers are locked in and cannot churn, they could artificially lower your overall churn numbers. The way to understand what is really going on is to look at the discretionary churn, which is the churn rate for all customers that are at the point where they have the option to churn, removing those whose contracts would have prevented them from churning.
Cash Management and forecasting
Cash is one of the most important items to get right in any startup. Run out of cash, and your business will come grinding to a halt regardless of how good any of your other metrics may be. One of the most important ways to run a SaaS company is to look at CashFlow profitability (not recognized revenue profitability). What is the difference: If your business only gets paid month by month, there will be no difference, but if you get longer term contracts, and get paid in advance, you will receive more cash upfront than you can recognize as revenue, so your cash flow profitability will look better than your revenue profitability, and is a more realistic view of whether you can survive day to day on the money coming in the door.
Here is another comment from Alastair Mitchell of Huddle on this topic: “SaaS companies tuning their model should think not just in terms of the months to recover CAC, but also the topline amount of cash required to get to cashflow profitability (or the next funding round). This is probably the single biggest mistake I see in early stage companies. They don’t look ahead, using these metrics, to figure out that if the time to repay CAC is 12 months, then in aggregate they are going to need 12 months of CAC spend PLUS the number of months required of further growth to cover their operating costs (mostly engineering) BEFORE they are even cashflow positive (let alone revenue profitability). Most businesses I see fundamentally miss this and end up short; frequently through under-estimating the time to recover CAC, and churn. The readers of this blog should be focused on cashflow profitability, not revenue profitability. (Hence why your point about annual/upfront contracts is so important)”
Drill down into Growth
Focusing on Growth as a separate parameter can be highly valuable. It is the nature of a SaaS business to grow MRR month on month, even if you only added the same number of customers every month. However your goal should be to grow the number of new customers that you sign up every month. You can do this by focusing on:
- Improvement in the overall funnel conversion rate
- Lead Generation Growth
- Growth in Funnel Capacity
The first two have been covered already. The last bullet: Growth in Funnel Capacity is an often overlooked metric that can bite you unexpectedly if you don’t pay attention to it. In my second startup, I had a situation where sales growth stalled after growing extremely rapidly for a couple of years. The problem, as it turned out, was that we had stopped hiring new sales people after reaching 20 people, a number that felt very large to me, and had maxed out on sales capacity. We started sales hiring again, and a couple of years later the business hit a $100m run rate. I witnessed a similar phenomenon at Solidworks, when after 2-3 years of phenomenal growth, their growth slowed. It turned out that their channel sales capacity had stopped growing. Solidworks started measuring and managing something that would later turn out to be a critical metric: channel capacity in terms of the number of FTE (Full Time Equivalent) sales people in their channel, and the average productivity per FTE. This has helped propel them to over $400m in annual revenues.
Another great way to grow your business is by adding new products that can be up-sold, or product features that can lead to a higher price point. Since you already have a billable contract, it is extremely easy to increase the amount being charged, and this can often be done with a touchless sale.
Other Metrics
There are a series of less important metrics that can still be useful to be aware of. I have listed some of these in the diagrams below:
After posting the above, I received a note from Gail Goodman of Constant Contact, noting that they include the cost of on-boarding a customer in CAC, not LTV as I have shown. Given that they are a public company with significant accounting scrutiny, this is likely the right way to do things.
Conclusions
If you have kept reading this long, it likely means that you are likely an executive in a SaaS company, and truly have a reason to care about this depth of analysis. I would very much like to hear from you in the comments section below to see if I have missed out on metrics that you think are important.
The main conclusion to draw from this article, is that a SaaS business can be optimized in many ways. This article aims to help you understand what the levers are, and how they can affect the key goals of Profitability, Cash, Growth, and market share. To pull those levers requires that you first measure the variables, and watch them as they change over time.
It also requires that you implement a very metrics driven culture, which can only be done from the top. The CEO needs to use these metrics in her staff meetings, and those execs need to use them with their staff, etc. Human nature is such that if you show someone a metric, they will automatically work to try to improve it. That kind of a culture will lead to true operational excellence, and hopefully great success.
David – thanks for this incredible post. I will have to brake it down to pieces and start analyzing my startup rigorously according to what you are saying here. I will get back to you if I find unclear things.
David, I have been following your blog for a while and I have to say that many of your posts blow me away in actual usefulness. Thank you for drilling down actionable topics in such a clear manner.
THank you for the post, it's quite amazing.
Thanks Luc. It is great to hear positive feedback!
in one word – wow!
I'm going to print this post are read it again and again
One of the big lessons that we learned in metric driven businesses in the late 90's (if.com and Direct Line Financial Services) is that you need to 'build to be measured'. When you build your systems you want to be able to, for instance, cohort-mark all your measurements so that you can create cohort-based metrics.
Alistair Mitchell of Huddle makes the valuable point about blending some of your metrics (when you lack the volume of business and resources to respond to unblended metrics) but you also need to design out un-de-blendable metrics – by that I mean measurements that aren't marked properly so you can break them out.
Design-to-be-measured also address the sticky problem of metrics-by-proxy where some thing that you have captured for operational reasons (eg a db write as part of a process) is used as a proxy for something else (this db write 'means' that the customer has successful done X/means Y/is in segment Z). Metrics-by-proxy acquire a meaningful name and are invested with all sorts of meaning, and can be simply aftefacts of software design and thoroughly misleading.
Cohort-based metrics are key here. One of the problems is that you are trying to measure the effect of multiple channels simultaneously, changes in product, pricing, source of leads, support, and so on and so forth. The cohort is the basic unit where all customers have the most similar experience. Your 12th month cohort should be wildely different to your 1st month cohort in a whole squad of ways. You are trying to do 2 things – massage a group of existing customers into a more valuable relationship with yourself – but also find better customers. These 2 desires interact in your metrics – but you only care about the result.
One of the lessons we learned in metrics-driven businesses (if.com, Direct Line Financial Services) in the late 90s is the necessity to 'design-to-be-measured'. Alistair Mitchell of Huddle makes a good point about blending your metrics (when the level of detail is too granular to be actionable because of resource constraints, immature processes, etc, etc). The other side of that is when you can't un-de-blend things. Data is captured, but not marked in a way that you can cohort it. So you know that 'users' do X here but not 'which users'.
Often this appears as 'metric-by-proxy' where an action (which is an artefact of how you have implemented a process) is taken to mean that the user did X/intended Y/achieved Z. Metrics-by-proxy can acquire a dangerous life and be quite misleading.
Your business model needs to be driven into the design and specification process – which is difficult. Often the business model only appears after customer/product fit – ie well after the base product is built. So your spec teams need to think through their possible Management Information issues up front – when the don't know what they will actually be.
Sorry usability problem here. I wrote a post submitted it and it appeared it had been eaten. So I reposted it. Turns out it hadn't been eaten at all – hence 2 'similar' posts.
We are an early stage SaaS startup, and we would like to implement this type of metrics-driven analysis from the very start. Are there any tools or products beyond simple csv exports and excel that can be used to do this analysis?
Richard, the products that I have seen work in my portfolio companies are a combination of three elements: HubSpot for Inbound Marketing, one of several marketing automation tools for Lead scoring and Lead Nurturing and campaigns (Marketo, Eloqua, etc.), and CRM (usually Salesforce.com or SugarCRM). I checked your blog and it seems that you already know about HubSpot. They are adding more and more lead nurturing tools, so over time you should be able to get away with using just them and a CRM product. You will likely need to spend some money to customize the CRM tool over time, but not critical when volumes are low in the early days.
Sadly they will not automatically spit out all the reports that you need. At some point in time, the best advice I can give you is to add a person to the sales/marketing team that knows how to program salesforce.com, and can write some automations. A tool like Cliqview may also be helpful. (Excuse my positive comments about HubSpot as a board member and investor. However I am a major fan of what they do.)
David,
Great post with an august group of contributors. :~)
My name is Bill Flynn, GM of 123together.com, a division of mindSHIFT Technologies. We are a SaaS company in the IT space focusing on email and other productivity apps. We derive a significant majority of our customers online by offering a 30-day no obligation trial. This is a tool used by many SaaS providers to facilitate signup. From this we have learned to track one additional metric beyond what you have provided here. We track something we call an “accidental customer”. That is, someone who signed up, went past the 30 day trial period and was subsequently billed. However, they did not intend to sign up sometimes even after 2 billing periods! They just forgot to cancel. We have specific logic in our system that does not count a customer as a true customer until they have passed a couple of hurdles that show us that they truly intended to signup and stay with the service. Without this metric, we would tend to overcount conversion. I hope you and your readers find this useful.
Thanks Bill. Very interesting comment. Is there any negative reaction when these accidental customers find out they were billed when they forgot to cancel? How do you handle it if there is?
I assume this means that you ask for credit card info before they can start a trial? Have you A/B tested the conversion rates when you don't ask for credit card info up front. I know that when I'm asked to give credit card info before a trial I will rarely go forward with it because of the fear of not remembering to cancel.
Thanks, David
Hi David,
We recently had a demo from HubSpot (by Mary Rogul, a wonderful salesperson by the way), and I saw that they are explicitly integrating with SalesForce. Are they moving towards becoming a one-stop-shop for metrics like the ones you describe? That is extremely appealing to me, especially since I am a technical founder and am having to learn the business components as I go. I would guess there is a wider market than early stage SaaS startups for this type of “metrics aggregation” tool.
P.S. I never have seen a tool that automatically spits out the reports I need. Now that's a great business idea!!
Bill,
From your comment above, I infer you ask for credit card or other billing information in your free trial form. When you made this decision, were you worried about the additional friction created by asking for that information up front? Also, had you considered a “freemium” model instead of the free trial model (i.e. up to 10 users is free, the 11 user incurs the monthly cost)?
Thanks!
Rich Wilner
http://www.sagepointsoftware.com
blog.sagepointsoftware.com
Bill,
I infer you ask for credit card or other billing information in your free trial form. When you made this decision, were you worried about the additional friction created by asking for that information up front? Also, had you considered a “freemium” model instead of the free trial model (i.e. up to 10 users is free, the 11 user incurs the monthly cost)?
Thanks!
Rich Wilner
http://www.sagepointsoftware.com
blog.sagepointsoftware.com
First of all, this is one of the best posts on SaaS metrics I have read, bar none. The one thing that always seems to be missing for me are channels. Yes, it's clear that self-service credit card transactions are attractive, however most of the SaaS vendors I've seen have relied almost exclusively on their own direct and/or inside sales force. Why so little on Channels? Is the value prop just not there for multi-tier distribution models?
Hi Dave, great article. Churn seems to be one of the biggest hurdles for SaaS businesses in the CRM space. You mention briefly that one way to understand churn is to have instruments in the product to measure usage rates. Measuring churn is one thing but it seems that the effort should be on making the product more attractive to interaction to avoid churn in the first place. One of the things I've noticed about CRM systems in general is that the effort required to manage or input daily data is too much for the average small business person. Over time they realize that the tool is not going to replace good old fashioned hard work and they simply turn it off. I'm dying to see a tool that actually does remove the effort of managing a CRM by making the tools super fun and attractive to use (and not necessarily because everything is apparently automated).
Good point on channels, I have two thoughts. First off, channel partner metrics can be added into many of the drill downs David mentions in this blog, including customer profitability, growth, CAC and conversion rates Secondly, there are very few examples of multi-tier distribution models for SaaS companies. I believe this has less to do with value add and is more related to economics. Traditional channel partners rely on resale or transfer of title, Most SaaS businesses are not resold because they can reach the customer directly and do not need to pay a resale “tax” of 10% to 30% for customer access. Therefore channel partners need to focus on other value added areas that enhance the SaaS experience such as consulting or application / API extensions to the service. I am a big believer in the power of channels, however, traditional channels will need to re-invent themselves in order to be successful in the world of SaaS
David,
Thanks for another solid article. I cannot agree more with how important tracking these key metrics is to building a successful recurring revenue business.
Question – The article states “CAC = No of Deals closed / Total cost of Sales & Marketing” Shouldn't it actually be CAC = Total cost of Sales & Marketing / No of Deals closed to get the Costs per Deal?
Thanks again,
Scott Bennion
Jaspersoft CFO
Saas business in a nutshell. It doesn't get more straightforward than this. Excellent!
Scott, you are quite right. Good catch! I have corrected the post. Thanks!!
Dave, great review. On the MRR analysis, it can also be useful to group cohorts by product mix/usage, because ARPU by product doesn't give the full picture around volume and longevity. Start-ups tend to have a wealth of product ideas. Figuring out which ones are driving growth means the company can better focus its limited resources. Finding the right balance between innovation and focus is always a challenge.
Tom, agreed, this is a very good point. If the SaaS company has either multiple customer segments, or products, or specific product areas that some customers use, it can be very valuable to do most of the analyses above by customer segment, and/or by product.
They already have some of the metrics that I mention such as tracking web traffic by source through to closed deal, which can be extremely valuable. Over time, I believe they plan to tackle more and more of these metrics, but not just for SaaS companies as they need to remain more generalized. This provides the marketing person with the key info they need to present to the CEO/board.
My apologies, I did not mean to give the impression that the SaaS model cannot work through channels. A great example of how a SaaS business is working to take advantage of channels can be found in today's announcement from HubSpot: http://www.hubspot.com/blog/bid/5618/Transformi....
Adding to what John Clancy wrote, the one pattern that I have observed is that traditional product selling channels don't do as well selling SaaS products as they are not used to selling small amounts of recurring revenue. However services companies that sell some form of service do like selling SaaS, as SaaS is really about a service, not software, and it complements their own services.
Richard, great point. One of the top reasons for churn is that the product is either hard to use, or not providing enough value. I should have mentioned this. (In the CRM example you describe, the tool provides value to the Sales manager who needs to manage the pipeline, but often does not provide enough value to the individual sales person. They often fight using it as it adds more work for them.)
David. I would very much like to not ask for credit card and test the throughput but in our business the impact of spammers is relevant, prevalent and detrimental. One of the ways that we filter these folks out is to ask for a credit card. It creates enough of a barrier to keep the issue to a minimum. We are working on other ways to limit our exposure to spammers such as a governor on the amount of email sent during the trial period until the credit card is offered. If other folks with similar issues have other ideas, I would love to hear them.
David,
Great blog on a topic that all SaaS Company Executives should put under their pillows so they absorb all of it and apply it within their businesses every day to measure how they are doing..
We are big fans of using Metrics/KPI's around the economic model of the portfolio companies we invest in. In fact every quarter we do an operational review with each company where we review the metrics with the management team and look for areaqs that we can improve upon which is the way you build great companies. As you mention in the end… it starts with the CEO… if he pays attention to these metrics everyone else within his company will too!
G
Wow great write up!! Thanks. I am involved with a few start ups at the moment and we are about ready to flip the switch and go live. Put our products out there and attempt to make money. You just did a great job highlighting many management aspects we need to start thinking about. Thanks.
Applications like SalesView are making data available within CRM applications, and automate the data entry process. This creates value for the sales reps, eliminate busy work, and increases CRM utilization.
Dave, thanks for an excellent post. You’ve covered how things should be measured in a SaaS company, and it was very interesting to compare your foundation against the findings of The SaaS & Support Project research. Let me touch on a few key points, but I’d love to have an opportunity for more in-depth discussion with you later. 1) Using longer-term contracts with advance payments can indeed help alleviate some cash problems, but there’s a risk as well, (which you point out later) in that this may tend to cloud churn monitoring. To that, I’d add the observation that it can also tempt your senior people into thinking like traditional-model software companies – ie., take the money and run. 2. It’s one thing to identify the metrics that matter (and again, you’ve done an excellent job at it!), but unfortunately it’s often another to actually do the tracking. CEOs need to ask themselves “Who in my organization is chartered and incented to own and track these numbers?” The results from the Project research all too often indicated the uncomfortable answer: no one. In the surveying and interviewing, we turned up indicators that point to a severe lack of designated and accountable ownership for the ongoing customer relationship. Buttressing that finding, the most common “Departure Driver” for customers was given as Divorce, where the customer’s management team lost connection with the SaaS Vendor. Here, too, you point right at the key problem with your quote from John Clancy: “Many SaaS businesses make the mistake of taking renewals for granted.” 3) Your final comment ought to be blazoned across every SaaS company CEO’s office wall: “It also requires that you **implement** a very metrics driven culture, which can only be done from the top.” Only the CEO can make the organizational changes that are required.
–mikael
Mikael Blaisdell
TheHotLineMgazine.com
The SaaS & Support Forum on LinkedIn
I think in many cases it is a contributing factor that there is simply not enough upfront revenue in the sale to create appropriate incentive for the channel partner, unless indeed they are open to long term revenue share deals.
I think that is right. I have heard from the owners of VARs that they are interested in building up recurring revenue, but when they actually look at the return versus the selling work and compare that with the money they can get selling something else such as VMWare and a nice big storage box, it doesn't look that attractive.
This is one of the most useful things I've ever read.
David, really nice article. We are on the verge of a restricted beta for our first ever SaaS product – and clearly we have been somewhat obsessed in getting something out the door and done far too little along the lines of what you have outlines. As several of the other folks commented we'll be printing this and reading it, I suspect, multiple times. While we have tracked HubSpot, Eloqua, Marketo and others of their ilk, you have given a great sense of what they do and how to bring it all together to drive CAC down and profits up. The only good (or bad, depending on your view) news seems to be that all of us are learning still as to how to make SaaS work. Thanks again for sharing in such length and depth and in a language and level of abstraction that mere mortals can get it!
Great article David, and thanks especially for the comment responses below on the best products for executing on this.
Hi David,
This is undoubtedly the best way to estimate profitability of SaaS that I have come across.I just wanted to ask: Apart from using the churn rate to calculate the average lifetime, how else would you calculate the average lifetime of a customer?
In a recurring revenue situation the best way I know to compute LTV is to take the total monthly recurring revenue and divide by the number of customers to get to the ARPU (average monthly revenue per customer). Then to get to LTV, divide ARPU by the monthly churn rate. There can be additional elements if the customer is purchases additional elements, or expands/contracts their installation and changes their payment amount.
In some situations, the churn rate can even go negative, which means that the average revenue per customer increases annually, despite some customer losses, (due to upsell/cross sell).
Let me know if this didn't answer your question.
Tim, sadly there are no good tools that I have yet found that will automatically collect this data. The companies that I work with use a combination of Salesforce.com, HubSpot, and some marketing automation tool like a Marketo or Eloqua. They then have a very good sales operations person that knows how to extract the data from these systems to create the appropriate reports.
I would love to hear if any other reader has found a better solution.
Hi David, here at GoodData we automate the collection of data from Salesforce.com and other S&M sources and distribution of reports, dashboards and metrics. Check out the video of our user Gazelle, one of the most metrics-driven companies I have ever seen: http://www.vimeo.com/10020004
Thanks Roman. What other sales and marketing sources are you able to gather data from? Do you include HubSpot, Eloqua, Marketo, etc.? Also are you able to collect data from all the various web tracking sources such as Omniture, Google Analytics, Feedburner, etc.?
One of the most comprehensive commentaries on low cost customer acquisition and customer retention I've read. Low cost customer acquisition is all about using online multi-touch programs, automated lead scoring & lead routing to reduce cost of sales & increase conversion rates.
Absolutely agree that a subscription renewal needs to be sold as the customer has choice. If the customer has not received value from the product during the initial term of the subscription it is much harder to recapture the subscription at renewal time.
IMO there are a few other critical components post initial customer acquisition which impact the renewal rate and the cost to renew 1) attach rate (actual usage) in the first 90 days, 2) consistent customer touch programs highlighting features and benefits of product during term of subscription through “customer only” online (low cost) mechanisms and 3) capturing specifics of usage. This makes it easier to renew the subscription because the sales rep has insight to if/how the customer has received value from the product.
Excellent article. Would also like to know how to differentiate between monthly and yearly payments by customers when calculating ARPU and other monthly stats.
Yearly payments in advance make a huge difference to cash flow (and hence the time to recover the cost of customer acquisition). So the upfront nature of the payment needs to be taken into consideration in certain of the metric calculations. However for anything calculating LTV, or EBITDA, you will need to use the monthly recognizable revenue. Best, David
So, if the customer has paid for a year in advance, is it ok to divide that by 12 and spread it across the next 11 months?
Yes
Best, David
Have you given any thought to the idea of ARFU? Average Revenue FROM User.
This could be generated by behaviors that trigger sponsor/affliliate revenues ($$ from online page impressions or click throughs for instance)
Andrew, I am not sure exactly what you mean by this term. Could I ask you to elaborate, perhaps using an example to illustrate. It sounds like an interesting concept. Thanks, David
Hi David,
Would you say that any SaaS startup with funding ($500k or more) should have a setup where it uses marketo or eloqua or something equivalent? I mean say you invest in a SaaS company, would you strongly advice the management to setup something like this or it is doable without this and more of a manual way?
I'm currently in the planning stage of my next venture and of course, as every comments, I find your article very valuable. I checked the tools mentioned and they all cost about $1k per month, so having 1-3 of these tools, I need to budget them
What do you think?
Hi David … firstly I'd just like to say thanks for the fantastic post … it would likely have taken me weeks to put all the pieces of this jigsaw together and even though it's a long post once through it all is good … if you and your readers are interested I've put all this together in 1 slide which I can send over if you like
Quick observation about Gail Goodman's point about where to put COGS. The side you choose could have quite a large impact on how 'rosy' your figures look. The reason being that you are looking for that min 3x multiple of LTV over CAC.
If you put COGS on the CAC side then your resulting multiple will look worse than if you put it on the LTV side (because to get this multiple you are dividing LTV by CAC).
It would be good to know whether this is one of those 'open to interpretation' things or whether there's a definite correct answer.
The reason being I could see a situation where internally it might be prudent to keep COGS on the CAC side to ensure you are being conservative with your position but then when it's time to go public (or raise money perhaps) you could switch COGS over to the LTV side to make that multiple look more attractive.
Have you any thoughts on this?