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Archive for the category: SaaS Metrics

The Metrics-driven SaaS Business

saas business metricsMy first serious lesson in the criticality of SaaS metrics was about six years ago when I was unexpectedly stumped in a board of directors meeting. I had just presented the booking plan for the year and one of the Director’s in the meeting said that the plan was good, but we really needed to increase our booking rate. My first reaction was something like: “Well our current booking rate is pretty strong and we’re a SaaS business, so even with no immediate improvement to bookings we’ll continue to pile up revenue quarter after quarter, right?” Wrong! I had totally neglected the impact of churn. At the time, SaaS investors and executives were still getting their heads around the SaaS recurring revenue business model, so there were very few resources to turn to for support. Yet as the person in the room primarily accountable for the top line, I had to have the answer.

Fast forward to today. In 2014, we not only have a much better understanding of the financial levers that drive SaaS business success, we are on the verge of a metrics revolution in the way SaaS businesses are managed. Unlike licensed enterprise software, the SaaS recurring revenue business model offers a much higher degree of stability, measureability and predictability. These three factors form a foundation that enables SaaS executives to take a much more analytical approach to driving SaaS business success. SaaS business executives are uncovering new operational metrics that connect SaaS customer success to SaaS financial success, and in the process are creating recurring revenue machines. Today we are witnessing the emergence of The Metrics-driven SaaS Business.

metrics driven saas business machine

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This is the first post in a new SaaS metrics series inspired by my ongoing collaboration with Bluenose Analytics. This series explores the promise of customer success metrics and their role as the glue that connects SaaS customer success to SaaS financial success. This first post discusses the unique qualities of SaaS that enable a more analytic approach to management than was possible with licensed enterprise software and introduces the concept of the Metrics-driven SaaS Business.

The SaaS Metrics Mandate

Why are metrics so uniquely important in SaaS? Read more »

Negative Churn | It’s Not that I Don’t Dislike It, I Do

negative churnMost of us were taught at an early age that double negatives are a bad thing, because they are unnecessarily complicated and increase the chances of miscommunication. It is with this principle in mind, that I propose that we permanently ban the ridiculous term “negative churn” from the SaaS metrics vocabulary. Churn is negative growth. Negative churn is simply growth.

Many of my esteemed SaaS colleagues have casually adopted the negative churn idea without issue, such as this post by David Skok, and this one by OpenView Partners, and this one by Lincoln Murphy, and to my knowledge the very first one by Daniel Drucker who attributes the origin of negative churn to the folks at Bessemer Venture Partners. A very prestigious group of SaaS metrics experts indeed. So, what’s got my goat?

SaaS Growth vs. SaaS Churn

Negative churn implies that the economics of SaaS growth are the same as SaaS churn, only reversed. This is not the case. The business processes and customer decisions that drive SaaS growth are fundamentally different from those that drive SaaS churn. For example SaaS growth might be driven by a sales process that targets a customer need, whereas SaaS churn might be driven by a customer going out of business. As metrics, these numbers are intended to measure those processes. When they are commingled, they lose their value.

Read more »

What is MRR Churn? | SaaS Metrics FAQs Part 2

saas mrr chrunSince publishing the original SaaS metics blog series and subsequent SaaS Metrics Guide to SaaS Financial Performance, I’ve received numerous inquiries on various details and hidden gotchas in SaaS metrics implementation. This new series of SaaS Metrics FAQs explores some of these finer SaaS metrics points in a simple Q&A format. In this second post, I examine SaaS MRR churn, a SaaS metric that extends from SaaS customer churn which was covered in the first installment.

SaaS Metrics FAQ #4 | What is MRR Churn?

SaaS MRR churn measures the erosion of SaaS monthly recurring revenue (MRR). Mathematically, the SaaS MRR churn rate is an extension of the SaaS customer churn rate calculated by substituting monthly recurring revenue in place of the number of customers. For example, if your SaaS business has 100 customers representing an MRR base of $1M at the beginning of the year, and 5 customers cancel a total of $100K in MRR during the year, then your annual MRR churn rate is 10%, while your annual customer churn rate is only 5%. The general formula for for SaaS MRR churn can be stated as the amount of MRR cancelled (ΔMRR) per time interval (Δt) divided by the total MRR at the beginning of the interval (MRRtotal).

SaaS MRR Churn Rate = ΔMRRcancelled contracts
Δt x MRRtotal

In the formula above, the Δ is a common math symbol that means change or interval.

SaaS Metrics FAQ #5 | Why Measure MRR Churn?

The simple answer to this question is money. Read more »

SaaS Metrics FAQs | What is Churn?

saas metrics faqsA little over two years ago, I published a series of well received articles on SaaS metrics that culminated in the SaaS Metrics Guide to SaaS Financial Performance. Since then, I’ve received numerous inquiries regarding the many practical quirks encountered in day-to-day SaaS metrics implementation. In response, I’ve decided to revisit the SaaS metrics topic with this series of SaaS Metrics FAQs where I’ll elaborate on some of these finer SaaS metrics details in a simple Q&A format. This first SaaS Metrics FAQs installment tackles the many problems associated with measuring SaaS churn, so if you have a Q, please feel free to submit it in the comments and I’ll do my best to provide an A.

SaaS Metrics FAQ #1 | What is Churn?

SaaS churn is the percentage rate at which SaaS customers cancel their recurring revenue subscriptions. It is a key SaaS metric of historical SaaS business performance and an important parameter in revenue forecasting. When used in forecasting, SaaS churn can be interpreted as the probability rate at which customers will cancel their subscriptions. In it’s simplest form, SaaS churn can be stated as the number of customers cancelling (ΔC) per time interval (Δt) divided by the number of customers at the beginning of the interval (C).

SaaS Churn = ΔC
Δt x C

In the formula above, the Δ is a common math symbol that means change or interval.

That’s the simple answer. In practice, SaaS churn can be both difficult to define and difficult to measure. Read more »

SaaS Benchmarks | Acquisition Cost and Churn Challenges

saas benchmarkI routinely get asked questions like the following: What is a typical churn rate for SaaS? How much should I pay my SaaS sales reps? What is a good time frame to recover acquisition costs? A few years ago, the best answers I could give were simply based on my own experience and conversations with other SaaS colleagues. However, as SaaS has matured as a category, some high quality SaaS benchmark studies have appeared.

Recent conversations with Lauren Kelley over at OPEXEngine highlight for me how SaaS companies across the board struggle with customer acquisition costs (CAC) and churn. The 2010 OPEXEngine SaaS benchmark study shows a WIDE range of results across these critical performance metrics, indicating that there is no one right way to tackle these challenges that will work for SaaS companies across all sizes and sectors. But, there are plenty of wrong ways.

SaaS Benchmark Results – Customer Acquisition Cost

SaaS companies vary a lot in their willingness to invest in customer acquisition. For example, the OPEXEngine SaaS benchmark report gives an average payback period for CAC alone of about Read more »

SaaS Metrics Guide to SaaS Financial Performance

I’ve wrapped up the highlights of my SaaS metrics series into a tidy SaaS Metrics Guide to SaaS Financial Performance. Like the original SaaS metrics series, this reference guide presents simple rules-of-thumb and graphic visualizations that capture the dynamic relationships between core SaaS metrics and SaaS financial performance.

It is NOT a comprehensive overview of SaaS metrics, but a deep dive into the most critical SaaS metrics with the goal of fostering intuition and deeper understanding of SaaS financial performance, including charts, formulas, definitions, sample calculations, and hyperlinks back to the full SaaS Metrics Rules-of-Thumb posts. Feel free to pass it along. Cheers! JY.

saas metrics

Click the image to download the
SaaS Metrics Guide to SaaS Financial Performance (PDF format)

Original SaaS Metrics Rules-of-Thumb Posts

SaaS Customer Lifetime Value Drives SaaS Company Value

For the life of me, I still can’t fathom how VCs value early stage startups. I think it is one part business logic and five parts voodoo (no offense to my VC friends, but you know what I mean). However, I’m guessing most SaaS-focused VCs know this SaaS company valuation principle in their gut even if they can’t reduce it to a financial projection: SaaS Customer Lifetime Value Drives SaaS Company Value. For what is a company if not the sum of its customers?

The link between SaaS CLTV and SaaS company valuation
arises naturally from the SaaS subscription model
where topline company revenue emerges
as the sum of individual customer revenue streams.

This is the final post in a series that aims to uncover the mysteries of SaaS financial metrics from a new angle, a little mathematics. In this installment, I’ll explore the important SaaS metric of customer lifetime value (CLTV) and introduce a new SaaS financial metrics rule-of-thumb that relates SaaS CLTV to SaaS company value.

Buyer Beware: The ideas presented in this installment of the SaaS metrics series are not meant to offer methods or models for evaluating the value of any particular SaaS company, but rather to offer credence to the gut reaction above. Use the formulas herein at your own discretion. Chaotic Flow, i.e., me, accepts no liability thereof.

SaaS Metrics Rule-of-Thumb #10
SaaS Customer Lifetime Value Drives SaaS Company Value

The financially accepted method for estimating the value of company is the calculation of the discounted value of its future cash flows, or net present value. Now, I’m not saying that anyone in InternetWorld actually uses this method, but for the sake of this series on SaaS financial metrics, this is the only approach that lends itself to mathematical analysis. So, I am stuck with it.

The exact mathematical statement of SaaS Metric Rule-of-Thumb #10 above is expressed as follows (see SaaS Metrics Math Notes below for the derivation):

SaaS Company NPV = CLTV x NEWLTV

Where CLTV is the average SaaS customer lifetime value and NEWLTV is an analogous measure for the lifetime value number of customers that represents Read more »

SaaS Metrics | Joel’s Magic Number for SaaS Companies

One of the mysteries I hoped to solve when I embarked upon this little SaaS metrics mathematical journey was the reality behind “The SaaS Company Magic Number” introduced by then Omniture CEO, Josh James, and immemorialized by my pal Lars Leckie over at Hummer Winblad. In principal, this number tells you how aggressively you should be spending to build up your customer base: “the key insight is that if you are below 0.75 then step back and look at your business, if you are above 0.75 then start pouring on the gas for growth because your business is primed to leverage spend into growth. If you are anywhere above 1.5 call me immediately.”-Lars Leckie’s Blog

In this installment of the SaaS metrics series, I will show why this benchmark works, and introduce what IMHO is the single most important SaaS financial metric for measuring the overall health of a SaaS business. Now, being as Josh and Lars have already laid claim to “The” SaaS Magic Number, I really have no alternative but to put all humility aside and dub my latecomer SaaS metric as “Joel’s” SaaS Magic Number (After all, I did similarly snag “The” Top Ten Do’s and Don’ts of SaaS, so it’s all good.)

SaaS Metrics Rule of Thumb #9 – Joel’s SaaS Magic Number

The truth be told I feel a bit guilty about the name, because Joel’s SaaS Magic Number is neither magic, nor mine really. It’s simply the the average customer rate of return, or rather the inverse of the average customer baseline break-even, 1/BE0, that has so consistently popped up as a driver and a constraint in the SaaS metrics rules-of-thumb.

Joel’s SaaS Magic Number = Average Customer Rate of Return

Where “ARR” is the average recurring revenue per customer, “ACS” is the average recurring cost of service per customer, and “CAC” is the average customer acquisition cost. Customer rate of return is powerful, because it measures the economics that make a SaaS business work (or not), whereas the individual revenue and cost metrics are simply accounting figures that in isolation say little about the health of the business. Let’s recap some of the things we know about this nifty magic number from earlier SaaS metrics rules-of-thumb.

Joel’s SaaS Magic Number Rules-of-Thumb
J [ ARR - ACS ] ÷ CAC average SaaS customer rate of return
1/J BE0 best case SaaS company time to profit
limiting g = a = J maximum, profitable rate of growth g or churn a
approaching g ⇒ J or a ⇒ J dramatically delays SaaS time to profit
exceeding g ≥ J or a ≥ J SaaS company will never be profitable
increasing ⇑J by ⇑ARR or ⇓TCS upselling & lower TCS accelerate profitability
recommended J > max( g , a ) or a + net growth (g – a)
benchmark J ≥ 50% per year is generally very healthy

Intuitively, the long run profitability of SaaS companies requires
the recurring contribution of current customers to cover the acquisition cost of new customers,
therefore the average customer rate of return for SaaS companies
must exceed both the current customer churn rate and the new customer growth rate.

So, what is a good value for Joel’s SaaS Magic Number? Well, I don’t think anyone could argue with 1, a valiant goal, but rather optimistic. Read more »

SaaS Revenue | The Beauty of Upselling and Upgrades

Too much churn, you lose money. Grow too fast, you lose money. Customer acquisition cost too high, you lose money. Recurring cost of service too high, you lose money. Just shoot me now! How on earth do you make money in SaaS?

If you’ve been following this series on SaaS metrics, then you’ve probably worked your way up to just such a level of frustration. Because, that pretty much sums up the last four SaaS metrics rules-of-thumb on SaaS profitability:

It just can’t be! This is high tech. This is the Internet! Software, not hardware. SaaS can’t just be a low-cost commodity business. There must be a value-based approach. A SaaS revenue solution!

There is. But, it doesn’t mean you can ignore the fundamentals. Driving down total cost of service through automation and economies-of-scale is fundamental. SaaS executives that ignore this put the long term profitability of their SaaS businesses in peril. But, enough on lowering SaaS costs. Let’s talk increasing SaaS revenue!

The previous post in this SaaS metrics series entitled Growing Up Poor – How Foolish SaaS Companies Lose Money was a bold attempt to once and for all solve the mystery of why seemingly successful SaaS companies lose money…in excruciating detail (sorry for that). The cornerstones of the analysis were the relationships established between the values of churn, “a”, growth, “g”, and the baseline average customer break-even time, “BE0” as follows:

BE0 = CAC ÷ [ ARR - ACS ]

Higher gBE0 or aBE0 means longer time to profit.
When gBE0 ≥ 1 or aBE0 ≥ 1 the SaaS company will never be profitable.
Hence g = a = 1/BE0 is the maximum, profitable rate of growth or churn.

In the formula above, “CAC” is the average acquisition cost per customer, “ARR” is the average recurring revenue per customer, “ACS” is the average recurring cost of service per customer, and the 0 attached to the BE is intended to indicate the absence of churn, i.e., the baseline break-even.

These constraints were the basis of SaaS metrics rules-of-thumb #6 and #7 which claim that both growth and churn, respectively, increase pressure to reduce total cost of service (CAC and ACS) in order to accelerate profitability (reduce BE0) and to ensure that profitability is even possible (gBE0,aBE0 < 1). However, the viable SaaS revenue strategy of increasing average recurring revenue (ARR) without increasing total cost of service was carefully set aside for later examination. Leading us to...

SaaS Metrics Rule-of-Thumb #8
Upselling and Upgrades Accelerate SaaS Profitability

What exactly does it mean to increase average recurring revenue without increasing average customer acquisition cost or average recurring cost of service? First, no additional customer acquisition cost means that we must increase recurring revenue from current customers. Second, no increase in average recurring cost of service means that we must do so in the normal course of business with very little extra effort, preferably through customer self-service (self-selling!). In other words, SaaS companies can accelerate time to profit by upselling and upgrading current customers, but only if it follows an exceptionally low cost purchase process distinct from the new customer acquisition process. The chart below depicts the impact of upselling and upgrades on SaaS time to profit.

saas upsell profitability

Upselling and upgrades leverage the initial investment of customer acquisition cost
to accelerate SaaS time to profit by countering the delays of both growth and churn.

The chart above depicts the effect of upselling on the two uglier examples presented Read more »

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