SaaS Metrics – Measuring and Improving What Matters
Transcript of SaaS Metrics – Measuring and Improving What Matters
SaaSMetrics– AGuidetoMeasuringandImprovingWhatMatters
This is aguest postby DavidSkok. Davidis a fivetime serialentrepreneur
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B R O W S EM A R K E T I N GT O P I C S
entrepreneurturned VC,at MatrixPartners
“If youcannotmeasureit, youcannotimproveit” –LordKelvin
This articleis acomprehensiveanddetailedlook at thekeymetricsthat areneeded tounderstandandoptimize aSaaSbusiness. Itis acompletelyupdatedrewrite ofan olderpost. Forthis
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thisversion, Ihave co-opted tworealexperts inthe field:Ron Gill,(CFO,NetSuite),and BradCoffey (VPof Strategy,HubSpot),to addexpertise,color andcommentaryfrom theviewpointof a publicand privateSaaScompany.My sincerethanks toboth ofthem fortheir timeand input.
SaaS/subscriptionbusinessesare morecomplexthantraditionalbusinesses.
Audits
businesses.Traditionalbusinessmetricstotally failto capturethe keyfactorsthat driveSaaSperformance.In the SaaSworld,there are afew keyvariablesthat makea bigdifferenceto futureresults.This post isaimed athelpingSaaSexecutivesunderstandwhichvariablesreallymatter,and how tomeasurethem andact on theresults.
The goal of
The goal ofthe articleis to helpyouanswer thefollowingquestions:
Is mybusinessfinanciallyviable?
What isworkingwell,andwhatneedsto beimproved?
Whatleversshouldmanagementfocuson todrivethebusiness?
ShouldtheCEO hittheaccelerator,or thebrakes?
What is
What istheimpacton cashandprofit/lossofhittingtheaccelerator?
(Note:although Ifocus onSaaSspecifically,the articleisapplicableto anysubscriptionbusiness.)
What’ssodifferentaboutSaaS?SaaS, andotherrecurringrevenuebusinessesaredifferent
differentbecausetherevenuefor theservicecomesover anextendedperiod oftime (thecustomerlifetime). Ifa customeris happywith theservice,they willstickaround fora longtime, andthe profitthat can bemade fromthatcustomerwillincreaseconsiderably.On theother handif acustomerisunhappy,they will
they willchurnquickly,and thebusinesswill likelylosemoney ontheinvestmentthat theymade toacquirethatcustomer.Thiscreates afundamentallydifferentdynamic toatraditionalsoftwarebusiness:there arenow twosales thathave to beaccomplished:
1. Acquiringthecustomer
2. Keepingthecustomer(tomaximize
maximizethelifetimevalue).
Because oftheimportanceofcustomerretention,we will seea lot offocus onmetricsthat helpusunderstandretentionand churn.But firstlet’s look atmetricsthat helpyouunderstandif yourSaaSbusiness isfinanciallyviable.
TheSaaS
TheSaaSP&L /CashFlowTroughSaaSbusinessesfacesignificantlosses inthe earlyyears (andoften anassociatedcash flowproblem).This isbecausethey haveto investheavilyupfront toacquire thecustomer,butrecoverthe profitsfrom thatinvestmentover a longperiod oftime. Thefaster thebusinessdecides to
grow, theworse thelossesbecome.Manyinvestors/boardmembershave aproblemunderstandingthis, andwant to hitthe brakesatpreciselythemomentwhen theyshould behitting theaccelerator.
In manySaaSbusinesses,this alsotranslatesinto a cashflowproblem,as theymay onlybe able toget thecustomerto paythem
themmonth bymonth. Toillustratetheproblem,we built asimpleExcelmodelwhich canbe foundhere. Inthatmodel, wearespending$6,000 toacquire thecustomer,and billingthem atthe rate of$500 permonth.Take alook atthese twographsfrom thatmodel:
If weexperiencea cash flowtrough foronecustomer,then whatwillhappen ifwe start todo reallywell andacquiremanycustomersat thesametime? Themodelshows thattheP&L/cashflowtroughgetsdeeper ifweincreasethe growthrate for thebookings.
But thereis light atthe end ofthe tunnel,aseventuallythere isenoughprofit/cashfrom theinstalledbase tocover theinvestmentneeded fornewcustomers.At thatpoint thebusinesswould turnprofitable/cashflowpositive –assumingyou don’tdecide toincreasespendingon salesandmarketing.And, asexpected,
the fasterthe growthincustomeracquisition,the betterthe curvelookswhen itbecomespositive.
Ron Gill,NetSuite:
Ifplansgowell,youmaydecideitistimetohittheaccelerator(increasingspendingonleadgeneration,hiring
hiringadditionalsalesreps,addingdatacentercapacity,etc.)inordertopick-upthepaceofcustomeracquisition.ThethingthatsurprisesmanyinvestorsandboardsofdirectorsabouttheSaaSmodel
modelisthat,evenwithperfectexecution,anaccelerationofgrowthwilloftenbeaccompaniedbyasqueezeonprofitabilityandcashflow.
Assoonastheproductstartstoseesome
somesignificantuptake,investorsexpectthatthelosses/cashdrainshouldnarrow,right?Instead,thisistheperfecttimetoincreaseinvestmentinthebusiness.whichwillcauselossestodeepenagain.
again.Thegraphbelowillustratestheproblem:
Noticeintheexamplegraphthatthefivecustomerpermonthmodelultimatelyyieldsamuchsteeperrateofgrowth,butyouhave
havetogothroughanotherdeeptroughtogetthere.Itistheconceptofneedingtore-enterthattypeoftroughafterjusthavinggottenthecurvetoturnpositive
thatmanymanagersandinvestorsstrugglewith.
Ofcoursethisaspecialchallengeearly-onasyouneedtoexplaintoinvestorswhyyou’llrequireadditionalcashtofundthatnextround
roundofacceleration.Butitisn’tjustastartupproblem.AtNetSuite,evenasapubliccompanyourrevenuegrowthratehasacceleratedineachofthelastthreeyears.Thatmeansthat
thateachannualplaninvolvesastepping-upofinvestmentinleadgenerationandsalescapacitythatwillincreasespendingandcashflowoutforsometimebeforeitstartsyieldingincrementalrevenue
revenueandcashflowin.Aslongasyou’reacceleratingtherateofrevenuegrowth,managingandmessagingaroundthisphenomenonis apermanentpartofthelandscapeforanySaaScompany.
Why is
Why isgrowthimportant?We havesuggestedthat assoon asthebusinesshas shownthat it cansucceed, itshouldinvestaggressivelyto increasethe growthrate. Youmight askquestion:Why?
SaaS isusually a“winner-takes-all”game, andit isthereforeimportantto grabmarketshare asfast aspossible tomake sureyou are the
you are thewinner inyourspace.Providedyou cantell a storythat showsthateventuallythatgrowth willlead toprofitability,WallStreet,acquiringcompanies,andventureinvestorsall rewardhighergrowthwith highervaluations.There’salso apremiumfor themarketleader in aparticularspace.
Howevernot allinvestments
investmentsmakesense. Inthe nextsection wewill look ata tool tohelp youensurethat yourgrowthinitiatives/investmentswill payback: UnitEconomics.
APowerfulTool:UnitEconomicsBecause ofthe lossesin the earlydays,which getbigger themoresuccessfulthecompanyis atacquiringcustomers,it is much
it is muchharder formanagementandinvestorsto figureoutwhether aSaaSbusiness isfinanciallyviable. Weneed sometools tohelp usfigure thisout.
A greatway tounderstandanybusinessmodel is toanswer thefollowingsimplequestion:
Can Imakemoreprofitfrommycustomersthan itcosts
costsme toacquirethem?
This iseffectivelya study ofthe uniteconomicsof eachcustomer.To answerthequestion,we needtwometrics:
LTV –theLifetimeValueof atypicalcustomer
CAC –theCost toAcquireatypicalCustomer
(For moreon how tocalculate
calculateLTV andCAC, clickhere.)
Entrepreneursare usuallyoveroptimisticabout howmuch itcosts toacquire acustomer.Thisprobablycomesfrom abelief thatcustomerswill be soexcitedaboutwhat theyhave built,that theywill beat apath totheir doorsto buy theproduct.The realityis oftenverydifferent! (Ihavewrittenmore onthis topic
this topichere:StartupKiller: TheCost ofCustomerAcquisition,and here:How SalesComplexityimpactsCAC.)
IsyourSaaSbusinessviable?In the firstversion ofthis article,Iintroducedtwoguidelinesthat couldbe used tojudgequicklywhetheryour SaaSbusiness isviable. Thefirst is agood way
good wayto figureout if youwill beprofitablein the longrun, andthe secondis aboutmeasuringthe time toprofitability(which alsogreatlyimpactscapitalefficiency).
Over thelast twoyears, Ihave hadthe chanceto validatetheseguidelineswith manySaaSbusinesses,and itturns outthat theseearlyguesseshave held
have heldup well.The bestSaaSbusinesseshave a LTVto CACratio thatis higherthan 3,sometimesas high as7 or 8. Andmany ofthe bestSaaSbusinessesare able torecovertheir CACin 5-7months.HowevermanyhealthySaaSbusinessesdon’t meettheguidelinesin the earlydays, butcan seehow theycanimprovethe
businessover timeto getthere.
Thesecondguideline(Months toRecoverCAC) is allabout timetoprofitabilityand cashflow.Largerbusinesses,such aswirelesscarriersand creditcardcompanies,can affordto have alongertime torecoverCAC, asthey haveaccess totons ofcheapcapital.Startups,on the
on theotherhand,typicallyfind thatcapital isexpensivein the earlydays.Howevereven ifcapital ischeap, itturns outthatMonths torecoverCAC is avery goodpredictorof how wella SaaSbusinesswillperform.Take alook at thegraphbelow,whichcomesfrom thesamemodelusedearlier. Itshows howthe
theprofitabilityis anemic ifthe time torecoverCACextendsbeyond 12months.
I shouldstress thatthese areonlyguidelines,there arealwayssituationswhere itmakessense tobreakthem.
ThreeusesfortheSaaSGuidelines
Guidelines1. One
of thekeyjobsof theCEO istodecidewhento hittheacceleratorpedal.Thevalueofthesetwoguidelinesis thattheyhelpyouunderstandwhenyouhave aSaaSbusinessthat isingoodshape,whereitmakes
makessenseto hittheacceleratorpedal.Alternativelyif yourbusinessdoesn’tmeettheguidelines,it is agoodindicatorthatthereismoretweakingneededto fixthebusinessbeforeyoushouldexpand.
2. Anotherway tousethetwoguidelinesis forevaluating
evaluatingdifferentleadsources.Differentleadsources(e.g.GoogleAdWords,TV,Radio,etc.)havedifferentcostsassociatedwiththem.Theguidelineshelpyouunderstandifsomeof themoreexpensiveleadgenerationoptionsmakefinancialsense.If theymeetthese
theseguidelines,itmakessenseto hittheacceleratoronthosesources(assumingyouhavethecash).Usingthesecondguideline,andworkingbackwards,wecantellthat ifwe aregettingpaid$500permonth,wecanaffordtospend
spendup to12xthatamount(i.e.$6,000)onacquiringthecustomer.Ifwe’respendinglessthanthat,youcanaffordto bemoreaggressiveandspendmoreinmarketingorsales.
3. Thereisanotherimportantway tousethis
typeofguideline:segmentation.Early-stagecompaniesareoftentestingtheirofferingwithseveraldifferentuses/typesofcustomers/pricingmodels/industryverticals.It isveryusefultoexaminewhichsegmentsshowthequickestreturnorhighest
highestLTV toCAC inordertounderstandwhichwill bethemostprofitabletopursue.
UnitEconomicsinAction:HubSpotExampleHubSpot’suniteconomicswererecentlypublishedin anarticle inForbes:
You cansee from
see fromthe secondrow in thistable howthey havedramaticallyimprovedtheir uniteconomics(LTV:CACratio) overthe fivequartersshown.The bigdriver forthis wasloweringthe MRRChurn ratefrom 3.5%to 1.5%.This droveup thelifetimevalue ofthecustomerconsiderably.They werealso ableto drive uptheir AVGMRR percustomer.
BradCoffey,
Coffey,HubSpot:
In2011andearly2012weusedthischarttoguidemanyofourbusinessdecisionsatHubSpot.BybreakingLTV:CACdownintoitscomponentswecouldexamineeachmetricand
andunderstandwhatleverswecouldpulltodriveoverallimprovement.
Itturnedoutthattheleverswecouldpullvariedbysegment.IntheSMBmarketforinstancewehadthe
therightsalesprocessinplace–buthadanopportunitytoimproveLTVbyimprovingtheproducttolowerchurnandincreasingouraveragepriceinthesegment.IntheVSB(Very
(VerySmallBusiness)segment,bycontrast,therewasn’tasmuchupsideleftontheLTV(VSBcustomershavelessmoneyandnaturallyhigherchurn)sowefocusedonloweringCACbyremovingfriction
frictionfromoursalesprocessandmovingmoreofoursalestothechannel.
TwokindsofSaaSbusiness:There aretwo kindsof SaaSbusiness:
Thosewithprimarilymonthlycontracts,withsomelongerterm
contracts.In thisbusiness,theprimaryfocuswill beon MRR(MonthlyRecurringRevenue)
Thosewithprimarilyannualcontracts,withsomecontractsformultipleyears.Heretheprimaryfocus ison ARR(AnnualRecurringRevenue),andACV(AnnualContractValue).
Most ofthe time inthis article,I will refertoMRR/ACV.Thismeans useMRR if youare thefirst kindofbusiness,or ACV ifyou are thesecondkind ofbusiness.Thedashboardshownbelowassumesmonthlycontracts(MRR).Howeverin thedownloadablespreadsheet,there is atab thatshows thesamedashboardfor thesecond
secondkind,focusingon ACVinstead ofMRR.
SaaSBookings:ThreeContributingElementsEverymonth in aSaaSbusiness,there arethreeelementsthatcontributeto howmuch MRRwill changerelative tothepreviousmonth:
Whathappenedwith newcustomersadded inthe month:
NewMRR (orACV)
Whathappenedin theinstalledbase ofcustomers:
ChurnedMRR (orACV)(fromexistingcustomersthatcancelledtheirsubscription.This willbe anegativenumber.)
ExpansionMRR (orACV)(fromexistingcustomerswhoexpandedtheirsubscription)
The sumall three ofthesemakes upyour NetMRR orACVBookings:
Irecommendthat youtrack theseusing achartsimilar tothe onebelow:
This chartshows thethreecomponentsof MRR (orACV)Bookings,and theNet NewMRR (orACV)Bookings.
Bookings.Bybreakingout eachcomponent,you cantrack thekeyelementsthat aredrivingyourbusiness.The onevariationwe wouldrecommendmaking tothis chartis to showa dottedline for theplan, soyou cantrack howyou aredoingagainstplan foreach of thefour lines.This is oneof themostimportantcharts tohelp you
understandand runyourbusiness.
Ron Gill,NetSuite:
Thischartisreallygood.IalsoliketolookatthisdataintabularformbecauseIwanttoknowy-o-ygrowthrates.E.g.
E.g.“NetnewMRRisup25%overJuneoflastyear”.TheY-o-Y%is ametriceasilycomparedwithincreasedspending,salescapacity,etc.
TheImportanceofCustomerRetention(Churn)
(Churn)In the earlydays of aSaaSbusiness,churnreallydoesn’tmatterthat much.Let’s saythat youlose 3% ofyourcustomerseverymonth.When youonly havea hundredcustomers,losing 3 ofthem isnot thatterrible.You caneasily goand findanother 3to replacethem.Howeveras yourbusinessgrows insize, theproblem
problembecomesdifferent.Imaginethat youhavebecomereally big,and nowhave amillioncustomers.3% churnmeansthat youare losing30,000customerseverymonth!That turnsout to be amuchhardernumber toreplace.CompanieslikeConstantContacthave runinto thisproblem,and it hasmade itvery hardfor them
for themto keep uptheirgrowthrate.
Ron Gill,NetSuite:
Oneoft-overlookedaspectofchurnisthatthechurnrate,combinedwiththerateofnewARRadds,notonlydefineshowfastyoucan
cangrowthebusiness,italsodefinesthemaximumsizethebusinesscanreach(seegraphbelow).
Itisanenlighteningexercisetobuildasimplemodellikethis
thisforyourbusinessandplotwhereyourcurrentrevenuerunratesitsonthebluelinedefinedbyyourpresentrateofARRaddsandchurn.Areyouneartheleft-
handside,wherethegrowthisstillsteepandtheceilingisstillfarabove?Or,areyoufurthertotherightwhererevenuegrowthwillleveloffandthereislimited
limitedroomlefttogrow?Howmuchbenefitwillyougetfromsmallimprovementsinchurnorthepaceofnewbusinesssign-up?
AtNetSuite,we’vehadgreatsuccessshiftingtheline
lineinthelastfewyearsbybothdramaticallydecreasingchurnandbyincreasingaveragedealsizeandvolume,thusincreasingARRadds.Theresultwasbothtosteadilymovethelimitupward
upwardandtosteepenthegrowthcurveatthecurrentARRrunrate,creatingroomforincreasinglyrapidexpansion.
ThePowerofNegativeChurnTheultimatesolution tothe churnproblem isto get toNegativeChurn.
Churn.
There aretwo waysto get thisexpansionrevenue:
1. Use apricingschemethathas avariableaxis,suchas thenumberofseatsused,thenumberofleadstracked,etc.Thatway,asyourcustomersexpandtheirusageof
ofyourproduct,theypayyoumore.
2. Upsell/Cross-sellthemtomorepowerfulversionsofyourproduct,oradditionalmodules.
To helpillustratethe powerof negativechurn, takea look atthefollowingtwo graphsthat showhowcohortsbehavewith 3%churn, andthen with
3%negativechurn.(Since thisis the firsttime I haveused thewordCohort, letme explainwhat itmeans. Acohort issimply afancy wordfor agroup ofcustomers.In the SaaSworld, it isusedtypically todescribethe groupthat joinedin aparticularmonth. Sotherewould betheJanuarycohort,Februarycohort, etc.In ourgraphs
graphsbelow, adifferentcolor isused foreachmonth’scohort, sowe can seehow theydecline orgrow,based onthe churnrate.)
In the topgraph, weare losing3% of ourrevenueeverymonth,and youcan seethat with aconstantbookingsrate of $6kper month,therevenuereaches$140kafter 40months,andgrowth is
growth isflatteningout. In thebottomgraph, wemay belosingsomecustomers,but theremainingcustomersare morethanmaking upfor thatwithincreasedrevenue.With anegativechurn rateof 3%, wereach$450k inrevenue(more then3x greater),and thegrowth inrevenuesisincreasing,notflattening.
For moreon thistopic, youmay wishto refer tothese twoblog postsof mine:
WhyChurnis SOcriticaltosuccessin SaaS
Multi-axisPricing:a keytool forincreasingSaaSrevenue
DefiningaDashboard
Dashboardfor aSaaSCompanyThefollowingsectionshould bemostuseful forreaderswho areinterestedputtingtogether adashboardto helpthemmanagetheir SaaSbusiness.To this, wecreated anexcel filefor animaginarySaaScompany,and laidout atraditionalnumericreport onone tab,and then adashboard
dashboardof graphson asecond tab(seebelow).Theserepresentone viewon how todo this.You mayhave averydifferentapproach.Buthopefullythis willgive yousomeideas. Iwouldrecommendadding adotted linewith theplannumber toall graphs.This willallow youto quicklysee howyou aredoingversus
versusplan.
There aretwoversions oftheDashboard:the oneshownbelow,which isdesignedforcompaniesusingprimarilymonthlycontracts(focusedon MRR).And asecondversionthat can befound herewhich isdesignedforcompaniesusingannualcontracts,focusingon ACV(AnnualContractValue).
Value).
BradCoffey,HubSpot:
HubSpot:
AtHubSpotweobsessoverthesemetrics–andwatchmanyofthemeveryday.Eachnightwesendouta‘waterfall’chartthattracksourprogressagainstourtypicalprogress
progressgiventhenumberofbusinessdaysleftinthemonth.Hereisanexampleofwhatwelookattoensurewe’reontracktomeetournetMRRgoals.
By lookingat thisdaily wecan takeactionimmediatelyif we’retrackingtowards abad monthor quarter.Things likeservicespromotion(forchurnedMRR) orsalescontests &promotions(for new &expansionMRR) areadjustmentswe makewithin agivenmonth inorder tonail ourgoals. (Inthis modelwecombineexpansion
andchurnedMRR intoonechurnedMRR line).
Detaileddefinitionsof thevariousmetricsusedDetaileddefinitionsfor each ofthe variousmetricsused canbe foundin thisreferencedocument:
RevenueChurnvsCustomerChurn– whyarethey
theydifferent?You mightbewonderingwhy it’snecessaryto trackbothCustomerChurn andRevenueChurn.Imagine ascenariowhere wehave 50smallaccountspaying us$100 amonth,and 50largeaccountspaying us$1,000 amonth. Intotal wehave 100customers,and anMRR of$55,000 atthe start ofthe month.Now
Nowimaginethat welose 10 ofthem. OurCustomerchurn rateis 10%. Butif out ofthe tenchurnedcustomers,9 of themwere smallaccounts,and onlyone was alargeaccount.We wouldonly havelost $1,900in MRR.Thatrepresentsonly 3.4%RevenueChurn. Soyou cansee thatthe twonumberscan bequitedifferent.But each isimportant
importanttounderstandif we wanta completepicture ofwhat isgoing on inthebusiness.
GettingpaidinadvanceGettingpaid inadvance isreallysmart ideaif you cando itwithoutimpactingbookings,as it canprovidethe cashflow thatyou needto coverthe cashproblemthat wedescribedearlier in
earlier inthe article.It is oftenworthprovidinggoodfinancialincentivesin the formofdiscountstoencouragethisbehavior.The metricthat weuse totrack howwell yoursales forceis doing inthis area isMonths upFront.
Gettingpaid moreupfrontusuallyalso helpslowerchurn. Thishappensbecausethecustomerhas made
has madea greatercommitmentto yourservice,and ismore likelyto spendthe timegetting itup andrunning.You alsohave moretime toovercomeissues thatmight arisewith theimplementationin the earlydays.CalculatingLTV andCAC
The Metric“Monthsup Front”has beenused atbothHubSpotandNetSuite inthe past asa way to
incentsalespeople toget morepaid upfront whena newcustomeris signed.Howeverasking formoremoney upfront mayturn offcertaincustomers,and resultin fewernewcustomers,so becarefulhow youbalancethese twoconflictinggoals.
CalculatingCACandLTVDetailedinformation
informationon how tocalculateLTV andCAC isprovidedin thesupplementaldocumentthat can beaccessedby clickinghere.
MoreonChurn:CohortAnalysisSincechurn issuch acriticalelementfor successin a SaaScompany,it is anarea thatrequiresdeeperexplorationtounderstand.Cohort
CohortAnalysis isone of theimportanttechniquesthat weuse to gaininsight.
Asmentionedearlier, acohort issimply afancyname for agroup. InSaaSbusinesses,we usecohortanalysis toobservewhathappensto thegroup ofcustomersthat joinedin aparticularmonth. Sowe willhave aJanuarycohort, aFebruarycohort, etc.
cohort, etc.We wouldthen beable toobservehow ourJanuarycohortbehavesover time(seeillustrationbelow).
This canhelpanswerquestionssuch as:
Are welosingmost ofthecustomersin thefirstcoupleofmonths?
DoesChurnstabilizeaftersome
someperiodof time?
Then iftook someactions totry to fixchurn inearlymonths,(i.e withbetterproductfeatures,easier on-boarding,bettertraining,etc.) wewouldwant toknow ifthosechangeshad beensuccessful.The cohortanalysisallows usto do thisbycomparinghow morerecentcohorts(e.g. July in
(e.g. July inthe tableabove)comparedagainstJanuary.The tableaboveshows thatwe made abigimprovementin the firstmonthchurngoing from15% to 4%.
Twowaysto runCohortAnalysisThere aretwo waysto runCohortAnalysis:the firstlooks atthenumber ofcustomers,and thesecondlooks at
theRevenue.Eachteaches ussomethingdifferentandvaluable.Theexamplegraphbelowsimplylooks atthenumber ofcustomersin eachcohortover time:
Theexamplegraphbelowlooks athow MRRevolvesover timefor eachcohort.Thisparticularexample
exampleillustrateshow thegraphwould lookif there isvery strongnegativechurn. Asyou cansee, theincrease inrevenuefrom thecustomersthat arestill usingthe serviceis easilyoutpacingthe lostrevenuefromchurnedcustomers.It is prettyrare to seethings lookthis good,but it is theidealsituationthat we arelooking for.For thosewonderingif this can
if this canbeachieved,onecompanyin ourportfolio,Zendesk,that hasnumbersthat areevenbetter thanthoseshown intheexamplebelow.
In thesituationabove, youwill need amorecomplexformula tocalculateLTV, as thevalue oftheaveragecustomerisincreasing
increasingover time.For moreon thattopic, youmay wantto checkout theaccompanyingdefinitionsdocument.
PredictingChurn:CustomerEngagementScoreSincechurn is soimportant,wouldn’t itbe useful ifwe couldpredict inadvancewhichcustomerswere mostlikely tochurn?That waywe couldput ourbestcustomer
customerservicereps towork in aneffort tosave thesituation. Itturns outthat wecan do thatbyinstrumentingour SaaSapplicationsandtrackingwhetherour usersareengagedwith thekey stickyfeatures oftheproduct.Differentfeatureswilldeservedifferentscores. Forexample ifyou wereFacebook,you mightscoresomeonewho
whouploaded apicture asfar moreengaged(andthereforeless likelyto churn),thansomeonewhosimplylogged inandviewed onepage.
Similarly ifyou soldyour SaaSproduct toa 100persondepartment,and only10 peoplewere usingit, youwouldscore thatdifferentlyto 90peopleusing it. Sotherecommendationis that you
is that youcreate aCustomerEngagementScore,based onallocatingpoints fortheparticularfeaturesused.Allocatemorepoints forthefeaturesyou believeare moststicky.(Later onyou can goback andlook at thecustomerswhoactuallychurned,andvalidatethat youpicked therightfeatures asa predictorof whowould
wouldchurn.)Andseparatelyscore howmanyusers areengagedwithspecificscores.
Over timeyou’ll alsocome todiscoverwhichtypes ofuse are thebestindicatorsof possibleupsell.(HubSpotwas thefirstcompanythat Iworkedwith whofigured thisout, andthey calledit their CHIscore. CHIstands forCustomerHappiness
HappinessIndex. Itevolved tobe a verygoodpredictorfor churn.)
BradCoffey,HubSpot:
AtHubSpotwehadalotofsuccesslookingatthismetric–wecalledinCustomerHappinessIndex(CHI).First–by
byrunningtheanalysisweidentifiedthepartsofourapplicationthatprovidethemostvaluetocustomersandcouldinvestaccordinglyindrivingadoptioninthoseareas.Second–weusedthis
thisaggregatescoreasanearlyproxyforsuccessasweexperimentedwithdifferentsalesandonboardingprocesses.If asetofcustomersgoingthroughanexperimenthadalowCHIscorewecould
couldkilltheprojectwithoutwaiting6or12monthstoanalyzethecohortretention.
NPS –NetPromoterScoreSince it islikely thatcustomersatisfactionis likely tobe goodpredictorof futurechurn, itwould beuseful tosurveycustomersatisfaction.
satisfaction.Therecommendedway tomeasurecustomerhappinessis to useNetPromoterScore(NPS). Thebeauty ofNPS is thatit is astandardizednumber,so you cancompareyourcompanyto others.For moredetails onNetPromoterScore, clickhere.
GuidelinesforChurnIf your NetRevenueChurn ishigh
high(above 2%permonth) it isanindicatorthat thereissomethingwrong inyourbusiness.At 2%monthlychurn, youare losingabout 22%of yourrevenueevery year.That isnearly aquarter ofyourrevenue!It’s a clearindicationthat thereissomethingwrong withthebusiness.As thebusinessgetsbigger, this
bigger, thiswillbecome amajor dragon growth.
Werecommendthat youwork onfixing theproblemsthat arecausingthis beforeyou go onto worryaboutother partsof yourbusiness.Some ofthepossiblecauses ofchurn are:
You arenotmeetingyourcustomersexpectations.
Theproductmaynotprovide
provideenoughvalue
Instabilityorbugginess
Yourproductis notsticky.It mightprovidesomevalue inthe firstfewmonths,andthenoncethecustomerhasthatvalue,theymayfeeltheydon’tneed tokeeppaying.Tomakeyour
yourproductsticky,trymakingit a keypart oftheirmonthlyworkflow,and/orhavethemstoredata inyourproductthat ishighlyvaluabletothem,wherethevaluewouldbe lostof theycancelled.
Youhavenotsuccessfullygot thecustomer’susersto
adopttheproduct.Or theymaynot beusingcertainof thekeystickyfeaturesin theproduct.
Yoursalesforcemayhaveoversoldtheproduct,or soldit to acustomerthat isnot wellsuitedto getthebenefits
Youmay besellingtoSMB’s
wherea lot ofthemgo outofbusiness.It isn’tenoughthatwhatyou’resellingissticky.Whoyou’resellingit tomustalso besticky.
You arenotusing apricingschemethathelpsdriveexpansionbookings
The bestway to findout whycustomers
arechurning isto get onthe phonewith themand askthem. Ifchurn is asignificantpart ofyourbusiness,werecommendthat thefoundersthemselvesmakethese calls.They needto hearfirst handwhat theproblem is,as this is soimportantfor thesuccess ofthebusiness.And theyare likelyto be thebestpeople todesign afix for the
fix for theproblem.
TheImportanceofCustomerSegmentationIn all SaaSbusinessesthere willlikely comea momentwhere theyrealize thatnot allcustomersarecreatedequal. Asanexample,biggercustomersare harderto sell to,but usuallyplacebiggerorders,and churnlessfrequently.We need away to
way tounderstandwhich ofthese aremostprofitable,and thisrequiresus tosegmentthecustomerbase intodifferenttypes, andcomputethe uniteconomicsmetrics foreachsegmentseparately.Commonsegmentsare thingssize of ofcustomer,verticalindustry,etc.
Despitethe addedwork toproducethemetrics,there is
there ishigh valueinunderstandingthedifferentsegments.This tellsus whichparts ofthebusinessareworkingwell, andwhich arenot. Inaddition toknowingwhere tofocus andinvestresources,we mayrecognizethe needfordifferentmarketingmessages,productfeatures.As soon asyou startdoing thissegmentedanalysis,
thebenefitswillbecomeimmediatelyapparent.
For eachsegment,werecommendtrackingthefollowingmetrics:
ARPA(AverageRevenueperAccountpermonth)
NetMRRChurnrate(includingMRRexpansion)
LTV
CAC
LTV:CACratio
Months
MonthstorecoverCAC
CustomerEngagementScore
BradCoffey,HubSpot:
AtHubSpot,westartedtoseesomeofourbiggestimprovementsinuniteconomicswhenwestartedsegmentingourbusinessandcalculatingthe
theLTVtoCACratioforeachofourpersonasandgotomarketstrategies.
Asonegoodexample–whenwestartedthisanalysis,wehad12repssellingdirectlyinto
intotheVSBmarketand4repssellingthroughValueAddedResellers(VARs).WhenwelookedatthemathwerealizedwehadaLTV:CACratioof1.5sellingdirect,andaLTV:CAC
LTV:CACratioof5sellingthroughthechannel.Thesolutionwasobvious.Twelvemonthslaterwehadflippedourapproach–keepingjust2repssellingdirectand25repssellingthroughthe
thechannel.Thisdramaticallyimprovedouroveralleconomicsinthesegmentandallowedustocontinuegrowing.
WeendedmakingsimilarinvestmentsinotherhighLTV:CACsegments.Wewentsofaras
astoincentivizeoursalesmanagerstogrowtheirteams–butthenwouldonlyplacenewsaleshiresintothesegmentswiththebesteconomics.Thisensuredwecontinuedtoinvestin
inthebestsegmentsandalignedincentivesthroughoutthecompanyonourLTV:CACgoals.Italsoallowedustopushinnovationdowntothesalesmanagerlevel.Managerscouldexperimentwithorgstructure,
structure,andsalesprocesses–buttheyknewthatiftheydidn’thittheirLTV:CACgoalstheywouldn’tbeabletogrowtheirteams.
CalculatingLTV:CACbysegmentcanbechallenging,especially
especiallyontheCACside.It’srelativelyeasyatthetopleveltoaddupallthemarketingandsalesexpenseinaperiodanddivideitbythetotalnumberofcustomers
customers(togetCAC).Onceyoutrytosegmentdownyourspendyourunintoquestionslike‘howmuchmarketingexpensedoIallocatetoagivensegment’,‘howmuchofthesales
salesexpense’?
Wesolvedthisbyallocatingmarketingexpensebasedonnumberofleadsandsalesexpensebasedonheadcountbutit’snotperfect.Forusthekeysare:1)Needstoaccount
accountforallcosts–nofreelunch,2)Itneedstobeconsistentovertime.Progressonimprovingthemetricismoreimportantthantheactualvalue.
FunnelMetricsThe
Themetricsthat matterfor eachsalesfunnel,vary fromonecompanyto the nextdependingon thestepsinvolved inthe funnel.Howeverthere is acommonway tomeasureeach step,and theoverallfunnel,regardlessof yoursalesprocess.Thatinvolvesmeasuringtwo thingsfor eachstep: thenumber ofleads thatwent intothe top of
the top ofthat step,and theconversionrate to thenext stepin thefunnel (seebelow).
In thediagramabove,(mirroredin thedashboard),we show averysimplethreephasesalesprocess,withvisitorscoming toa web site,and someportion ofthemsigning upfor a trial.Then someof the trials
of the trialsconvert topurchases.As you cansee in thedashboard,we willwant totrack thenumber ofvisitors,trials andcloseddeals. Ourgoalshould beto increasethosenumbersover time.And we willalso wantto track theconversionrates, withthe goal ofimprovingthose overtime.
UsingFunnelMetricsinForwardPlanning
PlanningAnotherkey valueof havingtheseconversionrates is theability tounderstandtheimplicationsof futureforecasts.Forexample,lets sayyourcompanywants todo $4m inthe nextquarter.You canworkbackwardsto figureout howmanydemos/trialsthatmeans,and giventhe salesproductivitynumbers –how many
salespeoplearerequired,and goingback astageearlier,how manyleads aregoing to berequired.These arecrucialplanningnumbersthat canchangestaffinglevels,marketingprogramspendlevels, etc.
SalesCapacityIn manySaaSbusinesses,sales repsplay a keyrole inclosingdeals. Inthose
thosesituations,thenumber ofproductivesalespeople(SalesCapacity)will be akey driverofbookings.It isimportantto workbackwardsfrom anyforecaststhat aremade, toensurethat thereis enoughsalescapacity.I’ve seenmanybusinessesmiss theirtargetsbecausethey failedto hireenoughproductivesalespeopleearly
earlyenough.
It’s alsoworthnoting thatsomepercentageof newsales hireswon’t meetexpectations,so thatshould betaken intoconsiderationwhensettinghiringgoals.Typicallywe haveseenfailureratesaround 25-30% forfield salesreps, butthis variesbycompany.The failurerate islower forinsidesales reps.
WhencomputingSalesCapacity, ifa newerrep is stillrampingand onlyexpectedto deliver50% ofquota,they canbe countedas half of aproductiverep. That isoftenreferred toas FullTimeEquivalentor FTE forshort.
Anotherimportantmetric tounderstandis thenumber ofleadsrequired tofeed asales rep. Ifyou areadding
addingsales reps,make sureyou alsohave aclear planof how youwill drivetheadditionalleadsrequired.
There ismuchmore thatcould besaid onthis topic,but since itis all verysimilar tomanaginga salesforce in atraditionalsoftwarecompany,we willleave thatfor otherblog posts.
Saa
aSMetrics–AGuidetoMeasur
ringandImprovingWhatMatt
Understanding
ters#contentmarketing
CLICKTOTWEET
UnderstandingtheROIfordifferentLeadSourcesOurexperienceswith SaaSstartupsindicatethat theyusuallystart with acouple ofleadgenerationprogramssuch asPay PerClickGoogle Ad-words,radio ads,etc. Whatwe havefound isthat eachof theseleadsourcestends tosaturateover time,and
andproduceless leadsfor moredollarsinvested.As a result,SaaScompanieswill needto beconstantlyevaluatingnew leadsourcesthat theycan layerin on topof the oldto keepgrowing.
Since theconversionrates andcosts perlead varyquiteconsiderably,it isimportantto alsomeasurethe overall
the overallROI byleadsource.
Growingleads fastenough tofeed thefront endof thefunnel isone of theperennialchallengesfor anySaaScompany,and islikely to beone of thegreatestlimitingfactors togrowth. Ifyou arefacing thatsituation,the mostpowerfuladvice wecan giveyou is tostartinvestingin InboundMarketingtechniques
techniques(see GetFoundusingInboundMarketing).This willtake timeto rampup, but ifyou can doit well, willlead to farlower leadcosts, andgreaterscalingthan otherpaidtechniques.Additionallythe typicalSaaS buyeris clearlyweb-savvy,andthereforevery likelytoembraceinboundmarketingcontentandtouchlesssellingtechniques.
WhatLeversareavailabletodriveGrowthSaaSbusinessesare morenumericallydriventhan mostotherkinds ofbusiness.Making asmalltweak to anumberlike thechurn ratecan have avery bigimpact onthe overallhealth ofthebusiness.Because ofthis wefrequentlysee a
see a“quant”(i.e. anumbersoriented,spreadsheetmodeling,type ofperson) asa valuablehire in aSaaSbusiness.AtHubSpot,BradCoffeyplayed thatrole, andhe wasable to runthe modelstodeterminewhichgrowthplaysmade themostsense.
Understandingthese SaaSmetrics isa key steptowardsseeing howyou can
you candrive yourbusinessgoingforward.Let’s lookat some ofthe leversthat theseimply asgrowthdrivers foryourbusiness:
ChurnGetChurnandcustomerhappinessrightfirst (ifthisisn’tright,thebusinessisn’tviable,so nopoint indrivinggrowthelsewhere.You willsimply
simplybefilling aleakybucket.)
ProductYou’rein aproductbusiness– firstandforemost:fix yourproduct.
Ifyou’reusingafreetrial,focusongettingtheconversionrateforthatright(ideallyaround15–20%).
20%).Ifthisisn’tright,yourvaluepropositionisn’tresonating,oryoumayhaveamarketwherethereisnotenoughpaintogetpeopletobuy.
Win/Lossratioshouldbegood
TrialorSalesconversion
ratesonqualifiedleadsshouldbegood
Funnelmetrics
Increasethenumberof rawleadscomingin tothe Topof yourfunnel
Identifytheprofitableleadsourcesandinvestin thoseasmuchaspossible.Converselystopinvesting
in poorleadsourcesuntiltheycan betweakedtomakethemprofitable.
IncreasetheConversionRates atvariousstagesin thefunnel
SalesMetrics
Salesproductivity(focusongettingthisrightconsistentlyacrossa broadset ofsalesfolksbefore
beforehittingthe gas)
AddSalesCapacity.But firstmakesureyouknowhow toprovidethemwiththerightnumberofleads.Thisturnsout tobe oneof thekeyleversthatmanycompaniesrely onforgrowth.Wehavelearnedfrom
fromexperiencehowimportantit is tomeetyourtargetsforsalescapacitybyhiringontime,andhiringtherightqualityof salespeoplesotherearefewerfailures.
Increaseretentionforyoursalespeople.Sinceyouhaveinvested
investeda lot inmakingthemfullyproductive,get themaximumreturnon thatinvestmentbykeepingthemlonger.
Look ataddingBusinessDevelopmentReps.Theseareoutboundsalesfolkswhospecializeinprospectingto atargetedlist ofpotentialbuyers.Formoreon this
topic,clickhere.
Pricing/Upsell/CrossSell
Multi-axispricing
Additionalproductmodules(easierto sellmoretoexistingcustomersthan itis to selltobrandnewcustomers)
BradCoffey,HubSpot:
Turnsoutthepricingyourproduct
productrightcanhaveahugeimpactontheuniteconomics.NotsimplybygettingtheaverageMRRright,orbyprovidingupsellopportunities–butalsobysignalingwhatpiecesofthe
theproductaremostvaluable.
AtHubSpotwechangedourpricingin2011tobetieredbasedonthenumberofcontactsinthesystem–andactuallysawanincreaseinadoption
adoptionofthecontactsapplicationafterwemadethechange.Thisiscounter-intuitivebutmakessensegiventhatwesellthroughaninsidesalesteam.Afterthepricingchange,salesrepsnow
nowcouldmakealotmoremoneybysellingthecontacts.Andtheyquicklybecomemuchbetteratpositioningthatpartoftheproduct,aswellasfindingcompanieswithacontacts-based
basedusecase.Productqualitywillremainparamount–butit’sremarkablehowmuchimpactpricing,packagingandsalescommissionstructurecanhaveonproductadoptionanduniteconomics.
CustomerSegmentation
CustomerSegmentationanalysiswill helppoint outwhich areyour mostprofitablesegments.Twoimmediateactionsthat aresuggestedby thisanalysisare:
Doubledownon yourmostprofitablesegments
Look atyourlessprofitablesegmentsandconsiderchangesthatwouldmakethemmore
moreprofitable:lowercostmarketing& salesapproaches,higherpricing,productchanges,etc. Ifnothingseemstomakesense,spendlesseffortonthesesegments.
InternationalMarketsExpansioninternationallyis onlyrecommendedfor fairlymatureSaaScompaniesthatalreadyhave
havehonedtheirbusinesspracticesin theirprimarymarket. Itis farharder toexperimentand tune abusiness infar offregions,withlanguageandculturaldifferences.
BradCoffey,HubSpot
Oneofthebiggestchallengeswefaceisthetrade-offbetween
betweengrowthanduniteconomics(specificallychurn).Manyofthethingsthatwehavedonetoreducechurnhave(potentially)comeattheexpenseofloweringourgrowthrate.Thosehavebeen
someofourhardestdecisions:e.g.requiringupfrontpayments,requiringcustomersbuyconsulting,holdingsalesrepsaccountableforchurn,etc.Wearealwayslookingatthingsthatgiveusgrowthwithoutthe
thetradeoffoflowergrowth.Forexampleproductimprovementisanobviousone– abetterproductiseasiertosellandprovidesmorevaluetothecustomer.Servicespromotionsactuallyworkwelltoo.
too.ManyoftheoptionsthatSaaScompanieshavetoadjusttheirbusinessarenotsimplyawin-winbutarestillworthexploring.Toomanycompaniesthinkthateveryproblemis aproduct
productproblemandeverysolutionisthattheproductmustgetbetter.
Theotherthingthat’sreallyimportantisthatcompaniesdon’ttrytospinthesenumbers.Thereissomuchpressureto
todismissabadcustomer(whohurtyourchurnnumber)orexcludecosts(onlycountmarketing‘program’spend–notheadcount).Ifyoucangettheaccountingcloseenoughtorightit
actuallyfreesmanagementfromneedingtomakeeverydecision.Iftheaccountingisrightmanagementcanobsessoversettinggoals(growth,LTV:CAC),holdpeopleaccountabletothosegoalsandthengiveautonomy
autonomytotheirteamonhowtoachievethosegoals.
PlanaheadIt takestime formostinitiativesto have animpact.We’velearnedfrom sometoughlessonsthatplanninghas to bedone wellin advanceto drive aSaaSbusiness.Forexample ifyou arenot happy
not happywith yourcurrentgrowthrate, it willoften takenine totwelvemonthsfrom thepoint ofdecisionbefore thegrowthresultingfromincreasedinvestmentin salesandmarketingwillactually beobserved.
TheHighLevelPicture:HowtoRun aSaaSBusiness
BusinessHopefullywhat youwill havegatheredfrom thediscussionabove isthat thereare reallythreethings thatreallymatterwhenrunning aSaaSbusiness:
1. Acquiringcustomers
2. Retainingcustomers
3. Monetizingyourcustomers
Theseconditemshould befirst onyour list ofthings toget right. Ifyou can’tkeep your
keep yourcustomershappy, andkeep themusing theservice,there is nopoint inworryingacquiringmore ofthem. Youwill simplybe filling aleakybucket.Ratherfocus yourattentiononpluggingthe leaks.
SaaSbusinessesareremarkablyinfluencedby a fewkeynumbers.Makingsmallimprovementsto thosenumberscandramatically
dramaticallyimprovethe overallhealth ofthebusiness.
Once youknow yourSaaSbusiness isviableusing theguidelinesprovidedforLTV:CAC,and Timeto recoverCAC, hittheacceleratorpedal. Butbepreparedto raise thecashneeded tofund thegrowth.
Althoughthis articleis long andoccasionallycomplex,we hopethat it has
helpedprovideyou withanunderstandingof whichmetrics arekey, andhow youcan goaboutimprovingthem.
AcknowledgementsI wouldlike tothank RonGill, theCFO ofNetSuite,and BradCoffey &BrianHalligan ofHubspotfor theirhelp inwritingthis. Iwould liketo thanktheHubSpotmanagement
teamwithoutwhomnone ofthis wouldbepossible.Most of mylearningson SaaShave comefromworkingwith them.I wouldalso like tothank GailGoodman,the CEO ofConstantContactwho alsotaught usmany ofthe keymetrics inher role asboardmember ofHubSpot.
AboutDavidSkok
David SkokjoinedMatrixPartnersas aGeneralPartner inMay 2001.He has awealth ofexperiencerunningcompanies.Davidstarted hisfirstcompanyat age 22.Since thenDavid hasfounded atotal offourseparatecompaniesandperformedone turnaround.Three ofthesecompanieswentpublic. HejoinedMatrix
fromSilverStreamSoftware,which hefounded inJune 1996.Prior to itsacquisitionby Novell,SilverStreamwas apubliccompanythat hadreached arevenuerun rate inexcess of$100m,withapproximately800employeesand officesin morethan 20countriesaround theworld.
David’swork as avalueaddedinvestor isbestknown for
known forhelpingJBoss,Netezza,AppIQ,CloudSwitch,Tabblo andDiligentTechnologiestosuccessfulexits.Davidserves onthe boardsofCloudBees,Digium(makers ofthepopularAsteriskOpenSourcePBX/telephonysoftware),Enservio,GrabCad,HubSpot,OpenSpan,andVideoIQ.He is alsoan investorin Meteor.
Davidwrites a
writes ablog forentrepreneursandstartupson topicssuch asviralmarketing,SaaSmetrics,building asales andmarketingmachine,techniquesforloweringcost ofcustomeracquisition,etc. Theblog canbe foundhere:www.forEntrepreneurs.com.
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