The SaaS business model & metrics: Understand the key drivers for success

It's a real pleasure to be here. It's a great city and it's interesting to see how the web summit is impacting this city. One of the companies in my portfolio. A company called Salsify has just decided to move its European headquarters here to Lisbon and that's quite different from what we used to see. everyone will be going to Dublin before that so it's nice to see recognition of what the city has to offer so I have a big topic to talk to you about this morning: the SAS

business

model

and

metrics

and in case to make them wonder why it is like this.

Very important. I love this quote from Lord Kelvin. If you can't measure it, you can't improve it and clearly we all want to improve our SAS

business

es, so

understand

ing

metrics

is important for that, but metrics also play another role, which is once you start regularly. By measuring a series of numbers, what you will find is that your team will realize the importance of those numbers and will begin to work to improve them so that they can act as a very powerful way to align your entire management team and your company in the direction you want. Comes in, but that also makes it really important that we

understand

which metrics to really highlight and try to simplify them to as few as possible and that's my goal today is to help you understand what the important metrics are and there's a caveat.

I'll give you what the metrics change depending on what stage you're at and I don't have time today to explain that detail, but I'll be in my next presentation at 12 o'clock at Start University talking a lot about these. stages and what you might think, how things change them, but let's also talk about something else here, which is that I have analyzed many companies over many years and I have never found a company that was so sensitive to small changes in key variables. than a SAS business and that makes it really important to try to understand what are these specific variables that unlock growth for us and again, that's my goal for you today, so one thing that I think most of you probably already know is that if you go to To look at SAS public companies and you wanted to calculate the valuation, if here we look at the valuation on the y-axis, what we have to use to calculate the valuation is to look at a combination of two factors, what is the growth rate as a percentage and which one? is the operating profit as a percentage of revenue and we add those two percentages and that will give us the x-axis and that is the best predictor of profitability, in other words, what this tells us is that you not only have to grow fast but also be profitable , but alternatively, if you are growing less quickly, you can get away with being much more profitable, which is why this is often talked about as the rule of 40 because you want your growth rate plus your profitability to equal 40%, so I could be growing at 50% and losing 10% per year or I could be growing at 10% but making a 30% profit and both would be acceptable and hit the rule of 40 so that tells me something I've been very focused on Any of you who read my blog here will know that I talked a lot about these three words here your goal is to produce a repeatable, scalable and profitable growth machine and these are really very easy words to say, but in reality they turn out to be very difficult. achieve in practice and they are very powerful words because if you can find a way to grow your business in a way that is scalable so that you can do everything you want and is also profitable, in effect, you will have defined and built a revenue generating machine. cash where you can invest $1.00 and a few years later get many more dollars, so this is something that growth investors really love.

Now the key indicator that you have managed to achieve repeatable and scalable growth is that you are able to increase your bookings and here it is important to recognize that I am not talking about revenue or ARR, but about your bookings reliably and consistently quarter after quarter, for what if you increase your bookings you don't increase your bookings your business will continue to grow but it will grow with a flat curve like that and what we are looking for is an exponential growth curve because you are

success

fully in charge of how to increase your bookings you understand how making your growth process scalable and how to scale it so that It brings us to the question of how we measure bookings.

It's actually quite different in a SAS business and the right way to measure bookings is to look at the net new AR AR and that new AR AR is made up of three components, the AR AR that you get from new customers the expansion AR AR that you get from your existing customers and we subtract from that the revenue that we will lose from the churned customers that we lost during the quarter, so these four components or the total summary of three components Plus Ones are the key. basic metrics for running a SAS business, if you don't do them reliably and regularly, it is important to keep this in mind and this is the chart that I recommend that all founders use on a monthly basis to understand their business, so this chart Those three components plus the sum of them, which is the dark red line, and again remember that our goal is to see that dark red line grow and we need the other components to understand why it is not growing or what is contributing to its growth. growth and what we can do better there and it's really important to have it as a time series, not just to look at a single point in time because you want to see if it's growing or not, so that any of you who read my blog know that a One of the things I really like to try to do is take complex things and simplify them and today I'm going to try to simplify the entire SAS business

model

into a single concept, which is what you can think of as a SAS business. like a funnel and if you run the entire business around this funnel idea, I think it really helps for everyone to recognize what you're trying to do and the SAS world, we need to extend the funnel because it's so important that we retain customers. to earn recurring revenue over a long period of time, so we'll look at a funnel that includes the backend of customer onboarding, retention, and expansion.

Now the beautiful thing about funnels is that they are governed by really very, very simple rules. math and that's what helps simplify my job today. The first part of the math is that to calculate bookings we simply have to take the number of leads that reach the top of our funnel, multiply it by our conversion rate and then that will tell us how. There were a lot of deals closed at the bottom of the funnel and then if we multiply that by our average deal size, we have our booking number, which tells me we need to be very focused on lead flow and conversion rate in the deals. first days and later we can worry.

As for the size of the deal, I wouldn't worry too much about that in the early days of your company, so let's take an example of a very simple business. This is a way of driving your customers to the website and then asking them to do a free trial and hoping to close them after that, so what I would recommend here is that the metrics you're looking at are the number of visitors that reach the website. top of your funnel and then the number of people going to trials and then the number of closed deals and plotting this as a time series again, it's very important to see if you're improving over time because our goal is to show that we know how control that growth rate at that time and, on top of that, we really want to know how. many visitors are converting to trials, our conversion rate and we also need to track them over time and try to improve them because clearly, if we can convert more visitors to trials, that will actually directly affect our bookings in exactly the proportion in the one we do that. change it now, a quick word about conversion percentages, they are not that easy to calculate.

The way to do the calculation is to track a cohort like the January group of people you saw coming to your website and observe them for several months, perhaps. up to five months or so to allow them to flow completely through the funnel to calculate conversion rates, then once you've done that you can get your overall conversion rate for your entire funnel and this can also be very powerful because now you can look There's my lead source and you can start to figure out which lead sources are giving you a good ROI that you can afford to spend more on and invest more money into those lead sources.

Until now, I described a funnel that did not require salespeople. actually it was just a marketing driven funnel but many times in fact most of the time there will be sellers involved and when sellers are involved we run into a different problem here which is a ramp time for a seller but also a capacity limit. There is a limit to the number of deals they can work on at any one time and as a result of that, our growth occurs in discontinuous units and depends on the number of sellers we have. If we don't hire enough salespeople, we will limit our growth because we win.

I don't have enough capacity to talk to our potential customers who get there, so I want to present a second formula to you and again, fortunately, it is a very simple formula, so when you have sellers, your reservations equal the number of sellers that you have multiplied by the PPR productivity per rep, which is the average amount of business each rep produces and let's look at each of these in turn, so one of the most important lessons I've learned is that every portfolio company I've dealt with have at least once and usually most of the time they missed their sales figures twice by not hiring salespeople on time and when you are a founder in the early days, you normally wouldn't worry about missing the hiring moment because you are saving money by Hire some people.

A little further on, this is the only place where it is really important not to do it because you will lose your booking plan if you don't hire sellers on time and that brings me to the importance of recruiting and I would really recommend that each of you understand that recruiting It's not one of the crucial skills you need to develop to have a

success

ful startup and you need to bring that skill in-house and not depend on external external recruiters for that. Look at the second variable in that formula: productivity per rep which is affected by the quality of the people you hire and, again, this goes back to why recruiting is so important;

You need to have great talent in your organization, but it's also affected by the good work you do in onboarding and training, and again. If you come to my 12 o'clock talk at a startup university, you'll hear me talk a lot about how to create this training and onboarding and how important it is for founders to do it, since you're spending so much on these salespeople. I need them to be productive, so I recommend monitoring productivity per rep again with a time series chart to see how it changes and see the details of how productivity per rep is evolving.

I highly recommend that you look at a chart like this where you have every salesperson you've ever had and a green bar that shows you if you're over quota or red if you've gone under quota and what we're looking to achieve here is in the far right column where we have a lot of green salespeople and that tells us that our onboarding and hiring is going well and we are making our salespeople productive. If it's not working well, then we need to fix onboarding training or hiring to make people productive and another chart that can be useful for What you need to do is look at how many of your reps are above 75% quota and a rough target here is 75% of them should be above that and how many of your reps are above one hundred percent quota and here's a rough target that's helpful.

If 50% of them need to be above one hundred percent, you may not get there in the first few days, but it's helpful to have some goals to aim for to stay on top of them, so that once we have our funnel working, we will come to ask. The question is that our funnel is profitable because I mentioned that the evaluation of our company is driven not only by growth rate but also by profitability, so to solve this well it is necessary to use unit economics where we analyze CAC and LTV. CAC is the acquisition cost. a customer and LTV is the lifetime value of the customer and our goal to have a viable business model is that our lifetime value must be significantly greater than the cost of acquiring the customer, so let's start by looking at the lifetime value of the customer and Obviously this depends on how long we can keep our customer during the useful life and the formula to calculate the useful life of thecustomer is simply 1 divided by the customer churn rate, which tells us that churn is extremely important as a variable that drives our profitability and, therefore, valuation of our company, churn is not simple, there are two forms of churn. and I want to show you what the difference is between the two: customer attrition and dollar attrition, so I'd like you to imagine a simple story here where we start the year with two customers, one makes $1,000 a month and the other makes $ 5,000 a month.

If we, who are the first customer, had a 50% customer churn, but we only had a 17 percent chance of dollars and it's not that bad in dollar churn, but if it's the other way around and we lose the second customer , we have lost eighty-three percent of our money, so we need to track both things separately, but something very interesting can happen which is, instead of just losing the one customer, if we are able to successfully increase the number of customers (5,000 to 7,000, in reality we would have) a 16 percent attrition in dollars and this is a negative attrition and it is a very, very important concept for a SAS business, so, to repeat again, the which is a negative churn occurs when the revenue from expansion from your existing customers exceeds the revenue you lost from your churned customers and it is very powerful now, some of you may know that I was on the board of directors of HubSpot in the early days of HubSpot we started with a product priced at five thousand, so actually with six thousand dollars a year five hundred dollars a month and we had no way to make expansion income because there was nothing else to sell to you after that, we bought the initial product, so A key lesson we had to learn was that to get expansion revenue we needed to have variable price axes and you can get variable price axes by introducing different editions of your product or by charging four users or, as in the case of points central, charging by some other metric. like the number of leads they were storing, which was a better equator - how much value the software was providing to customers, so it was a good lesson to learn there again.

I wouldn't panic if it didn't have variable pricing if you're an early-stage startup, it's a secondary thing that comes later once you've got your business up and running here, but I think negative attrition is crucial to success and to illustrate that , I would like to talk about it. This company has a revenue loss of two and a half percent monthly and you can see that if there is 10 million ARR to get back to ten million next year, they will have to make another three million. three million just to replace the business they are going to lose, well three million is not a big deal, we can easily set aside three million at some point, but if you take it a little further and look at that same business when they hit one hundred million , now they have to replace 30 million just to stay spilled just to stay the same size as they were before and that turns out to be a very big problem and I was very friendly with Gayle Goodman from Constant Contact and this was the exact problem they ever ran into They were able to get to a negative churn rate and as a result the business just had a hard time growing and growing, so negative churn is the answer to how to get a long term successful business and now the other.

What I'm going to show you here is that if you look at a particular simple model that I created and change it, you track what happens if the two of you have two and a half percent churn or to an office and negative churn after 40 months. , the differences in the On the right side we have four hundred K and ARR versus just one hundred fifty K on the left side, so there is a big difference in how fast your business will grow with negative churn. Now there's another reason we need SAS unit economics and that's because every other business has been measured by traditional GAAP accounting metrics of P&L and balance sheet, but these don't work for SAS and the reason they don't work is because we have this strange phenomenon where we lose a lot of money in the first few days acquiring our customers, but we don't get that money back very quickly, we get it back over a period of time, so we have negative cash flow over a long period of time. time with every customer we add, so that's one customer.

What happens if we add a lot of customers, let's show you what happens if we add five customers a month, this is just looking at sales and marketing expenses, we have minimal cash flow. I call this the SAS minimum cash flow and it is something that is very important. so that the investors and the board members understand it because all the SAS businesses that are successful will lose a lot of money and that is because of this phenomenon here and what also happens is that in this model that I showed here, the faster grows, the deeper your cash becomes.

The flow is going so this is an interesting thing and one of the HubSpot board members was NetSuite effort Ron Gill and he gave me this quote for a blog post I did which surprises a lot of investors and boards. directives on SAS. The model is that even with perfect execution, acceleration of growth will often be accompanied by contraction, profitability and cash flow, so they saw this constant return to negative cash flow when they started to re-accelerate their growth there and I used to run into this problem with my partners when I would come in and talk about the fact that HubSpot was doing really well and they would say why was it losing so much money and it kept getting worse and worse and worse and I had to explain it to them. with these charts here, but it brings you to an important question: If you are losing money at an increasing rate, how do you know that you have a business that will turn the corner and be a successful business?

The answer is that about 10 years ago I wrote a blog post where I came up with these guesses as guidelines: that your lifetime value should be at least more than three times that and that you should be able to recover the CAC in less than 12 to 18 months, approximately. very rough guidelines and I assumed them, but 10 years later it turns out that they've been tested and time-tested and I think they're really solid key guidelines to help you figure out if you're really going to turn the tide. So another thing that's very powerful about unit economics is that you can use it to help you understand your customer segments.

Here we have HubSpot again on the left side, the very small business segment only has one and a. half the LTV to CAC ratio, but the VAR channel that we were using to sell to very small businesses actually had a five to one LTV to CAC ratio, so this helps us recognize that we had a very unprofitable, but at the same time also I had 12 reps assigned to the very small company, but only four reps assigned to the large company, so obviously 12 months later we changed that completely. Now we only had two representatives left selling to VSP and 25 representatives assigned to sell to the VAR channel, so that helps. understand where and how to drive business for yourself, so the last thing to recognize here is that there are other types of unitary comics that can be useful and that is for the seller, so if you pay yourselves around a hundred thousand per goal, my recommendation is that you set the quarter between four and six times longer in order to get very profitable sellers and one last thing I want to talk about here is that in my model I studied the impact of making annual payments up front and I found that this has a great impact on your business. the cash flow, not your profit and loss because it doesn't change that, but here's my model that I ran and it shows that in one case you ended up with three and a half million in cash and in the other case you ended up with thirty-eight million in cash and prevented all cash flow, so if I could, this is one of the most powerful variables, so in short, all I did was try to simplify the SAS until I recognized that it is just a funnel and, if you look, To optimize that funnel, you have a great way to create the metrics that you want, so in bookings we worry about using the formula that I talked about, we worry about retaining customer happiness at the bottom of the funnel and we generate a negative turnover and we care about profitability through unit economics and gross margin and lastly, as I showed you for your cash flow, collecting cash up front is a very key metric.

Now it's clearly a lot more than this, but I only had 20 minutes to talk to you today, so I had to narrow things down. To the extent possible, if any of you are interested in reading further here, I would recommend going to my blog and one last thing that might be interesting for you is that at 12 o'clock I am speaking on the Startup University stage about nine stages to get to a repeatable, scalable, profitable growth model and I'll talk about how crucial it is to understand each of these stages and why you can't rush and how much damage you cause by moving forward, so I hope to see some of you with that but otherwise thank you very much for your time and for listening to me and it has been a pleasure talking with you