The SaaS business model & metrics: Understand the key drivers for success
This video is about The SaaS business model & metrics: Understanding the key drivers for success.
In this talk, David Skok, author of the now famous SaaS Metrics 2.0 blog post will talk through those key metrics and their impact on the overall SaaS business model. This web summit was held in Lisbon, Portugal.
Before summarizing the video, let’s see what is SaaS and what does it do.
Software as a Service, also known as SaaS, is a cloud-based service where instead of downloading software into your desktop, PC, or business network to run and update, you instead access an application via an internet browser. The software application could be anything from office software to unified communications among a wide range of other business apps that are available.
Summary of The Video
What is Metrics? Why it is important?
To improve SaaS businesses, one needs to understand metrics. Metrics is also important cause when you start measuring a series of numbers in a regular basis, you will find that your team will realize the importance of those numbers.
They will start to improve those numbers. They can act as a very powerful way to align your entire management team and company around a direction you wanted to head in. It’s also important to understand which metrics to highlight and try to simplify those down to the smallest numbers possible. Metrics change according to stage.
If you look at public SaaS companies and you wanted to compute valuation then on the y-axis here what we have to use to compute valuation is to look at a combination of two factors i) what is the growth rate as a percentage and ii) what is the operating profit as a percentage of revenue and add those two percentages together. These two will give us the x-axis and that’s the best predictor of profitability. So, in other words what this tells us is that you have to not only grow fast but also be profitable.
But alternatively, if you’re growing less fast you can get away with that by being much more profitable. So, this is talked about often as the rule of 40 because you want your growth rate plus your profitability to be equal to 40%. So, you could be growing at 50% and losing 10% per year or you could be growing at 10% but making 30% profit and both of them would be acceptable and hit the rule of 40 then.
There are three key startup growth goals-
If you can figure out a way to grow your business in a way that’s scalable so you can do it as much as you want to. Besides, it’s also profitable. You have in effect defined and built a cash generating machine where you can put in $1.00 of investment and a few years later get out many more dollars. So, this is something that growth investors really love.
Now the key indicator that you’ve successfully managed to get repeatable and scalable growth is that you are able to grow your bookings and here it’s important to recognize your bookings reliably and consistently quarter after quarter. So, if you don’t grow your bookings, your business will still grow but it will grow with a flat curve and what we’re looking for is an exponential growth curve because you are successfully in charge of how to grow your bookings.
You understand how to make your growth process scalable and how to scale it.
The right way to measure SaaS bookings is to look at net new ARR. Net New ARR is made up of three components. They are
- New ARR (New Customers)
- Expansion ARR (Existing Customers)
- Churned ARR (Lost Customers)
- Net new ARR= New ARR + Expansion ARR – Churned ARR
Growth comes in discontinuous units depends on the number of salespeople we have if we don’t hire enough salespeople. We will limit our growth because we won’t have enough capacity to talk to our leads that are coming in there. There is a simple formula and it is when you have sales people your bookings equals how many salespeople you have multiplied by the
PPR (productivity per rep). That’s the average amount of business. One of the biggest lessons is that every portfolio company has at least once and normally most often twice missed their sales numbers by failing to hire salespeople on time and when you’re in a founder in the early days you’d normally don’t worry about missing your hiring timing because you’re saving money.
By hiring people a little bit later this is the one place where that really is important to not do because you will miss your bookings plan. If you don’t hire salespeople on time and that leads me to the importance of recruiting and recruiting is not one of the crucial skills you need to build to have a successful startup and you need to bring that skill in-house and not rely on third party outside recruiters for that.
Customer Churn V Dollar Churn
There are two forms of churn and the difference between the two of them is customer churn and dollar Churn. Imagine a simple story where we start the year with two customers, one is doing $1,000 a month and the other one is doing $5,000 a month.
If we lose the first customer we had 50% customer churn but we only had 17 percent dollar chance and not too bad on the dollar churn but if it goes the other way around and we lose the second customer we’ve lost eighty-three percent of our dollars.
So, we need to track both of these things separately but something very cool can happen which is instead of just losing customer one if we were successfully able to grow customer – from 5k to 7k we would actually have – 16 percent dollar churn and this is negative churn and it is a very important concept for a SaaS business. Negative Churn is when expansion revenue from existing customers is greater than revenue lost from Churning customers.
The key metrics and levers are
- Bookings when there are sales reps
- Customer happiness/Retention/Churn
- Unit economics
- Months of cash collected up front
There are 9 steps to get a repeatable, scalable, profitable model. These are:
- Test hypothesis
- Prove the value
- Prove it can be called
- Find repeatable sales motion
- Prove non-founders can sell
- Make it scalable
- Ensure customer success
- Make it profitable
- Hit the gas and scale
0:35- What is Metrics and Why it is Important
1:41- SaaS Business
2:08- SaaS valuations
3:06- Key Startup Growth
4:31- The right way to measure SaaS Bookings
5:43- Simple model for a SaaS business
9:36- Number of Sales People
13:00- Customer Churn V Dollar Churn
16:10- Impact of Negative Churn
18:37- Guideline for SaaS success
20:46- Key Metrics and Levers