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Discussion Topics:
•   The Business Objectives
•   The key drivers
•   Metrics
•   Other Benefits of SaaS
The Business Objectives
• Profit
• Cash
• Growth
Understanding Profit in the SaaS world

• The micro-economic view
• Look at economics of:




      Sales person          Customer
Excel Spreadsheet
• Available here:
    – www.forEntrepreneurs.com/saas-economics-1


Part of a blog post that describes the model

•   The figures I have used should not be taken as a default set of values for any SaaS business
     –   There are going to be wide variations in funnel efficiencies that will make each individual business
         considerably different
Key Variables
Sales compensation and overhead
Base Compensation                 $   50,000
Variable Compensation             $   55,000 with 50% draw for first four months
Draw on Variable Comp                   100%            70%           30%           0%
Productivity Ramp                        10%            33%           66%         100%
Additional overhead               $   30,000
                                             a factor to discount bookings to account
Sales attrition factor                   15% for failed sales hires and attrition

On target annual bookings
 Annual Bookings                      500,000 ACV (Annual Contract Value)
 Monthly Bookings                 $   41,667 ACV (Annual Contract Value)
 Monthly Bookings                 $    3,472 Billed monthly (=ACV / 12)

Churn Rate and Margin
Churn Rate (monthly)                   2.50%
Gross Margin                          80.00%
Key Variables
Sales compensation and overhead
Base Compensation                   $     50,000
Variable Compensation               $     55,000 with 50% draw for first four months
Draw on Variable Comp                       100%           70%           30%            0%
Productivity Ramp              Standard Inside Sales Stuff:
                                             10%           33%           66%          100%
Additional overhead            •Compensation
                                    $     30,000
                               •Quota: $500k     a factor to discount bookings to account
Sales attrition factor         •Ramp time 15% for failed sales hires and attrition
                               •Attrition
On target annual bookings
 Annual Bookings                            500,000 ACV (Annual Contract Value)
 Monthly Bookings                    $      41,667 ACV (Annual Contract Value)
 Monthly Bookings                    $       3,472 Billed monthly (=ACV / 12)

Churn Rate and Margin
Churn Rate (monthly)                         2.50%
Gross Margin                                80.00%
How Revenue Builds for a SaaS Salesperson
             (assuming no ramp up time)
Looking at a Single Salesperson
The Cash Flow Gap

                            11 months to
                             breakeven




Cash
Gap




                 (Slightly later breakeven point, because Gross Profit is less than MRR)
The SaaS Cash Flow Trough




       Total amount   23 Months to get   But a great
         invested:         back the       return on
           $110k         investment      investment
Our Example Marketing Funnel

                             Visitors to Web Site
                                                      Other Paid
                   Organic Traffic        SEM
                                                     lead sources
 Top of Funnel
                                     Raw Leads
                               Registered Visitors



Middle of Funnel               Qualified Leads


  Inside Sales                   Inside Sales



  Closed Deal                        Closed Deal
Our Example Marketing Funnel

Quick Marketing Calculation
          50% amount of traffic that is organic versus paid
        $1.50 cost per paid visitor (Google AdWords, etc.)
$        0.75 Cost per visitor (both paid and unpaid)
           3% visitors convert to raw leads
          20% number of raw leads that turn into qualified leads



            1 qualified lead
            5 raw leads required
          167 visitors required
         $125 Cost of visitors (also = Cost per qualified lead)
Our Example Marketing Funnel

Quick Marketing Calculation
          50% amount of traffic that is organic versus paid
        $1.50 cost per paid visitor (Google AdWords, etc.)
$        0.75 Cost per visitor (both paid and unpaid)
           3% visitors convert to raw leads
          20% number of raw leads that turn into qualified leads



             1 qualified lead
             5 raw leads required
           167 visitors required
       $125 Cost per qualified lead
Our Example Marketing Funnel
The model also computes CAC and LTV

                                             Excludes people costs
Lead Gen costs per deal     $        1,250   (Cost per qualified lead x no of leads required per closed deal)


Selling costs per deal      $        1,620   Excludes cost of sales management


                                             Excludes people costs in marketing, and sales management.
Total CAC                   $        2,870   (CAC= Cost to Acquire a Customer)

                                             Calculated by dividing average monthly gross profit per customer
Total LTV                   $       16,000   (ARPU x Gross Margin ) by the churn rate




      This excludes people costs in marketing, and sales management costs
My rules for CAC/LTV balance in a SaaS
                model


          LTV           > 3x           CAC

           Months

                        < 12 months
              to
           recover
             CAC

         Required for Capital Efficiency
What we are looking for
A well balanced business model




                                 Monetization
                                    (LTV)



 Cost to
Acquire a
Customer
  (CAC)
The Balancing Act
                •   Viral effects
                •   Inbound Marketing
                •   Free or Freemium
                •   Open Source
                •   Free Trials              • High Churn Rates
                •   Touchless conversion     • Low customer
                •   Inside Sales               satisfaction
                •   Channels
                •   Strategic partnerships



Cost to Acquire a                                                    Monetization
 Customer CAC)                                                          (LTV)




                • Field Sales                •   Scalable Pricing
                • Outbound Marketing         •   Cross Sell/Upsell
                                             •   Product line expansion
                                             •   Lead Gen for 3rd parties
When To Grow?
Conserve Cash                       Invest Aggressively




Search for Product/Market Fit


                 Search for Repeatable & Scalable
                            Sales Model


                                                    Scaling the Business
What happens at the company level when
 we add 2 new sales hires every month?




   Worst loss:                      Total amount   32 Months to get
                 First profitable     invested:         back the
    $190k in
                    month: 21           $2.6m         investment
   month 11
How MRR Grows when hiring 2
            salespeople per month




• Tracking growth in MRR shows new bookings
    • Shows how constantly adding new sales hires increases the bookings every month
What happens if you don’t keep hiring
        new sales people?

                                                                     Very little
                                                                    impact from
                                                                       churn




                                                                Monthly churn
                                                               becomes a bigger
                                                                negative factor
                                                                 as MRR grows




  • The business still keeps growing, but at a slower, slightly declining rate
Comparison: hiring one versus two
      sales people per month




• Not surprisingly, MRR and Growth in MRR directly correlate to sales hiring rate
Comparison: hiring one versus two
    sales people per month




        The time to                          Not adequately shown,
     breakeven remains    The cash flow
                                            but the acceleration after
         the same        trough is halved
                                            breakeven is also halved
What’s the blocker to faster growth?
• Usually it is the rate at which you can grow leads
   – Typically each lead source maxes out
   – Adding new lead sources often means paying more per lead
                  Leads



                                                 Source C


                                      Source B


                                 Source A
                                                            Time




• Another blocker:
   – The rate at which you can hire and train really high quality sales people
The Key Metrics
                         CAMPAIGNS
                          TO DRIVE
                          TRAFFIC



                          VISITORS
       OVERALL
     CONVERSION %
                                       CONVERSION
                                           %



                           TRIALS
     (BY LEAD SOURCE)

                                       CONVERSION
                                           %



                        CLOSED DEALS
What happens if we collect a year’s
      payment in advance?


       Year in advance
                         Eliminates the cash
                           flow trough, and
                          means $35m more
                         cash in this scenario




              Monthly
Lesson Learned
• Look for ways to get customers to pay in
  advance
  – Depending on the cost of your capital, this can be
    worth fairly large discounts
• Churn Rate plays a huge role in success
How Churn affects LTV


• Average customer lifetime in months =


      1 / Monthly Churn
How Churn affects Lifetime
Months




                           Monthly
                            Churn
How Churn affects LTV
LTV




                              Monthly
                               Churn
Impact of lowering Churn




• Impact of lower churn rate is felt more heavily in the later years, as expected
• It has a significant impact on the long term profitability of the business
Churn
• 1% to 2.5% churn per month is acceptable
• Higher than that, you are filling a leaky bucket
  – Need to understand why you have low customer
    satisfaction and address the problem
A way to get to negative Churn
   Top of Funnel



  Middle of Funnel


    Inside Sales     Increasing revenue
                     per client over time
                     will create negative
    Closed Deal              churn



      Expand,
    Upsell, Cross
        Sell
Sales Complexity
How I assumed the two would relate
A rough estimate of CAC versus Sales
            Complexity



    Rough Estimates of Cost of Customer Acquisition (CAC)
The relationship is roughly exponential



                              Clearly adding
                              Human Touch
                               dramatically
                             increases costs
CAC (logarithmic)


                            10x




                    10x




            10x




                      Sales Complexity
High CAC requires higher pricing
• … which leads to greater approval complexity
SaaS Sales Complexity
• Low risk to customer
  – Easy to try before buying
  – Small initial financial commitment
  – Easy to cancel if not working


• Low IT involvement in decision process

• No infrastructure or IT
How SaaS changes Sales Complexity
   Value / Pain / Urgency = LTV (logarithmic)




                               Sales Complexity 
Product Development
•   Single version of the product at all customers
•   Can be improved monthly
•   Provides clear feedback on what is working
•   Great indicator of customer happiness
    – Which is a predictor of churn
For More information
• Visit my blog at www.forEntrepreneurs.com

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The SaaS business model

  • 1.
  • 2. Discussion Topics: • The Business Objectives • The key drivers • Metrics • Other Benefits of SaaS
  • 3. The Business Objectives • Profit • Cash • Growth
  • 4. Understanding Profit in the SaaS world • The micro-economic view • Look at economics of: Sales person Customer
  • 5.
  • 6. Excel Spreadsheet • Available here: – www.forEntrepreneurs.com/saas-economics-1 Part of a blog post that describes the model • The figures I have used should not be taken as a default set of values for any SaaS business – There are going to be wide variations in funnel efficiencies that will make each individual business considerably different
  • 7. Key Variables Sales compensation and overhead Base Compensation $ 50,000 Variable Compensation $ 55,000 with 50% draw for first four months Draw on Variable Comp 100% 70% 30% 0% Productivity Ramp 10% 33% 66% 100% Additional overhead $ 30,000 a factor to discount bookings to account Sales attrition factor 15% for failed sales hires and attrition On target annual bookings Annual Bookings 500,000 ACV (Annual Contract Value) Monthly Bookings $ 41,667 ACV (Annual Contract Value) Monthly Bookings $ 3,472 Billed monthly (=ACV / 12) Churn Rate and Margin Churn Rate (monthly) 2.50% Gross Margin 80.00%
  • 8. Key Variables Sales compensation and overhead Base Compensation $ 50,000 Variable Compensation $ 55,000 with 50% draw for first four months Draw on Variable Comp 100% 70% 30% 0% Productivity Ramp Standard Inside Sales Stuff: 10% 33% 66% 100% Additional overhead •Compensation $ 30,000 •Quota: $500k a factor to discount bookings to account Sales attrition factor •Ramp time 15% for failed sales hires and attrition •Attrition On target annual bookings Annual Bookings 500,000 ACV (Annual Contract Value) Monthly Bookings $ 41,667 ACV (Annual Contract Value) Monthly Bookings $ 3,472 Billed monthly (=ACV / 12) Churn Rate and Margin Churn Rate (monthly) 2.50% Gross Margin 80.00%
  • 9. How Revenue Builds for a SaaS Salesperson (assuming no ramp up time)
  • 10. Looking at a Single Salesperson
  • 11. The Cash Flow Gap 11 months to breakeven Cash Gap (Slightly later breakeven point, because Gross Profit is less than MRR)
  • 12. The SaaS Cash Flow Trough Total amount 23 Months to get But a great invested: back the return on $110k investment investment
  • 13.
  • 14. Our Example Marketing Funnel Visitors to Web Site Other Paid Organic Traffic SEM lead sources Top of Funnel Raw Leads Registered Visitors Middle of Funnel Qualified Leads Inside Sales Inside Sales Closed Deal Closed Deal
  • 15. Our Example Marketing Funnel Quick Marketing Calculation 50% amount of traffic that is organic versus paid $1.50 cost per paid visitor (Google AdWords, etc.) $ 0.75 Cost per visitor (both paid and unpaid) 3% visitors convert to raw leads 20% number of raw leads that turn into qualified leads 1 qualified lead 5 raw leads required 167 visitors required $125 Cost of visitors (also = Cost per qualified lead)
  • 16. Our Example Marketing Funnel Quick Marketing Calculation 50% amount of traffic that is organic versus paid $1.50 cost per paid visitor (Google AdWords, etc.) $ 0.75 Cost per visitor (both paid and unpaid) 3% visitors convert to raw leads 20% number of raw leads that turn into qualified leads 1 qualified lead 5 raw leads required 167 visitors required $125 Cost per qualified lead
  • 18. The model also computes CAC and LTV Excludes people costs Lead Gen costs per deal $ 1,250 (Cost per qualified lead x no of leads required per closed deal) Selling costs per deal $ 1,620 Excludes cost of sales management Excludes people costs in marketing, and sales management. Total CAC $ 2,870 (CAC= Cost to Acquire a Customer) Calculated by dividing average monthly gross profit per customer Total LTV $ 16,000 (ARPU x Gross Margin ) by the churn rate This excludes people costs in marketing, and sales management costs
  • 19. My rules for CAC/LTV balance in a SaaS model LTV > 3x CAC Months < 12 months to recover CAC Required for Capital Efficiency
  • 20. What we are looking for A well balanced business model Monetization (LTV) Cost to Acquire a Customer (CAC)
  • 21. The Balancing Act • Viral effects • Inbound Marketing • Free or Freemium • Open Source • Free Trials • High Churn Rates • Touchless conversion • Low customer • Inside Sales satisfaction • Channels • Strategic partnerships Cost to Acquire a Monetization Customer CAC) (LTV) • Field Sales • Scalable Pricing • Outbound Marketing • Cross Sell/Upsell • Product line expansion • Lead Gen for 3rd parties
  • 22.
  • 24. Conserve Cash Invest Aggressively Search for Product/Market Fit Search for Repeatable & Scalable Sales Model Scaling the Business
  • 25. What happens at the company level when we add 2 new sales hires every month? Worst loss: Total amount 32 Months to get First profitable invested: back the $190k in month: 21 $2.6m investment month 11
  • 26. How MRR Grows when hiring 2 salespeople per month • Tracking growth in MRR shows new bookings • Shows how constantly adding new sales hires increases the bookings every month
  • 27. What happens if you don’t keep hiring new sales people? Very little impact from churn Monthly churn becomes a bigger negative factor as MRR grows • The business still keeps growing, but at a slower, slightly declining rate
  • 28. Comparison: hiring one versus two sales people per month • Not surprisingly, MRR and Growth in MRR directly correlate to sales hiring rate
  • 29. Comparison: hiring one versus two sales people per month The time to Not adequately shown, breakeven remains The cash flow but the acceleration after the same trough is halved breakeven is also halved
  • 30. What’s the blocker to faster growth? • Usually it is the rate at which you can grow leads – Typically each lead source maxes out – Adding new lead sources often means paying more per lead Leads Source C Source B Source A Time • Another blocker: – The rate at which you can hire and train really high quality sales people
  • 31. The Key Metrics CAMPAIGNS TO DRIVE TRAFFIC VISITORS OVERALL CONVERSION % CONVERSION % TRIALS (BY LEAD SOURCE) CONVERSION % CLOSED DEALS
  • 32.
  • 33. What happens if we collect a year’s payment in advance? Year in advance Eliminates the cash flow trough, and means $35m more cash in this scenario Monthly
  • 34. Lesson Learned • Look for ways to get customers to pay in advance – Depending on the cost of your capital, this can be worth fairly large discounts
  • 35.
  • 36. • Churn Rate plays a huge role in success
  • 37. How Churn affects LTV • Average customer lifetime in months = 1 / Monthly Churn
  • 38. How Churn affects Lifetime Months Monthly Churn
  • 39. How Churn affects LTV LTV Monthly Churn
  • 40. Impact of lowering Churn • Impact of lower churn rate is felt more heavily in the later years, as expected • It has a significant impact on the long term profitability of the business
  • 41. Churn • 1% to 2.5% churn per month is acceptable • Higher than that, you are filling a leaky bucket – Need to understand why you have low customer satisfaction and address the problem
  • 42. A way to get to negative Churn Top of Funnel Middle of Funnel Inside Sales Increasing revenue per client over time will create negative Closed Deal churn Expand, Upsell, Cross Sell
  • 43.
  • 45. How I assumed the two would relate
  • 46. A rough estimate of CAC versus Sales Complexity Rough Estimates of Cost of Customer Acquisition (CAC)
  • 47. The relationship is roughly exponential Clearly adding Human Touch dramatically increases costs
  • 48. CAC (logarithmic) 10x 10x 10x Sales Complexity
  • 49. High CAC requires higher pricing • … which leads to greater approval complexity
  • 50. SaaS Sales Complexity • Low risk to customer – Easy to try before buying – Small initial financial commitment – Easy to cancel if not working • Low IT involvement in decision process • No infrastructure or IT
  • 51. How SaaS changes Sales Complexity Value / Pain / Urgency = LTV (logarithmic) Sales Complexity 
  • 52.
  • 53. Product Development • Single version of the product at all customers • Can be improved monthly • Provides clear feedback on what is working • Great indicator of customer happiness – Which is a predictor of churn
  • 54. For More information • Visit my blog at www.forEntrepreneurs.com