Inside SaaS: 7 key dimensions that matter for a well oiled SaaS machine(& how to harness 21 areas and monitor +60 SaaS metrics)
SaaS businesses are extraordinary and can grow very fast… with the right execution.
The past few years have seen incredible innovation and execution take place and taken many companies to horizons never imagined before. Yet these SaaS businesses require a specific structure and well oiled parts to function well. Any large organization like SAP, which has sustained the years and grown its revenue base, recognizes that a few right mechanisms can be key to achieve fast growth and long term sustainability.
We get the question everyday: what are those magic metrics to make the SaaS machine move as fast as possible?
There is much literature on the subject, and feedback from entrepreneurs. So here is a net net summary of a few of the most important dimensions and metrics. Not only at primary level, but beyond. And as we live in an increasingly graphic world, it is provided as a table format — for convenience. More details follow below for those who want to know more. And then of course every person can choose a subset (I personally try to look at all or most of them).
So want more details? Here they are:
1) REVENUES AND PROFIT EXPANSION
· Revenues: Usually the first quantitative metric to assess how a business is doing. First, while gross merchandise volume (GMV) is the overall revenue flowing into a company (example: a flight ticket of 100$), the interesting part is usually the net revenues, which takes into account the actual revenues after immediate cost of sales, commissions, etc. (net revenues for a flight ticket is usually a fraction of GMV. Typically net revenues are [Net revenues = GMV — directly related sales expenses]. SaaS businesses often report their revenues in terms of annual recurring revenues (ARR), or monthly recurring revenues (MRR). However sometimes calculations are needed to calculate the actual truly monthly recurring revenues. Indeed, some of the revenues may not be recurring (such as for maintenance, services, on-boarding, trainings, etc.) and need to be removed to get to the recurring part. Or some revenues may be accounted as a one-off or pre-booked. One usualy needs to then spread them over the duration of the contracts (which means needing to look into contracts and clauses! Some companies get veeery creative on how they report their ‘MRR’). Hence the most usual way to assess a business, the golden ‘MRR’, may require some calculations too. MRR is [MRR = revenues over the year — part of non annually recurring revenues brought back on a monthly basis (taking into account timing of cash flows].
· Business model and margin. Here one of course wants to understand how the revenues and margin are generated, both as a whole business and per account. Revenues are usually [revenues = price per type of product * units sold per type of product]. Contribution margin is [contribution margin = revenues — variable costs including selling, administrative and operational costs associated with serving the customer]. Then other fixed costs of the structure can be deduced to get to the EBIT or EBITDA. A basic P&L analysis can follow to ensure there is no abnormal behavior of one of the cost lines, over months and years. Upsell and cross-sell are also important at this stage and can also be part of the SaaS business model, when for instance a business has a strategy to ‘land and expand’, thereby ‘upselling’ or ‘cross-selling’ to customers after the initial foot in the door. Of course one needs to not stop here, but also look, among others, at customer-per-customer metrics, e.g. margin per customer (vs. as a business) which is [contribution magin = revenue from customer minus variable costs for this customer, e.g. CAC in most cases].
· Cash: Here one wants to understand how much time a business has until some cash constraint may occur. What is the burn rate? How much cash is left? And how much cash will be left taking into account the current revenues and growth in revenues? Some businesses like to have a year left in cash to feel safe. It is not uncommon however nowadays to see some businesses with burn rates that are a significant portion (>75% sometimes) of the revenues. After all, what matters the most if the momentum (right after). Another dimension to take into account is the bookings vs. cash relationship. The moment a contract is signed is usually different from the timing of cash flows that then occur. Both dimensions are important and one should look at both bookings and net cash positions to project cash needs.
· Growth: Probably one of the most important area and one the world tends to look more than any other: Growth. Top investors usually require a 3X growth year on year, equivalent to a 10% month on month. But more than the overall growth, one will want to look at growth per product (if there are several) and most importantly revenue growth per customer. This brings the very important metric of upsell in, which is the amount that is sold in addition to the initial MRR over a period of time (usually a year). This is very important and shows customer adoption and expansion. In some cases, this implies the use of ‘cohorts’, e.g. groups of users or customers in a specific time point, to track how they evolve over time — we will come back to this in the LTV calculation.
· Engagement: Here the net promoter score (NPS) is the most basic value to judge wether there is a good perception of a software. But this is not the only metric to look at! Reviews, number of active users and its growth, and also monthly unique visitors can be important metrics. But how ‘active’ is an ‘active’ user? It will be important to look at the devil in the details here and clearly define ‘active user’. Both growth in base and repeatability of visit is important. Indeed would you prefer a business a fast growing base of active users or a regular basis of users that increasingly come to a platform? The best scenarios are usually when both happen at the same time. So both growth in base and frequency are ideal.
· Retention and churn: Next to engagement is another very related area: retention (and its opposite — churn, which is the number or percentage of subscribers that discontinue their subscription in a given time period). How many of the customers are still customers after a while? Good SaaS businesses will want to show ‘negative churn’. Typically one calculates gross churn % as : [Gross churn % = number of lost customers / last Month total number of customers] and [MRR churn % = churned MRR / last month MRR]. Some also report net churn % [Net churn % = (MRR lost — MRR from upsells in a month) / MRR at beginning of month]. Gross churn % is a measure of customer loss, while net churn % understates this customer loss, as it blends upsells in the number). Negative churn is usually achieved through either 1) price increases 2) upsell 3) cross-sell. As mentioned, retention is the opposite of churn.
3) COST OF MOMENTUM
· Acquisition cost: Great — many customers. But how much did it cost to acquire them? For this an analysis per channel (web marketing, physical, newsletter, as well as sales conversion ratio, etc.) will be required. Beyond company metrics, another area to look at it how much the business raised. Between a 4 years old business having raised 10M USD and boasting 50 large enteprise customers for 3M USD ARR, and a 2 year old business having raised 1M USD mentioning 5 customers for 1M USD ARR — which would you prefer? On the one hand, 10M raised produced 3M ARR USD, on the other 1M USD raised produced 1M ARR USD… Probably the latter is slighty more exciting.
· Time to value: A very important next metric is the LTV which applies itself well in SaaS. When [contribution margin per customer = price * units * contribution margin of customer], and the lifespan of the customer is [lifespan of customer = 1 / monthly churn]. the life time value is [LTV = contribution margin per customer * average lifespan of the customer]. This is a very important metric, basically how much money the business will make with the customer over time, or with a cohort when this applies. Similarly, one may want to monitor the overall breakeven point of the business e.g. when the business will turn profitable. This is usually at a time when [price * volume * contribution margin > fixed costs], hence is usually a function of both time and volume.
· Sales and marketing effort: Here one needs to look at the processes for reaching out to prospective customers and the resulting Customer Acquisition Cost (CAC). CAC is [sales expenses + marketing expenses / Nb of customers acquired]. What overall budget is being spent? What budget per headcount, per account? Is is growing? And what are the converstion rates? From database to lead? From lead to pilot? From pilot to customer? From customer to cash receipt? From initial cash to upsell? (some customers pay late or forget to pay…). Usually conversion rates of >30% at each step of the way is a good sign. Both new sales and upsells need to be monitored. More importantly, the process needs to be CRYSTAL clear. It can be improved, but it needs to be clear: how many people on each account? What does each do, how many times, how do they interact? For instance, some SaaS business have up to 7 employees active in the lifetime of a customer, and sometimes up to 5 simultaneously, from pre sales, to sales, architect, implementation, customer success, ticket level 1, relationship maintainer, evangelizer, marketing case study builder, etc.
4) CUSTOMER SUCCESS AND VALUE-ADD
· Need: This is one of the most basic and most important areas. What is the actual value being created for the customer? What use cases coresponding to what needs? Can they be easily illustrated through an explanation, pdf or video? What are the corresponding benefits the solution brings? And what is the ROI / how can it be calculated? Typically, one will want to monitor there is fast ROI (less than in two years), in qualitative and quantivative ways. The quantiative measuring can be in terms of additional revenues of costs. Overall ROi is [ROI = associated increase in revenues, direct or indirect + other quantifiable benefits such as time, positioning, market share, efficiency, etc. — associated decrease in costs, direct or indirect]
· Channels and segmentation: In SaaS, testing several business models, and choosing one what works is key. Choices can encompasse direct, or indirect sales channel; small, medium or large customers; geographies; types of products sold; segments of the population; etc. Hence why at SAP we like supporting companies so much. Because for certain companies, it just makes sense to work with a large software partner like SAP to quickly accelerate sales globally.
· Sales efficiency: Understanding the right metrics for sales can enable fast replication. Many sales metrics such as conversion rate, ARPA, etc. The cost of net new ARR may be important, it is [Net new ARR sales cost efficiency = net new ARR / sales expense (and marketing)]. For instance if 1M is spent to get 1.5M in revenues, then the net new ARR sales cost efficiency ratio is 1.5M/1M = 150%. In addition, one may want to monitor the CAC payback period which is the time to be breakeven on initially spent budget to acquire a customer. It is [CAC payback time = sales expense (and marketing) / (net new ARR * recurring revenue margin) * 12].
5) TECHNOLOGY AND PRODUCT
· Product and roadmap: This is one of the most complex areas. No wonder startups usually have difficulties finding the right heads of products. Above all, product management is about answering the right customer needs with the right functionalities and design. And managing the piles of customer requests, feedbacks and potentially bugs. One needs to constantly review the platform connections, bandwidth, processing, volumes of data, etc. to ensure the tech stack and architecture can withhold the delivery in scalable ways. Hence, key activites to monitor are the establishment of a clear roadmap, prioritizaiton of steps, team organization around tasks, and delivery of tasks and improvements. Metrics to watch may include the R&D expense, time to log a need, clarity of roadmap and resulting metrics may be the product adoption, % usage, usage type and time spent using specific features, or the user and customer retention or churn rate.
· Stickiness: High level, stickiness can be assessed through metrics including average usage time, usage of features and number of connections and customer retention and churn rate. But the interesting patterns happen at the lower level. Stickiness is about much more than the product itself. It is about the quality of the on-baording, the availability of training, the UX, speed and availability of the SaaS offering, connectivity
· Support: Here one wants to ensure the answer to any issue is done fast. Typical metrics include the number of tickets or the average response and resolution time. Some SaaS businesses assign people specifically to their top priority accounts. Ensuring there is a well functioning support can be key for most SaaS businesses
6) ORGANIZATION AND PEOPLE
· Culture: The best VCs say it over and over again: the culture is super important! The best companies are run with a crystal clear culture, built around a few values, that is consistently communicated across the organization. From old employees to new hire, everybody needs to be aligned on what it is that the organization is trying to achieve, what it lives for/its purpose, and how people behave in it. The world has seen many too companies grow, then fail miserably in the face of dissent caused by unstable and unclear culture and values. So, among others, one needs to ensure clear a) Purpose b) Values c) Communication channels d) Issues reporting channels.
· Leadership: Here one wants to look at the structure of leadership. A few potential questions: How many heads in the business are there? How long have they known each other? What are the decision mechanisms? What is the power map? This includes ceo, cfo, cro, cpo, cto, cmo, etc. but also board and investors. In some cases this may include the partners too, when they represent a sizable part of the revenue and have a strong influence.
· Employees: What is the employee dynamic, turnover, morale? Is the culture well explained and does it percolate at all levels and in all departments? Is the on-boarding of a high quality? Making sure the employees form a cohesive group is both easy and difficult to monitor. But SaaS businesses are like any businesses and people topics are often both the most complex and the most important to ensure the long term sustainability of the company.
· Market dynamics: All right, onto markets now. The segments are often as important as their dynamic. How large is the market? How fast does it grow as a whole? How large are the segments and how fast does each each grow? Who are the leaders and what are their dynamics? A few cases make a great market: 1) New market creation (new technology, etc.) 2) A large old slow incumbent that can be disrupted and maintains itself through acquisitions and partnerships 3) A market to be taken due to the fall of a player that has been acquired or is divesting 4) A new market where a race can make sense between small/medium players (often a cash game then to acquire customers) 5) The secret market (a market people are not concious of yet). In all cases, the market potential, growth and dynamics are key. Too many entrepreneurs start a business without having looked enough at the market dynamics.
· Competitive pressures: Here one can assess the consolidation taking place (good or bad), fragmentation of players, etc. Again it is all in the dynamics. A fragmented market can be both good and bad. It may be fragmented because the barriers to entry are low and it is difficult for one single player to dominate (=bad), or it could be fragmented because no true execution/innovative leader has come up (=good — market share to take). Especially important are the disruptive forces that could take place.
· Partnership dynamics: Last but not least as we say. And SAP, with its platform strategy is at the heart: partnerships. Many businesses easily grow to 1M ARR, or even 10M ARR, but how can one grow to be a 100M ARR? This requires impeccable product and technology, scalable organization, clear sales and marketing processes, etc. This is where partners come in — they help with growth and scale! Their role is so important that a very very large part of the most successful businesses have actually made it because they have chosen the right partners. This means choosing right + building the right relationship (awareness + choice of efficient POCs) + usually a technical connection + contractualizing a working model + executing! Usually businesses need a few of these, not too many as this is time consuming but a few. And when they work well, oh my, revenues suddently grow by themselves! Many things can be assessed here such as the number of partners and they dynamics, the type of deal (re-sell, co-sell, % commission, sales incentives, etc.) but also the processes to share opportunities and deals, the number of event invitations, media exposure, etc. A whole area in itself which is absolutely key in SaaS!
That’s all folks, hope this was interesting, comments/thoughts/feedback welcome!