The Convexity Effects of Rereading (Ep. 3)

The ideas I wish to describe are old ideas. There is practically nothing that I am going to say tonight that could not easily have been said by philosophers of the seventeenth century. — Richard Feynman

Airline Economics

Several investors recently disclosed stakes in airlines. Mohnish Pabrai, manager of Pabrai Funds and author of The Dhando Investor, recently purchased shares of Southwest Airlines (LUV). Additionally, Berkshire Hathaway disclosed stakes in American Airlines (AAL), Delta Airlines (DAL), and United Continental Airlines (UAL). Airlines are popular topics in business schools because historically customers captured the value of incremental gains. As proof, Wikipedia maintains a long list of U.S. airline bankruptcies. Oliver Wyman’s 2015 “Airline Economic Analysis” presents data substantiating the case for improving airline economics. Data suggests lower fuel prices and better overall unit economics have expanded profit margins.

Unit profits (defined as operating profit in US cents per available seat mile) rose 61.6% for US airlines systemwide to 2.23¢ during the second quarter of 2015. The upswing in profitability can be largely attributed to the dramatic decline in fuel costs — unit fuel cost decreased 31.5% — combined with other declining non-labor unit costs.

SaaS Unit Economics 201

David Skok of Matrix Partners has numerous blog posts worthy of keeping on your nightstand. Buried in podcast archives is David’s interview with Harry Stebbings on the SaaStr podcast. Below I provided my transcription of one (of many) memorable segments.

Those are the three contributors. Two of them are positive: new customers and expansion revenue. And one is negative and that is churn.
My advice to every SaaS entrepreneur is that in their cornerstone graph they use to run their business with is a bookings graph that has got those three components plus the fourth one that is the sum total of all those, the net new ARR, that they added in the month or quarter. And that they track those three numbers against a planned dotted line number on a graph over time. Those will allow them to really understand the main things that are going to make up whether they are making their bookings number.
I have one last piece to add. What I see when I meet with a lot of SaaS companies is they like to show me their ARR graph. This is a graph that has the ending ARR at the end of every quarter or month. It is a graph that always goes up and to the right because that is the nature of SaaS. The first thing I do with that is I look at the growth rate by looking at the slope of the line. If it is a direct straight line that I can fit through their graph, it tells me their bookings is not increasing. They are adding the same amount of new ARR quarter after quarter, and that is a bad sign. So what I am looking for is a different graph to that, which saves me from having to do that differential analysis of their ARR graph. I am looking for them to show me what does their bookings like this quarter, last quarter, and previous quarter. Are they stuck? If they booked $100k in new ARR in Q1, and $100k in Q2, and $100k in Q3, their ARR graph is going to look pretty good. But their bookings graph is not going to look good. It is a flat line. It tells me that they have not figured out how to repeatably grow the way they are acquiring customers. They are stuck. It is often caused by the fact that they have not added enough sales capacity or they don’t know how to increase their lead flow at the top of the funnel, or some other aspect of their funnel is broken and they don’t know how to scale it.

VC Conviction

Arthur Ventures has two offices, one in Fargo, North Dakota and the other in Minneapolis, Minnesota. They invest in SaaS outside of Silicon Valley. Remember, not all the best investors work near a major city. Is Fargo the new Omaha? Patrick Meenan offers intelligent perspectives on SaaS, and his article on VC conviction teaches us that there is more to building a durable business than short-term financial milestones.

I want to thank Abnormal Returns and the Collaborative Fund for the inspiration for my posts.