Insight: SaaS (33) Quarter-life crisis of SaaS
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In the previous post ‘Insight: SaaS (32) In 2022, is it still a good time to start a SaaS company?’, we addressed if now is a good time to start a SaaS company, and today we’ll talk about the SaaS’ quarter-life crisis.
Before I get into the midlife crisis, I’d like to discuss one SaaS metric.
In the SaaS series of articles, we’ve primarily introduced two indicators: Customer Acquisition Cost Payback Period and Net Dollar Retention. CACPP can be used to assess the effectiveness of client acquisition as well as the growth rate of businesses. The NDR represents the health level and reflects the renewal status. In contrast to the two indicators CACPP and NDR, the definition of Quick Ratio is derived from a collection of indicators rather than some essential business scenarios. Surprisingly, it represents the sustainability of SaaS businesses.
Quick Ratio = NEW ARR + UPSELL ARR / CHURNED ARR + DOWNGRADE ARR
The Quick Ratio is not the same as NET DOLLAR RETENTION.
It includes New ARR, a key component of early SaaS growth. The Quick Ratio assesses the overall picture of the SaaS industry. Churned ARR and Downgrade ARR are negative indicators for SaaS. NEW ARR and UPSELL ARR are positive elements for SaaS. When the positive things outnumber the negative factors, a business is growing. The disadvantages outweigh the advantages, and the company begins to decline.
In the early stages of the company, most SaaS enterprises have a Quick Ratio of 20 or greater because NEW ARR accounted for a large proportion of revenue. The Quick Ratio will achieve a relatively high value at this point.
However, as the size of the customer base grows, NEW ARR’s contribution will become increasingly negligible, more consumers will churn, and the Quick Ratio will steadily decline. For SaaS, a Quick Ratio of 4 is considered acceptable. If your Quick Ratio is larger than 4, your growth rate is pretty excellent.
For SaaS businesses, Quick Ratio=1 is the tipping point. If your Quick Ratio is near 1, it means your churn is covering your growth totally. The company’s whole focus is on maintaining its status rather than regressing.
1. Churned ARR is the most serious pitfall in the SaaS business model.
Churned ARR is inescapable. SaaS has just one final fate: no matter how successful your clients are, you will eventually lose them. Because no client can guarantee the longevity of their foundation, and no purchaser can guarantee that they would renew their purchases indefinitely. As a result, Churned ARR often maintains a ratio, such as a 5% churn rate. Then Churned ARR will grow at an exponential rate. It will only get worse if you don’t take action.
Churn will eventually offset all growth.
2. The best strategy to overcome Churned is to rely on existing customers to enhance revenue rather than trying to keep customers who can’t be retained.
Upsell is a crucial ally in the fight against Churned. The key to ‘Upsell’ is to figure out how to provide greater service to existing consumers. One path is to develop new products on a continuous basis to resolve the challenges of customers in a value chain. Atlassian’s product range, for example, is extremely diversified and addressed by JIRA, Trello, and BitBucket which are all related. There are numerous options for cross-selling. If customers who have purchased JIRA wish to undertake code management, they can purchase Bitbucket. They’ll go back and buy Trello if they want all departments except R&D to collaborate. Other Zendesk and Hashicorp companies are in the same boat.
We can conclude NDR > 1 when Upsell > Churned + Downgrade. The Quick Ratio is also bigger than one at this moment. Upselling is the only method to counter churn. New ARR is based on the organizational expansion of SaaS enterprises. In general, the amount of New ARR is determined by the number of salespeople in the organization. The number of salespeople, on the other hand, is limited, and it is impossible to grow endlessly. As the company grows, the percentage of New ARR will decrease.
In reality, many SaaS companies have Quick Ratios that are close to 1. They have the following characteristics:
1. It has been in operation for 5–7 years. The brand has some credibility, although it is not a well-known large corporation. It’s also been a long time since the last round of funding.
2. Products can tackle certain problems, but they are in a competitive market. Even the industry itself, such as CRM, is not revolutionary. The market was popular in the early days of startups, but no one cares about it now.
3. You can’t die even if you want to. The corporation has put a lot of effort into expanding the market but to little avail. Live as though you’re a person who tries hard but doesn’t have a good quality of life.
This is SaaS’s mid-life crisis, which necessitates CEOs’ efforts to find a new PMF, a new second growth curve, and get out of the predicament.
Please send me an email (jasperhanlingyi@gmail.com) if you have any questions or suggestions.
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