An exploration of SaaS, what it means, and why you may need to call your mother.
So you’ve decided you want some kind of career in a cool tech startup. You’re an engineer, designer, product owner, copywriter, or something else just as cool and you’re excited by the prospect of open company culture, great perks, a dynamic environment, and all the other things that come with a tech company or startup. Great! Cool career choice, who likes to wear a tie to work? Now that you’ve made that choice, chances are that means SaaS. But what is it? What does working in SaaS mean, and why are there so many other acronyms, what do they mean? I hear you, you want to sit in your interview and seem like you know what you’re talking about. That, I can help you with. Not only will I tell you what all those acronyms mean, I’ll tell you how you can put several of them in a single sentence to wow people, or at least make them think you’re worth hiring.
SaaS: The definition.
Software As A Service.
Boom, done. Told you I knew what it meant. Ok, ok, I can give you more than that. When deciding whether a company is SaaS or not, you need to look at three simple things.
1. Is it software?
2. Do you pay a subscription fee every month?
3. Is it centrally hosted in “the cloud”?
If you check all three of these boxes, congrats, you’ve got a SaaS business.
- Salesforce? SaaS!
- Slack? SaaS!
- Google Docs? SaaS!
Why do these matter? Well it’s all about what used to be. Back in the day, not all software was SaaS.
Microsoft Word 97? Not SaaS.
In the dark old days before the cloud (ironic that the world was darker beforethere was a cloud), you paid for your software, it came in a box, you installed it in a server and sat back and watched as it slowly but surely went out of date. If you have no idea what I’m talking about, ask your parents. If they don’t know, tell them I don’t think blogs are valid tools for raising a toddler.
Today, SaaS accounts for about 25% of all software and it’s on the rise. But why? Why are investors funding SaaS startups with such huge amounts of money? Well to answer that, I have to turn to rock and roll, yeah come on!
Ok, so it’s not actual rock and roll like the music, it’s the names I’ve given my two fictional companies, because I think I’m funny and I really like Led Zeppelin (again, ask your parents).
So here are my two companies, they both sell the exact same software, I won’t tell you what, because it doesn’t matter.
Now, tell me, as a purchaser, which one of these options are you going to take? Of course, you’re gonna go with Roll. It’ll only cost you $50 right now, and if you don’t like it, you don’t pay for it anymore. Easy decision. Correct decision.
And that’s one of the essential reasons more and more companies are choosing this model. The other effect of a recurring payment is that it drives more adoption by the purchaser. If you’re paying a small amount per user every month, there’s a higher chance of everyone who’s paying actually using the thing they’re paying for. It’s lower risk and higher adoption and both people and companies LOVE that.
SaaS, the drawback.
I know, I know, buzzkill! But there is one major disadvantage to the SaaS model, and it’s linked to the reason consumers prefer the Roll Ltd option. Yep, you got it, you have to wait for your money. Rock Inc gets all the money up front. They then have the money to go and make a new improved version of their software that they can sell in 3–4 years when their existing version is out of date. Roll Ltd has to wait 24 months to get the same amount of money, meaning they don’t have the same cash to spend on making their product better.
The answer to this conundrum is of course, investment.
SaaS Investment. Or, “get someone to give you cash now!”
My favorite SaaS acronym is also the longest one I’ll explain here.
Cash is more important than your mother!
[Calls mother: “Hi mom, love you. Can I get some money for my new business? Sorry to ask but I really need it, without it, no one cares how good my technology is, without cash, the business is dead!”
Stop it! There are people other than your poor mom who you can ask for that all important cash. But why would anyone give you money? Well, simply it’s because they’re going to get much more money back in a few years. That’s why it’s called “investment money” and not “wasting money”. If you want to waste money, move to Vegas and develop a gambling habit.
But how can you be sure that investing in a SaaS company isn’t the Silicon Valley equivalent of fluttering away huge sums at the roulette table? Well, the answer to this, as with so many things in the tech world, is a whole bunch of capital letters, in this case specifically these ones:
- Gross Margin (why didn’t the world make this one an acronym?)
So let’s define them one-by-one, and then see how they give your investors signals about whether they should invest or if you need to go back to your poor mom.
CAC. How much do your users cost?
Customer Acquisition Cost.
Essentially, how much do you spend on sales and marketing to persuade people to use your product? The lower this number, the better.
CAC is particularly important to a SaaS company — remember how Roll Ltd is having to wait 24 months to get the same amount of money as Rock Ltd? That means they have less money to get customers, and customers mean money. Here are two graphs to help you picture it:
Notice how the one on the right is actually negative at the start (this is the reason you’re asking for investment) but as the line moves to the right, it’s shooting up at a great speed? That’s the kind of return that’s going to mean mom can hang on to her savings.
The Growth Paradox:
This is quite the problem for a SaaS company. As the graphs above us show, providing your CAC stays the same, the more customers you acquire in the early stages, the deeper into debt you will go. This means, the more customers you get, and boy do you need customers, the more money you burn. It’s at this point that I want you to take the SaaS worker’s pledge of allegiance.
“I know that burning more money is not an indicator of future success.”
Thinking otherwise would mean you have no hope of landing that SaaS job. So good CAC is not enough. We need something else added in to indicate our chances of success.
Months to Recover CAC
ARPU- Average revenue per user.
So it goes without saying that spending less to acquire customers who give you more sounds just great. But it’s particularly important for a SaaS investor as it indicates when you can start to see a return on your investment. And you can find out how many months it will take you simply by dividing one number by the other. For Roll Ltd. it looks like this.
Ten months until you get back your money. For SaaS that’s pretty ok. How ok? Well, look at this chart.
So, now we know how long until we start to get our money back. Cool, that’s the info we need to make a decision. Wait, there’s something I forgot to tell you.
SaaS: The other drawback.
Again, I have killed your buzz, I’m genuinely sorry. But the other big problem with SaaS is again another reason it’s so popular. You can leave whenever you want, just hit the cancel button and you’re free. Leaving a SaaS company is called churn.
Churn. The White Walkers of SaaS
Churn gives everyone in SaaS nightmares because it means an end to that sharply rising line of money I showed you earlier. Basically, it’s like having a license to print money, and then someone takes it away. If people end their subscription, then you’ll have to go get new users. And that means you’re spending money. Churn comes in the form of a percentage, and you have to keep it low. How you do that is a whole other post that I’ll write someday, but for now there are three basic reasons a user will leave you. They’re amazingly similar to the reasons your partner might leave you.
- They found something better.
- They died (went out of business).
- They don’t get any use out of you anymore.
Avoid those and you’ll keep churn from your door.
Next, let’s look at something gross.
Gross Margin: How much money do you get to keep?
What, not funny? Ok, this one is simple really, as your company gets bigger you have more and more things to pay for like salaries, training programs, office space, and all that stuff. This one you want to be as high as possible as it means more money back for you and your investors. And, we need it to calculate the indicator of long-term profitability that those investors are really looking for…
LTV: How much money your customers give you in a lifetime.
Who’s lifetime? Theirs! The LTV of your SaaS business is how much money you will get for a user for the whole time they’re with you. Now, there are a whole load of ways to calculate it, but to keep it simple, let’s apply the following formula to the Roll Ltd example.
If Average Revenue Per Customer X (1 / Churn Ratio) X Gross Margin…
…and Roll Ltd has:
Gross Margin: 80%
50 X 1/0.02 X 80% = 2,000
On average Roll Ltd will receive $2,000 per customer
Two thousand dollars from every customer? Sounds great. Well it depends on how many users you have, how much you’re spending, and all those other things I already talked about. To see how good it really is, let’s look at my all time favorite SaaS ratio. Drum roll please.
LTV / CAC. The golden SaaS ratio.
When we take the LTV of Roll Ltd and divide it by its CAC, we get a number:
CAC = $500
LTV = $2000
How good is 4? Glad you asked, check out this handy chart.
And that’s it! That’s SaaS in a nutshell Medium post. By now, you should have a pretty good idea of the basics of SaaS. I hope you get that job. You could even try applying for TravelPerk, we’re SaaS and we’re hiring. If you found this post useful, or even enjoyed it, make sure to check back for more to come.
About the Author:
JC Taunay-Bucalo is not just the proud owner of two hyphenated names, he’s also the Chief Commercial Officer at TravelPerk (one of the fastest-growing tech startups in the world).
Before holding a title with one less letter than his initials, JC led multiple successful SaaS companies through exponential growth as a sales and marketing executive, though not all at the same time. That’d be too amazing. They include EMS Cortex (later sold to Citrix), Vend HQ, and Veeqo.
Born and raised in France (making the names even harder to say), his career has taken him around the world from New Zealand to North America. When not working in or blogging about SaaS, you will find him either on a yoga mat, 60-feet underwater scuba diving, running with his dog (Lomu), or signing his very long name on various documents.