The SaaS business model and metrics

1. The SaaS Business Model & Metrics David Skok, Matrix Partners

2. Before we get started, there’s one useful concept to discuss…

3. 3 STAGES OF A STARTUP And how the CEO should manage the company

4. Search for Product/Market Fit Scaling the Business Search for Repeatable & Scalable Sales Model Conserve Cash Invest Aggressively

5. The SaaS Business Model David Skok, Matrix Partners

6. What we were used to: Licensed Software -10000 -5000 0 5000 10000 15000 20000

7. What’s so different about SaaS? $(7,000) $(6,000) $(5,000) $(4,000) $(3,000) $(2,000) $(1,000) $- $1,000 Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12 Cash Flow for a Single Deal CAC (Cost to acquire the customer) Subscription payments * GM%

8. Cash Impact of a typical deal $(7,000) $(6,000) $(5,000) $(4,000) $(3,000) $(2,000) $(1,000) $- $1,000 $2,000 $3,000 Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12 Month 13 Month 14 Month 15 Month 16 Month 17 Month 18 Negative Cash Flow

9. If cash flow is bad for one customer, what happens when we grow, and add many more customers?

10. Modeling a slow increase in the number of customers added every month $(1,000,000) $(500,000) $- $500,000 $1,000,000 $1,500,000 Month1 Month3 Month5 Month7 Month9 Month11 Month13 Month15 Month17 Month19 Month21 Month23 Month25 Month27 Month29 Month31 Month33 Month35 Month37 Month39 Month41 Month43 Month45 Month47 Month49 Month51 Month53 Month55 Month57 Month59 Cash Flows CAC Subscription Payments * GM%

11. Cumulative Cash Flow $(3,000,000) $(2,000,000) $(1,000,000) $- $1,000,000 $2,000,000 $3,000,000 $4,000,000 $5,000,000 $6,000,000 $7,000,000 Month1 Month3 Month5 Month7 Month9 Month11 Month13 Month15 Month17 Month19 Month21 Month23 Month25 Month27 Month29 Month31 Month33 Month35 Month37 Month39 Month41 Month43 Month45 Month47 Month49 Month51 Month53 Month55 Month57 Month59

12. The SaaS Cash Flow Trough $(3,000,000) $(2,000,000) $(1,000,000) $- $1,000,000 $2,000,000 $3,000,000 $4,000,000 $5,000,000 $6,000,000 $7,000,000 Month1 Month3 Month5 Month7 Month9 Month11 Month13 Month15 Month17 Month19 Month21 Month23 Month25 Month27 Month29 Month31 Month33 Month35 Month37 Month39 Month41 Month43 Month45 Month47 Month49 Month51 Month53 Month55 Month57 Month59

13. “The thing that surprises many investors & boards of directors about the SaaS model is that, even with perfect execution, an acceleration of growth will often be accompanied by a squeeze on profitability and cash flow.” Ron Gill, CFO at Netsuite

14. What’s the impact of faster growth? $(10,000,000) $(5,000,000) $- $5,000,000 $10,000,000 $15,000,000 $20,000,000 $25,000,000 2 more Customers/Month 5 more Customers/Month 10 more Customers/Month

15. What’s the impact of faster growth? $(10,000,000) $(5,000,000) $- $5,000,000 $10,000,000 $15,000,000 $20,000,000 $25,000,000 2 more Customers/Month 5 more Customers/Month 10 more Customers/Month Cash Flow Trough gets deeper

16. “As soon as the product starts to see some significant uptake, investors expect that the losses / cash drain should narrow, right? Instead, this is the perfect time to increase investment in the business, which will cause losses to deepen again.” Ron Gill, CFO at Netsuite

17. What typically happens… Courtesy of Ron Gill, CFO at Netsuite

18. When your SaaS business is losing money at an increasing rate, how can you tell if the business is going to work eventually?

19. UNIT ECONOMICS A Powerful Tool

20. Unit Economics Can I make more profit from my customers than it costs me to acquire them?

21. Unit Economics Cost to Acquire a Customer Lifetime Value of a Customer CACCAC LTVLTV

22. A Viable Business Model CA C CAC LTVLTV< But surprising how many Entrepreneurs underestimate CAC

23. Computing the Customer Lifetime Customer Lifetime = 1 Churn

24. How Churn affects LTV $100,000 $50,000 $20,000 $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 1% 2% 5% LTV vs Churn RateLTV Monthly Churn

25. Customer Churn vs $ Dollar Churn

26. Customer Churn vs $ Dollar Churn Customer 1 $1k MRR Customer 2 $5k MRR Starting period

27. Customer 1 $1k MRR Customer Churn vs $ Dollar Churn Customer 2 $5k MRR Customer 2 $5k MRR Customer 1 Churned 50% Customer Churn 17% $Dollar Churn Starting period A year later

28. Customer 1 $1k MRR Customer Churn vs $ Dollar Churn Customer 2 $5k MRR Customer 1 $1k MRR Customer 2 Churned 50% Customer Churn 83% $Dollar Churn Starting period A year later

29. Customer 1 $1k MRR Negative $ Dollar Churn Customer 2 $5k MRR Customer 2 $7k MRR Customer 1 Churned 50% Customer Churn -16% $Dollar Churn Starting period A year later

30. Negative Churn Expansion Revenue from Existing Customers Revenue Lost from Churning Customers>

31. Implies another part of the Sales Funnel Expand, Upsell, Cross Sell Top of Funnel Middle of Funnel Sales

32. How do we get Expansion Revenue? If we only have one SaaS product, what more can we sell the customer?

33. Variable Pricing Axes A critical factor for expansion revenue

34. Basic Edition Features

35. Users Basic Edition Features

36. Users Depth of Usage Examples: - Mailing list size - Database size - Amount of storage used Basic Edition Features

37. Revenue from one group of customers (cohort) with no upsell/cross-sell Time $’s Upsell revenue from the same cohort Negative Churn Revenue from a single cohort

38. CRR and DRR CRR: Customer Retention Rate DRR: Dollar Retention Rate Annual Numbers – expressed as a percentage Look at the year ago cohort

39. WHY CHURN IS SO IMPORTANT

40. Revenue Lost with 2.5% monthly Churn Renewals Lost due to Churn YEAR 3 $3m $7m Becomes harder & harder to replace this with new bookings Renewals Lost due to Churn YEAR 6 $30m $70m

41. Impact of Negative Churn

42. 1 2 3 4 5 6 7 Jan 85% 75% 65% 62% 61% 58% 57% Feb 87% 78% 70% 67% 63% 59% Mar 88% 84% 79% 75% 71% Apr 92% 89% 86% 82% May 93% 89% 85% Jun 94% 90% Jul 96% Months after starting usage Cohort Shows improving first month churn Shows churn stabilizing in fourth month Cohort Analysis

43. CUSTOMER SUCCESS An important new function

44. Customer Success • Not just the responsibility of Customer Success department • Product • Design • Quality (response time, bugs and downtime) • Sales • Don’t over sell the product • Don’t sell the product to the wrong customer types • Marketing • Marketing to customers, not just prospects • But good to have single executive who has this as their top priority

45. Customer Success Focusing on retention a month before the contract expires

46. Customer Success Focusing on retention a month before the contract expires Focusing on successful on- boarding

47. CHI – Customer Happiness Index • Find a way to predict the likelihood of churn • Most common and simple technique: Usage • More sophisticated: • Score usage of specific features higher than others • E.g. • Commenting on someone else’s posts on Facebook = Low • Creating your own post = High

48. High Usage does not correlate with High Value Usage Business Value Optimal Worst

49. My Suggestion • Consider a CHI score based on Business Value achieved, and find a way to measure automatically in the app • Example: • How many new leads did you bring the customer? • How much did you improve the lead to customer conversion rate?

50. ANOTHER IMPORTANT VARIABLE Time to Recover CAC

51. $(5,000,000) $- $5,000,000 $10,000,000 $15,000,000 $20,000,000 $25,000,000 Month1 Month7 Month13 Month19 Month25 Month31 Month37 Months to recover CAC: 6.3 Months to recover CAC: 12.5 Months to recover CAC: 18.8 Cumulative Cash Flow Impact of Months to Recover CAC 6.3 months to recover CAC 12.5 months to recover CAC 18.8 months to recover CAC

52. Cumulative Cash Flow Impact of Months to Recover CAC 6.3 months to recover CAC 12.5 months to recover CAC 18.8 months to recover CAC $(5,000,000) $- $5,000,000 $10,000,000 $15,000,000 $20,000,000 $25,000,000 Month1 Month7 Month13 Month19 Month25 Month31 Month37 Months to recover CAC: 6.3 Months to recover CAC: 12.5 Months to recover CAC: 18.8 2x Deeper P&L trough 2x longer to reach breakeven 3x Deeper P&L trough 3x longer to reach breakeven

53. Two Guidelines for SaaS success LTV CAC> 3x Months to recover CAC < 12 months Required for Capital Efficiency

54. What Metrics should we use to measure a SaaS business?

55. We care about recurring revenue MRR Monthly Recurring Revenue ARR Annually Recurring Revenue

56. Net New MRR/ACV Expansion MRR/ACV (Existing Customers) Churned MRR/ACV (Lost Customers) New MRR/ACV (New Customers)

57. Always ask to see Bookings over Time Entrepreneurs always happy to show their MRR over time But this doesn’t tell whether their bookings are growing $(15.0) $(10.0) $(5.0) $- $5.0 $10.0 $15.0 $20.0 $25.0 $30.0 $35.0 Jan Feb Mar Apr May Jun MRR Bookings New MRR Net New MRR Expansion MRR Churned MRR

58. Salesperson Unit Economics Another valuable analysis

59. How Revenue Builds for a SaaS Salesperson (assumingnorampuptime) $0 $5,000 $10,000 $15,000 $20,000 $25,000 $30,000 $35,000 $40,000 $45,000 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec With Churn of 2.5% Jan Custs Feb Custs Mar Custs Apr Custs May Custs Jun Custs Jul Custs Aug Custs Sep Custs Oct Custs Nov Custs Dec Custs $0 $5,000 $10,000 $15,000 $20,000 $25,000 $30,000 $35,000 $40,000 $45,000 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec With no Churn Jan Custs Feb Custs Mar Custs Apr Custs May Custs Jun Custs Jul Custs Aug Custs Sep Custs Oct Custs Nov Custs Dec Custs

60. The Cash Flow Gap $(25,000) $(20,000) $(15,000) $(10,000) $(5,000) $- $5,000 $10,000 $15,000 $20,000 $25,000 Month1 Month2 Month3 Month4 Month5 Month6 Month7 Month8 Month9 Month10 Month11 Month12 Month13 Month14 Month15 Month16 Month17 Month18 Month19 Month20 Month21 Month22 Month23 Month24 Net profit - New Sales Hire $- $5,000 $10,000 $15,000 $20,000 $25,000 $30,000 Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12 MRR vs Expenses – New Sales Hire MRR Expenses Cash Gap (Slightly later breakeven point, because Gross Profit is less than MRR) 11 months to breakeven

61. The SaaS Cash Flow Trough $(200,000) $(100,000) $- $100,000 $200,000 $300,000 $400,000 Cumulative Net Profit - New Sales Hire 23 Months to get back the investment Total amount invested: $110k But a great return on investment

62. Search for Product/Market Fit Scaling the Business Search for Repeatable & Scalable Sales Model Conserve Cash Invest Aggressively

63. What happens at the company level when we add 2 new sales hires every month? $(250,000) $(200,000) $(150,000) $(100,000) $(50,000) $- $50,000 $100,000 $150,000 Month1 Month2 Month3 Month4 Month5 Month6 Month7 Month8 Month9 Month10 Month11 Month12 Month13 Month14 Month15 Month16 Month17 Month18 Month19 Month20 Month21 Month22 Month23 Month24 Net profit $(3,000,000) $(2,000,000) $(1,000,000) $- $1,000,000 $2,000,000 $3,000,000 $4,000,000 Cumulative Net Profit 32 Months to get back the investment Total amount invested: $2.6m First profitable month: 21 Worst loss: $190k in month 11

64. Comparison: hiring one versus two sales people per month $(400,000) $(200,000) $- $200,000 $400,000 $600,000 $800,000 Month1 Month3 Month5 Month7 Month9 Month11 Month13 Month15 Month17 Month19 Month21 Month23 Month25 Month27 Month29 Month31 Month33 Month35 Net Profit 1 sales hire a month 2 sales hires a month $(3,000,000) $(2,000,000) $(1,000,000) $- $1,000,000 $2,000,000 $3,000,000 $4,000,000 Month1 Month3 Month5 Month7 Month9 Month11 Month13 Month15 Month17 Month19 Month21 Month23 Month25 Month27 Month29 Month31 Month33 Month35 Cumulative Net Profit 1 sales hire a month 2 sales hires a month The time to breakeven remains the same The cash flow trough is halved Not adequately shown, but the acceleration after breakeven is also halved

65. Salesperson Unit Economics CA C OTE LTVQuota< 5x On Target Earnings A typical good ratio is around 6x in SaaS

66. Annual up-front payment Instead of Monthly

67. What happens if we collect a year’s payment in advance? $(5,000,000) $- $5,000,000 $10,000,000 $15,000,000 $20,000,000 $25,000,000 $30,000,000 $35,000,000 $40,000,000 Month1 Month3 Month5 Month7 Month9 Month11 Month13 Month15 Month17 Month19 Month21 Month23 Month25 Month27 Month29 Month31 Month33 Month35 Cumulative Cashflow comparision - monthly payments vs year in advance Cumulative Net Profit Cumulative Net Cash Flows $(500,000) $- $500,000 $1,000,000 $1,500,000 $2,000,000 $2,500,000 Cashflow comparison - monthly payments vs year in advance Net profit Net Cash Flows Eliminates the cash flow trough, and means $35m more cash in this scenario

68. MORE ON CAC The impact of sales complexity

69. Sales Complexity Freemium No Touch Self- Service Light Touch Inside Sales High Touch Inside Sales Field Sales Field Sales with SE’s

70. How I assumed the two would relate

71. A rough estimate of CAC versus Sales Complexity Freemium No Touch Self- Service Light Touch Inside Sales High Touch Inside Sales Field Sales Field Sales with SE’s $0- $40 $30 – $200 $300 - $800 $3,000 - $8,000 $25,000 – $75,000 $75,000 – $200,000 Rough Estimates of Cost of Customer Acquisition (CAC)

72. The relationship is roughly exponential Clearly adding Human Touch dramatically increases costs

73. Sales Complexity CAC (logarithmic) 10x 10x 10x

74. Understanding Public SaaS companies

75. Example Operating Model Revenue 100% CoGS 24% Sales & Marketing 51% R&D 15% G&A 13% Loss (6%)

76. Break apart Sales & Marketing Revenue 100% CoGS 24% Sales & Marketing 51% R&D 15% G&A 13% Loss (6%) Expansion & Retention 25% New Customer Sales 26%

77. To make it comparable with a traditional software business, eliminate New Customer Sales, as those benefit the future Revenue 100% CoGS 24% Sales & Marketing 51% R&D 15% G&A 13% Profit 20% Expansion & Retention 25% New Customer Sales 26% CoGS 24% R&D 15% G&A 13% Loss (6%) Expansion & Retention 25%

78. Profit 20% Expansion & Retention 25% CoGS 24% R&D 15% G&A 13% Now look at DRR (Dollar Retention Rate): • Example DRR = 123% (Zendesk’s number) • The existing customer base with no additional revenue is growing at 23% annually • So you have a business growing 23% year-on-year, generating 20% Profit

79. SUMMARY

80. Summary • Expect to see the P&L / Cash Flow trough • Use Unit Economics to evaluate the business • Look for negative churn, (where DRR > 100%) • Use SaaS metrics, not traditional metrics

81. The 3 Keys to SaaS Success 1 Acquisition 2 Retention 3 Monetization

82. • Visit my blog at www.forEntrepreneurs.com For more information…

83. APPENDIX Some more adanced topics

84. The Magic Number • In general, I don’t like the Magic Number • Hard to explain and understand • BUT – a public company may not give: • LTV:CAC ratio • Months to recover CAC • So use Magic Number to calculate something roughly equivalent • First developed by the Josh James, CEO of Omniture • The key insight - if your Magic Number is: • Above 0.75 – step on the gas • Below 0.75 – step back and look at your business • Below 0.5 – business probably not ready to expand

85. The Formula for Magic Number • QRR[X] = Quarterly Revenue in the current quarter • QRR[X-1] = Quarterly Revenue in the prior quarter • Sales & Marketing Expense [X-1] = Sales & Marketing expense in the prior quarter 𝑀𝑎𝑔𝑖𝑐 𝑁𝑢𝑚𝑏𝑒𝑟 = (𝑄𝑅𝑒𝑣 𝑋 − 𝑄𝑅𝑒𝑣 𝑋 − 1 ) ∗ 4 𝑆𝑎𝑙𝑒𝑠 & 𝑀𝑎𝑟𝑘𝑒𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 [𝑋 − 1] 𝑀𝑎𝑔𝑖𝑐 𝑁𝑢𝑚𝑏𝑒𝑟 = 𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑄𝑢𝑎𝑟𝑡𝑒𝑟𝑙𝑦 𝑅𝑒𝑐𝑢𝑟𝑟𝑖𝑛𝑔 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 ∗ 4 𝑃𝑟𝑖𝑜𝑟 𝑄𝑢𝑎𝑟𝑡𝑒𝑟′ 𝑠 𝑆𝑎𝑙𝑒𝑠 & 𝑀𝑎𝑟𝑘𝑒𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 Expressed in a slightly more readable form:

86. Example Magic Number calculation Q1 Q2 Q3 Revenue $1,000,000 $1,200,000 $1,500,000 Sales & Marketing Expense $800,000 $900,000 Magic Number 1.0 1.33

87. 2008 Magic Number Graph