The lecture looks at business models, metrics and healthchecks for subscription businesses

1. Building Innovative
Subscription-based
Businesses
BUS-185
Lecture 2: The Subscription Business
Model
Martin Westhead

2. Overview
 No standard
 Concepts
 Recurring Revenue
 Lifetime Revenue
 Acquisition, Boost, Churn (ABC)
 Modeling Revenue (easier – so start there)
 Leaky bucket
 Subscription Plateau
 Understanding Churn
 Subscription Health checks
 Magic numbers
 The only three metrics that matter
 Case Study: SendGrid

3. Optics check
 Which Month is better?
 Now which Month is better? (same data)

4. Always start with $
 Two problems with subscription numbers
 Apples and Oranges cannot be added
 3 bronze + 2 gold is like 3 inches + 2 feet
 But even without the sum confusing to see them
together
 Summaries should present either:
 Dollars or
 % change (in dollars)
 Subscription/Customer numbers ARE useful
 Just not recommended for summaries

5. Recurring Revenue
 Recurring Revenue
 Annual (ARR)
 Monthly (MRR)
 Quarterly (QRR)
 But there is a gotcha even with RR…
Churn Rate of Annuals
is often not the same as
Churn Rate of Monthlies
So, even if annuals have lower MRR, can be worth more

6. Lifetime Revenue
 Customer Lifetime Revenue (CLR)
 Subscription Lifetime Revenue (SLR)
 All time expected revenue
 Note : different from CLV
 Multiple ways to calculate it…

7. Lifetime Revenue 1
 Gold monthly
 Recurring Cost $100
 Churn 5%
 Expected return is
 $100 in month 1
 $100 – 5% month 2
 $95 – 5% month 3
 Etc. (see chart)
More details:
 Total expected return is http://chargethru.com/profiles/blogs/weighin
g-up-the-true-value-of-a-customer
area of chart
 $100 / 5% = $2000

8. Lifetime Revenue 2
 Use actual aggregated churn data
 Build a retention model
 Multiply retention by recurring revenue
 Sum across the chart

9. Lifetime Revenue 3
 Find average lifetime of Subscriptions
 Multiply by Recurring Revenue
 Used by Sendgrid (see later)

10. Exercise
 Experiment with the three different approaches
to modeling lifetime revenue
 What are the pros and cons of each?
 When would you use one over another?
 Discussion Topic on Charge Thru

11. Modeling Revenue

12. Subscription Business
Boost Revenue Per
Customer
Acquire New Customers
Notes:
 Boost can be positive or negative
 Sometimes these are separated (see
SendGrid)
Reduce Churn
 Alternatively Boost can be folded into
Churn
 So Churn can be positive or negative

13. Core revenue model:
The leaky bucket
Acquisitions
B Boost: Up sell/Cross sell
Recurring
Revenue (RR) Churn

14. The Math Acquisitions
Recurring
Revenue Recurring
Revenue (RR)
B Boost
Churn
B C
B C
A
Rt+1
A
Rt
t t+1 t+2 time
Rt+1 = Rt+ At + Bt- Ct

15. Natural relationships
 Churn naturally modeled as % of existing ($)
 Boost naturally modeled as % of existing ($)
 Acquisitions is usually* independent of existing ($)
 Define:
 B = Bt / Rt
 C= Ct / Rt
 Assume At is fixed At = A
Rt+1 = Rt(1 + B–C) + A
 *In a viral (referral-base) model A is % of existing

16. Constant Acquisitions
Recurring
Revenue
Acquisitions B
C
unchanged
A
B C
A
t t+1 t+i t+i time
Rt+1 = Rt(1 + B–C) + A

17. Subscription Plateau
“Water level equilibrium of the
Leaky Bucket”
MRR for 2 businesses
over 5 years  Same acquisition rate (100 customers
per month,
 Same ARPC ($100 per month).
 Red has churn rate of 2.5%
 Blue has churn rate of 5%
 Both businesses are starting plateau
 But the 5% faster and lower MRR

18. Understanding Churn
 Cancellations
 Obvious, easy to quantify
 Learn what you can about why
 Behavioral analysis
 Questionnaire
 Overdue payments
 Failed payments
 Chargebacks / Paypal cancellations
 Covert cancellations
 Hard to quantify
 Establish a Dunnings (Overdue Enforcement) process
 Make sure you understand the scale of covert cancels
 Industry average (SaaS) annual churn of 10-20%
 More details:http://chargethru.com/profiles/blogs/churn-to-the-
power-three

19. Subscription
Health
Metrics

20. Warning about modeling
costs
 Cost models are more business specific
 Be particularly careful about projecting costs
 Fixed costs can be changed
 Variable costs can change with volume
 Always be aware of your assumptions when you
construct business models

21. “The” Saas Magic number
 Revenue growth per sales and marketing dollar
M = (QRRt – QRRt-1)*4 / SMt-1
 QRRt: Quarterly Recurring Revenue for period t
 QRRt-1: Quarterly Recurring Revenue for the period t-1
 SMt-1: Sales and Marketing Expense for the period t-1
 1.0 => $1 S&M leads to $1 ARR growth
 Under 0.75 problems, over 0.75 accelerate marketing
 Over 1.5 “call me immediately”
(Lars Leckie's Blog) http://larsleckie.blogspot.com/2008/03/magic-number-for-saas-companies.html

22. Joel’s SaaS Magic number
 Average customer rate of return
J = (ARR – ACS) / CAC
 “ARR” is the average recurring revenue per customer
 “ACS” is the average recurring cost of service per customer
 “CAC” is the average customer acquisition cost
 1/J time to profit per customer (Payback Period)
 J = 1 profit in first year. J >0.5 profit in under 2 years
 No reference to Churn
(Joel York) http://chaotic-flow.com/saas-metrics-joels-magic-number-for-saas-companies/

23. The Only 3 Metrics that Matter
Retention (%)
 How much ARR you keep (1 – Churn)
Recurring Profit Margin (%)
 (ARR – Churn – Non-growth spend)/ARR
Growth Efficiency (ratio)
 Cost to acquire $1 of new ARR
 Profit vs. Growth
Details: http://www.slideshare.net/Zuora/zuora-always-on20123-saas-metrics-that-matter-12301579

24. Industry Benchmarks
Best
Practice
Model
Retention 83% 86% 92% 90%
Recurring 58% 47% 19% 50%
Profit Margin
Growth 0.75:1 1.26:1 2.15:1 1:1
Efficiency

25. SaaS Metrics Case Study
Slides from Jim Franklin, CEO SendGrid Inc. (used with permission)

26. Key
goals
Growth Profitability

27. Metrics To Measure Growth
 Monthly/(Annual) Recurring Revenue (MRR)
 Roll forward of MRR (Beginning+New+Increase-Lost-Decrease)
 Monthly growth rates
 Churn analysis (cohort, by product, size, etc)
 Customers
 Roll forward of customer count
 Monthly growth rate
 Churn analysis (cohort, by product, size, etc)

28. # of
Deals/Customers
Increase in
Deal Growth
MRR/Customers
Add New
Product/Service
Growth for upsell
Churn
Decrease in
MRR/Customers
Deal Reduction

29. MRR = Monthly Recurring Revenue
Understand each as it relates to your business, products, geo, etc.

30. Customer Count
Understand each as it relates to your business, products, geo, etc.

31. Customer Retention/Churn
Cohort Analysis
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 Month 19 Month 20 Month 21 Month 22 Month 23 Month 24
Customer 100% 99% 97% 96% 94% 94% 94% 93% 93% 92% 91% 91% 91% 91% 90% 90% 89% 89% 89% 87% 86% 86% 86% 86%
Dollar 100% 103% 105% 110% 112% 115% 116% 115% 120% 124% 127% 130% 137% 138% 141% 141% 152% 162% 168% 168% 173% 161% 168% 182%
Product/GEO/Vertical Analysis
Customer % MRR %
Product 1 110 53% $ 4,000 17%
Product 2 75 36% $ 6,000 26%
Product 3 20 10% $ 3,000 13%
Product 4 4 2% $ 10,000 43%
209 $ 23,000

32. Metrics To Measure Profitability
 Customer
 Customer acquisition cost
 Lifetime value of the customer
 Financial Statements
 Cash flows (direct method)
 Income statement
 Employee
 Revenue per employee
 Cost per employee

33. CAC
Customer
LTV
Cash Flow
Financial
Profitability
Statement
Income
Statement
Revenue per
Employee
Per Employee
Expenses per
Employee

34. Customer Acquisition Cost (CAC)
 What does it cost to acquire a customer?
 How many months of MRR does it take to
recover your costs of acquiring that customer?

35. CAC = (Sales + Marketing +Deploy Costs)
# of Deals Closed
Sales Costs = $100,000
Marketing Costs = $150,000
# of Deals Closed = 600
$100,000 + $150,000 = $416 CAC
600

36. How long does it take to recover the CAC?
Payback Period = CAC/MRR per Customer
Average MRR Per Customer = $100
$416/$100 = 4.16 months
Rule of thumb: 12 months or less is good.

37. Lifetime Value of Customer
(Average Lifetime of a Customer * MRR/Cust)
- Cost of Revenue
- CAC
= Lifetime Value of Customer
Lifetime of Customer = 36 mths 24 mths
MRR per Customer = $100 $100
Margin = 80% 80%
CAC = $416 (4.16 mth payback) $1,600 (16 mth payback)
(36*$100)-$720-$416 = $2,464 (24*$100)-$480-$1,600 = $320
Rule of thumb: LTV that is greater than 3x CAC is good

38. Class Exercise
…don’t leave it too late

39. Guest Lecturer
Celia House
Director of Product Management,
MLS Listings Inc.