The SaaS business model

Discussion Topics:
The Business Objectives
The key drivers
Metrics
Other Benefits of SaaS

The Business Objectives
Profit
Cash
Growth

Understanding Profit in the SaaS world
The micro-economic view
Look at economics of:
Sales person Customer

Excel Spreadsheet
Available here:
www.forEntrepreneurs.com/saas-economics-1
Part of a blog post that describes the model
The figures I have used should not be taken as a default set of values for any SaaS business
There are going to be wide variations in funnel efficiencies that will make each individual business considerably different

Key Variables Sales compensation and overhead Base Compensation $ 50,000 Variable Compensation $ 55,000 with 50% draw for first four months Draw on Variable Comp 100% 70% 30% 0% Productivity Ramp 10% 33% 66% 100% Additional overhead $ 30,000 Sales attrition factor 15% a factor to discount bookings to account for failed sales hires and attrition On target annual bookings Annual Bookings 500,000 ACV (Annual Contract Value) Monthly Bookings $ 41,667 ACV (Annual Contract Value) Monthly Bookings $ 3,472 Billed monthly (=ACV / 12) Churn Rate and Margin Churn Rate (monthly) 2.50% Gross Margin 80.00%

Key Variables Sales compensation and overhead Base Compensation $ 50,000 Variable Compensation $ 55,000 with 50% draw for first four months Draw on Variable Comp 100% 70% 30% 0% Productivity Ramp 10% 33% 66% 100% Additional overhead $ 30,000 Sales attrition factor 15% a factor to discount bookings to account for failed sales hires and attrition On target annual bookings Annual Bookings 500,000 ACV (Annual Contract Value) Monthly Bookings $ 41,667 ACV (Annual Contract Value) Monthly Bookings $ 3,472 Billed monthly (=ACV / 12) Churn Rate and Margin Churn Rate (monthly) 2.50% Gross Margin 80.00%
Standard Inside Sales Stuff:
Compensation
Quota: $500k
Ramp time
Attrition

How Revenue Builds for a SaaS Salesperson (assuming no ramp up time)

Looking at a Single Salesperson

The Cash Flow Gap (Slightly later breakeven point, because Gross Profit is less than MRR) 11 months to breakeven Cash Gap

The SaaS Cash Flow Trough 23 Months to get back the investment Total amount invested: $110k But a great return on investment

Our Example Marketing Funnel Top of Funnel Middle of Funnel Inside Sales Closed Deal Qualified Leads Inside Sales Closed Deal Organic Traffic SEM Other Paid lead sources Visitors to Web Site Raw Leads Registered Visitors

Our Example Marketing Funnel Quick Marketing Calculation 50% amount of traffic that is organic versus paid $1.50 cost per paid visitor (Google AdWords, etc.) $ 0.75 Cost per visitor (both paid and unpaid) 3% visitors convert to raw leads 20% number of raw leads that turn into qualified leads 1 qualified lead 5 raw leads required 167 visitors required $125 Cost of visitors (also = Cost per qualified lead )

Our Example Marketing Funnel Quick Marketing Calculation 50% amount of traffic that is organic versus paid $1.50 cost per paid visitor (Google AdWords, etc.) $ 0.75 Cost per visitor (both paid and unpaid) 3% visitors convert to raw leads 20% number of raw leads that turn into qualified leads 1 qualified lead 5 raw leads required 167 visitors required $125 Cost per qualified lead

Our Example Marketing Funnel

The model also computes CAC and LTV Lead Gen costs per deal $ 1,250 Excludes people costs (Cost per qualified lead x no of leads required per closed deal) Selling costs per deal $ 1,620 Excludes cost of sales management Total CAC $ 2,870 Excludes people costs in marketing, and sales management. (CAC= Cost to Acquire a Customer) Total LTV $ 16,000 Calculated by dividing average monthly gross profit per customer (ARPU x Gross Margin ) by the churn rate This excludes people costs in marketing, and sales management costs

My rules for CAC/LTV balance in a SaaS model > 3x LTV CAC Months to recover CAC < 12 months
Required for Capital Efficiency

What we are looking for Monetization (LTV) Cost to Acquire a Customer (CAC) A well balanced business model

The Balancing Act Monetization (LTV) Cost to Acquire a Customer CAC)
Viral effects
Inbound Marketing
Free or Freemium
Open Source
Free Trials
Touchless conversion
Inside Sales
Channels
Strategic partnerships
Field Sales
Outbound Marketing
Scalable Pricing
Cross Sell/Upsell
Product line expansion
Lead Gen for 3 rd parties
High Churn Rates
Low customer satisfaction

When To Grow?

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

What happens at the company level when we add 2 new sales hires every month? 32 Months to get back the investment Total amount invested: $2.6m First profitable month: 21 Worst loss: $190k in month 11

How MRR Grows when hiring 2 salespeople per month
Tracking growth in MRR shows new bookings
Shows how constantly adding new sales hires increases the bookings every month

What happens if you don’t keep hiring new sales people? Very little impact from churn Monthly churn becomes a bigger negative factor as MRR grows
The business still keeps growing, but at a slower, slightly declining rate

Comparison: hiring one versus two sales people per month
Not surprisingly, MRR and Growth in MRR directly correlate to sales hiring rate

Comparison: hiring one versus two sales people per 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

What’s the blocker to faster growth?
Usually it is the rate at which you can grow leads
Typically each lead source maxes out
Adding new lead sources often means paying more per lead
Another blocker:
The rate at which you can hire and train really high quality sales people
Source C Source B Source A Leads Time

The Key Metrics VISITORS CAMPAIGNS TO DRIVE TRAFFIC TRIALS CLOSED DEALS CONVERSION % CONVERSION % OVERALL CONVERSION % (BY LEAD SOURCE)

What happens if we collect a year’s payment in advance? Eliminates the cash flow trough, and means $35m more cash in this scenario Year in advance Monthly

Lesson Learned
Look for ways to get customers to pay in advance
Depending on the cost of your capital, this can be worth fairly large discounts

Churn Rate plays a huge role in success

How Churn affects LTV
Average customer lifetime in months =
1 / Monthly Churn

How Churn affects Lifetime Months Monthly Churn

How Churn affects LTV LTV Monthly Churn

Impact of lowering Churn
Impact of lower churn rate is felt more heavily in the later years, as expected
It has a significant impact on the long term profitability of the business

Churn
1% to 2.5% churn per month is acceptable
Higher than that, you are filling a leaky bucket
Need to understand why you have low customer satisfaction and address the problem

A way to get to negative Churn Top of Funnel Middle of Funnel Inside Sales Closed Deal Increasing revenue per client over time will create negative churn Expand, Upsell, Cross Sell

Sales Complexity

How I assumed the two would relate

A rough estimate of CAC versus Sales Complexity Rough Estimates of Cost of Customer Acquisition (CAC)

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

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

High CAC requires higher pricing
… which leads to greater approval complexity

SaaS Sales Complexity
Low risk to customer
Easy to try before buying
Small initial financial commitment
Easy to cancel if not working
Low IT involvement in decision process
No infrastructure or IT

How SaaS changes Sales Complexity Sales Complexity  Value / Pain / Urgency = LTV (logarithmic)

Product Development
Single version of the product at all customers
Can be improved monthly
Provides clear feedback on what is working
Great indicator of customer happiness
Which is a predictor of churn

For More information
Visit my blog at www.forEntrepreneurs.com

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The SaaS business model

by David Skok on Dec 15, 2010

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