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-1Part 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 VariablesSales compensation and overheadBase Compensation $ 50,000Variable Compensation $ 55,000 with 50% draw for first four monthsDraw on Variable Comp 100% 70% 30% 0%Productivity Ramp 10% 33% 66% 100%Additional overhead $ 30,000 a factor to discount bookings to accountSales attrition factor 15% for failed sales hires and attritionOn 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 MarginChurn Rate (monthly) 2.50%Gross Margin 80.00%

Key VariablesSales compensation and overheadBase Compensation $ 50,000Variable Compensation $ 55,000 with 50% draw for first four monthsDraw on Variable Comp 100% 70% 30% 0%Productivity Ramp Standard Inside Sales Stuff: 10% 33% 66% 100%Additional overhead •Compensation $ 30,000 •Quota: $500k a factor to discount bookings to accountSales attrition factor •Ramp time 15% for failed sales hires and attrition •AttritionOn 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 MarginChurn Rate (monthly) 2.50%Gross Margin 80.00%

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

Looking at a Single Salesperson

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

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

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

Our Example Marketing FunnelQuick 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 FunnelQuick 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 Excludes people costsLead Gen costs per deal $ 1,250 (Cost per qualified lead x no of leads required per closed deal)Selling costs per deal $ 1,620 Excludes cost of sales management Excludes people costs in marketing, and sales management.Total CAC $ 2,870 (CAC= Cost to Acquire a Customer) Calculated by dividing average monthly gross profit per customerTotal LTV $ 16,000 (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 LTV > 3x CAC Months < 12 months to recover CAC Required for Capital Efficiency

What we are looking forA well balanced business model Monetization (LTV) Cost toAcquire aCustomer (CAC)

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

When To Grow?

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

What happens at the company level when we add 2 new sales hires every month? Worst loss: Total amount 32 Months to get First profitable invested: back the $190k in month: 21 $2.6m investment 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 Not adequately shown, breakeven remains The cash flow but the acceleration after the same trough is halved 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 Leads Source C Source B Source A Time• Another blocker: – The rate at which you can hire and train really high quality sales people

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

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

How Churn affects LTVLTV 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 Increasing revenue per client over time will create negative Closed Deal 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

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

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

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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