Building Innovative Subscription-based Businesses: Lecture 2

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

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Building Innovative Subscription-based Businesses: Lecture 2

  1. 1. Building Innovative Subscription-based Businesses BUS-185Lecture 2: The Subscription Business Model Martin Westhead
  2. 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. 3. Optics check Which Month is better? Now which Month is better? (same data)
  4. 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. 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. 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. 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% = $2000
  8. 8. Lifetime Revenue 2 Use actual aggregated churn data Build a retention model Multiply retention by recurring revenue Sum across the chart
  9. 9. Lifetime Revenue 3 Find average lifetime of Subscriptions Multiply by Recurring Revenue Used by Sendgrid (see later)
  10. 10. Exercise Experiment with the three different approaches to modeling lifetime revenue  What are the pros and cons of each?  When would you use one over another? Discussion Topic on Charge Thru
  11. 11. Modeling Revenue
  12. 12. Subscription Business Boost Revenue Per Customer Acquire New CustomersNotes: Boost can be positive or negative  Sometimes these are separated (see SendGrid) Reduce Churn Alternatively Boost can be folded into Churn  So Churn can be positive or negative
  13. 13. Core revenue model: The leaky bucket Acquisitions B Boost: Up sell/Cross sellRecurringRevenue (RR) Churn
  14. 14. The Math Acquisitions Recurring Revenue Recurring Revenue (RR) B Boost Churn B C B C ARt+1 ARt t t+1 t+2 time Rt+1 = Rt+ At + Bt- Ct
  15. 15. Natural relationships Churn naturally modeled as % of existing ($) 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. 16. Constant AcquisitionsRecurringRevenue Acquisitions B C unchanged A B C A t t+1 t+i t+i time Rt+1 = Rt(1 + B–C) + A
  17. 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. 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. 19. Subscription Health Metrics
  20. 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. 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 Leckies Blog) http://larsleckie.blogspot.com/2008/03/magic-number-for-saas-companies.html
  22. 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. 23. The Only 3 Metrics that MatterRetention (%)  How much ARR you keep (1 – Churn)Recurring Profit Margin (%)  (ARR – Churn – Non-growth spend)/ARRGrowth Efficiency (ratio)  Cost to acquire $1 of new ARR Profit vs. GrowthDetails: http://www.slideshare.net/Zuora/zuora-always-on20123-saas-metrics-that-matter-12301579
  24. 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. 25. SaaS Metrics Case StudySlides from Jim Franklin, CEO SendGrid Inc. (used with permission)
  26. 26. Key goalsGrowth Profitability
  27. 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. 28. # of Deals/Customers Increase in Deal Growth MRR/Customers Add New Product/ServiceGrowth for upsell Churn Decrease in MRR/Customers Deal Reduction
  29. 29. MRR = Monthly Recurring Revenue Understand each as it relates to your business, products, geo, etc.
  30. 30. Customer CountUnderstand each as it relates to your business, products, geo, etc.
  31. 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 24Customer 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. 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. 33. CAC Customer LTV Cash Flow FinancialProfitability Statement Income Statement Revenue per Employee Per Employee Expenses per Employee
  34. 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. 35. CAC = (Sales + Marketing +Deploy Costs) # of Deals ClosedSales Costs = $100,000Marketing Costs = $150,000# of Deals Closed = 600$100,000 + $150,000 = $416 CAC600
  36. 36. How long does it take to recover the CAC?Payback Period = CAC/MRR per CustomerAverage MRR Per Customer = $100$416/$100 = 4.16 monthsRule of thumb: 12 months or less is good.
  37. 37. Lifetime Value of Customer(Average Lifetime of a Customer * MRR/Cust) - Cost of Revenue- CAC = Lifetime Value of CustomerLifetime of Customer = 36 mths 24 mthsMRR per Customer = $100 $100Margin = 80% 80%CAC = $416 (4.16 mth payback) $1,600 (16 mth payback)(36*$100)-$720-$416 = $2,464 (24*$100)-$480-$1,600 = $320Rule of thumb: LTV that is greater than 3x CAC is good
  38. 38. Class Exercise…don’t leave it too late
  39. 39. Guest Lecturer Celia House Director of Product Management, MLS Listings Inc.

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