A VCs Perspective on Software Operating Metrics

3,137 views

Published on

General Catalyst’s tagline is “entrepreneurs investing in entrepreneurs,” and partners of the active venture firm are well known for lending deep operating experience to their portfolio executives’ growing businesses. I’ve known General Catalyst Managing Director Larry Bohn for years, since we were both operating executives at various software companies.

Here is Larry's take on the key operating metrics that executives need to be on top of to stimulate growth and profitability — as well as the metrics that drive valuation in today’s market.

Published in: Business, Technology
  • Awesome slide...GET FUNDING NOW...Instantly send your startups pitchdeck to over 5700 of VC's and Angel's with just 1 click. Visit: Angelvisioninvestors.com
       Reply 
    Are you sure you want to  Yes  No
    Your message goes here
  • WONDERFUL JOB!.... STARTUPS...Send your pitchdeck to over 5700 of VC's and Angel's with just 1 click. Visit: Angelvisioninvestors.com
       Reply 
    Are you sure you want to  Yes  No
    Your message goes here

A VCs Perspective on Software Operating Metrics

  1. 1. 
Interview
with
Larry
Bohn,
Managing
Director,
General
Catalyst
Perspectives
of
a
VC
on
Key
Software
Operating
Metrics
in
2011
General
Catalyst’s
tagline
is
“entrepreneurs
investing
in
entrepreneurs,”
and
partners
of
the
active
venture
firm
are
well
known
for
lending
deep
operating
experience
to
their
portfolio
executives’
growing
businesses.

I’ve
known
Larry
for
years
since
we
were
both
operating
executives
at
various
software
companies.

Here’s
his
take
on
the
key
operating
metrics
that
executives
need
to
be
on
top
of
to
stimulate
growth
and
profitability
‐‐
as
well
as
the
metrics
that
drive
valuation
in
today’s
market:
Lauren:

What
key
operating
metrics
do
you
track
as
an
investor
and
board
member
at
your
portfolio
companies?


Larry:

The
metrics
we
track
depend
a
great
deal
on
the
stage
of
the
company.

We
invest
in
many
very
early
stage
companies
which
are
still
building
products,
so
the
key
metrics
for
those
companies
are
around
the
overall
cash
burn,
cost
per
employee,
and
relative
costs
by
function.
In
a
pre‐revenue
company
we
watch
these
metrics
to
ensure
the
company
has
the
runway
to
get
to
its
initial
goals
that
are
set
for
further
funding.
In
an
early
stage
company
with
early
customers,
the
key
metrics
to
watch
are
around
the
cost
of
customer
acquisition
(coca),
cost
of
sale,
average
deal
size,
implementation
costs,
and
projected
support
costs.
The
key
focus
for
this
phase
of
the
business
is
to
develop
a
solid
and
repeatable
sales
model
that
can
bring
the
company
to
profitability
and
growth.

This
phase
in
company
development
is
often
fraught
with
lots
of
change
as
the
management
team
learns
the
intricacies
of
the
fit/finish
of
the
product
and
the
true
underlying
economics
of
selling.

A
major
mistake
of
this
period
is
to
anticipate
too
early
what
is
repeatable
only
to
pour
cash
into
an
unproven
sales
model.
In
a
company
that
has
proven
a
sales
model
and
market
fit,
the
key
measures
are
around
the
ratio
of
cost
of
customer
acquisition
to
revenue.
In
an
enterprise
software
license
environment
this
is
most
accurately
measured
by
looking
at
sales/marketing
expense
in
relation
to
growth
in
revenue
and
bookings.

The
belief
here
is
that
since
revenues
are
often
lumpy
and
sales
often
direct,
investors
are
willing
to
invest
in
sales
and
marketing
early
because
it
generally
brings
cash
and
predictable
revenues
(near
term)
to
the
business.

In
a
SaaS
company,
the
key
measure
to
track
is
that
of
MRR
(monthly
recurring
revenue)
and
churn.
MRR
is
most
significant
because
it
is
the
best
predictor
of
overall
success
and
long
term
growth
and
value.
Churn
is
key
because
while
many
SaaS
companies
are
good
at
on
boarding
many
early
customers,
churn
in
the
customer
base
basically
erodes
the
value
of
the
business
as
it
is
growing.
It’s
like
building
a
sandcastle
and
realizing
that
the
base
keeps
eroding
the
higher
the
sculpture.

  2. 2. Another
important
SaaS
metric
is
to
track
the
underlying
cost
of
supporting
an
individual
customer.
In
lightweight
SaaS
applications
this
may
be
trivial
as
much
of
the
cost
appears
in
cogs
as
expenses
to
Amazon
or
Rackspace.
But
increasingly
SAAS
is
moving
to
more
demanding
applications
and
the
cost
of
the
underlying
infrastructure
(whether
cloud,
or
self‐managed)
along
with
the
costs
of
supporting
customers
becomes
a
significant
factor
in
profitability
and
growth.
The
worst
case
is
where
there
are
major
step
functions
in
supporting
customers
due
to
poor
product
design
or
complexity.
Lauren:

Yes,
we’ve
been
tracking
these
SaaS
metrics,
such
as
customer
acquisition
cost
and
average
cost
to
maintain
a
customer,
along
with
about
a
dozen
others,
for
4
years
now
in
our
annual
software
benchmarking.
By
comparing
your
own
numbers
to
close
peers
with
a
similar
sales
model,
you
can
test
whether
you
are
as
efficient
as
you
might
be
or
identify
specific
areas
for
improvement.

How
have
you
seen
these
metrics
change
or
evolve
as
software
business
models
have
evolved?


Larry:

The
major
change
in
the
software
business
model
is
around
the
movement
to
SaaS
for
all
types
of
software
products,
from
collaboration
to
SFA
to
ERP.
The
SaaS
business
model
is
terrific
in
that
it
aligns
customer
interests
with
vendors
(if
you
don’t
serve
me,
I’ll
cancel
my
subscription)
but
it
is
one
that
is
complex
and
often
costly
for
the
company
and
its
investors.
In
the
licensed
model,
companies
become
profitable
sooner
as
they
are
able
to
sell
expensive
perpetual
licenses
(sometimes
that
don’t
get
deployed);
get
cash
up
front,
and
generally
don’t
worry
much
about
the
customers’
deployment
except
when
it
affects
maintenance
fees.
This
model
tends
to
favor
and
support
an
expensive
direct
sales
force
that
can
convince
customers
of
the
utility
of
the
software
and
work
toward
a
major
transaction
that
makes
the
customer
profitable
instantly,
often
for
the
long
term.

In
SaaS,
the
vendor
takes
on
much
of
the
risk
of
not
only
acquiring
customers
but
keeping
them
satisfied
in
an
ongoing
way.

Also,
SaaS
companies
provide
more
than
software—the
whole
stack
of
infrastructure
software,
hardware,
SLA,
etc.
So
the
vendor
has
a
requirement
to
ensure
that
customers
that
come
on
the
platform
stay
because
they
generally
do
not
get
large
upfront
commitments,
but
their
fixed
costs
to
build
the
product
and
sell
it
are
high.
So
SaaS
companies
often
require
significantly
more
capital
to
build
before
they
become
profitable
(often
2x
previously)
and
this
leads
to
a
focus
on
managing
sales/marketing
costs
with
a
more
granular
focus.

For
example,
it
is
now
the
basic
trend
of
SaaS
companies
to
focus
on
an
inbound
selling
model
that
uses
low
cost
internet
techniques
(SEO,
blogging,
SEM)
to
build
a
customer
pipeline
and
to
then
use
an
inside
sales
model
to
nurture
and
close
customers.
SaaS
makes
this
possible
because
the
vendor
takes
on
almost
all
deployment
responsibility
remotely
so
they
can
“own”
the
deployment
in
a
way
licensed
vendors
often
can’t.


Management
teams
and
board
members
therefore
track
the
customer
funnel
through
stages
of
qualification,
conversion,
acquisition,
and
deployment
with
an
eagle
eye
to
get
the
funnel
into
the
proper
“shape”
where
the
economics
and
predictability
are
good.
The
best
companies,
at
maturity,
have
an
internal
language
around
these
funnel
metrics
and
it
provides
a
good
way
for
the
company
to
manage
functions.
The
core
metrics
are
around
COCA
(cost
of
customer
acquisition)
and
LTV
(life
time
value)
but
there
are
others
around
time
to
profitability,
growth
within
customers,
etc.



  3. 3. One
of
my
favorite
metrics,
developed
by
my
friend
Rory
O’Driscoll
at
Scale
Ventures,
is
called
the
“Magic
Number”.
Rory
was
on
my
board
at
NetGenesis
and
on
the
board
of
Omniture
where
the
Magic
Number
was
championed
and
is
an
expert
at
looking
at
sales
expense
and
revenue
growth.
He
developed
the
Magic
Number
as
a
concept
to
capture
how
a
monthly
increase
in
marketing
and
sales
expense
will
predictably
affect
increase
in
MRR.
It’s
a
way
to
determine
if
a
company
really
has
a
predictable
model
in
place
and
helps
an
investor
decide
when
it’s
the
right
time
to
“turn
on
the
gas”
for
company
growth…..
I
would
provide
some
caution
that
not
all
SaaS
applications
fit
the
same
low
cost
sales
model.
Sometimes
there
is
a
sort
of
mindlessness
today
that
investors
want
to
see
companies
look
like
robots
that
have
a
product,
and
an
internet
sales/marketing
engine
that
scales
without
human
involvement.

This
sometimes
works
for
lightweight
or
lookalike
apps
but
tends
to
make
all
aspects
of
the
business
simple,
even
where
it
warrants
sophistication
or
complexity.
Some
of
the
best
SaaS
companies
now
have
solid
and
growing
businesses
that
sell
strategic
software,
have
direct
sales
organizations
that
are
required
to
partner
with
customers,
and
are
able
to
get
long
term
commits
and
upfront
cash
from
customers
to
balance
the
customer/vendor
partnership.
The
SaaS
subscription
and
delivery
model
does
not
dictate
the
type
of
value
or
customer
approach
that
works.

I
see
too
many
companies
trying
to
shoehorn
their
business
into
an
inside,
low
cost
sales
model
that
may
never
work
for
the
value
they
are
providing.
Lauren:
I
agree
and
I
think
that
the
type
of
sales
model
that
is
right
for
your
company
will
drive
a
number
of
the
other
financial
and
operating
ratios
as
well
so
if
you
benchmark,
you
want
to
compare
your
numbers
against
other
companies
with
similar
sales
structures.

We
separate
our
benchmarks
for
software
companies
with
low
average
deal
sizes/low
cost
sales
models
versus
companies
with
high
average
deal
sizes/more
expensive
sales
models
so
that
if
I’m
selling
a
high
value/high
sales
expense
product,
I
can
compare
my
operating
ratios
to
companies
with
a
similar
model
rather
than
to
companies
with
a
lower
sales
expense
model.


Which
numbers
do
you
track
as
key
leverage
points
to
ratchet
up
growth?

How
do
you
measure
whether
sales
and
marketing
investments
are
getting
efficient
“bang
for
the
buck”
in
customer
and
revenue
growth
that
you
and
company
executives
want
to
see
with
venture
money?
Larry:

The
numbers
that
we
like
to
track
before
ratcheting
up
growth
are
COCA
and
churn
which
gives
the
best
perspective
on
overall

LTV.
In
some
businesses,
though,
MRR
growth
within
customer
is
really
significant
as
it
shows
how
customers
can
often
be
a
“channel”
for
a
vendor’s
products
(either
internally
or
though
their
own
channels).

Also
some
of
the
newer
SaaS
companies
sell
indirectly
through
partners,
so
tracking
the
metrics
around
number
of
partners,
time
to
get
them
productive,
etc.
gives
us
insight
into
further
investment.

The
best
way
to
ensure
the
efficiency
of
sales
and
marketing
spend
is
to
ruthlessly
track
the
pipeline
metrics
that
I
discussed
earlier.

With
inbound
marketing
techniques
now
it’s
possible
to
quantify
the
cost
of
leads,
track
their
conversion
as
sales
expense,
and
determine
how
that
investment
translates
into
customer
revenue
and
bookings.
The
internet
has
taken
a
lot
of
the
hand
waving
out
of
sales
and

  4. 4. marketing
and
the
truly
great
SaaS
companies
have
marketers
who
act
like
engineers
as
they
adjust
and
refine
their
funnel
techniques.
One
of
the
great
things
about
what’s
happening
today
is
that
the
cloud
is
now
proving
out
the
“pay
by
the
drink”
model
of
purchasing
IT
infrastructure.
The
result
is
that
it’s
less
expensive
and
problematic
to
build
a
scalable
SaaS
company.
Five
years
ago,
the
SaaS
companies
we
backed
almost
all
were
building
out
their
own
infrastructure
at
a
managed
service
or
hosting
facility.
This
was
capital
intensive
and
difficult.
With
the
advent
of
Amazon
and
Rackspace
these
same
companies
now
are
buying
this
infrastructure
in
both
a
secure
and
scalable
way.
Now
this
does
not
universally
apply,
and
some
high
end
SaaS
companies
need
to
own
their
own
infrastructure,
but
for
the
bulk
of
applications
the
cloud
works
and
it
means
a
direct
increase
in
innovation,
economy,
and
benefit
for
customers.
Whereas
the
earlier
SaaS
companies
often
took
$50m
plus
to
get
to
profitability,
the
newer
SaaS
companies
can
do
this
for
half
that
amount.
There
is
still
lots
of
complexity
and
subtlety
around
cloud
pricing,
lock‐in
concerns,
security,
etc,
but
the
overall
trend
is
inexorable.

Also,
with
the
growing
number
of
companies
and
applications
moving
to
SaaS
there
is
now
a
growing
ecosystem
of
component,
integration,
and
service
providers
that
round
out
the
cloud
infrastructure
itself
to
make
building
robust
products
easier
and
more
reliable.
And
some
of
these
companies
look
to
be
great
investments…..
Lauren:

We
definitely
have
been
seeing
in
the
benchmarking
that
venture‐backed
software
companies
are
on
average
getting
to
profitability
earlier
than
they
were
five
years
ago,
I’m
sure
partially
due
to
the
lower
cost
of
building
out
infrastructure
and
using
other
cloud
services.

What’s
your
outlook
for
metrics
in
2011?
Larry:

I
think
2011
will
be
a
great
year
for
SaaS
as
there
are
a
number
of
very
prominent
and
varied
SaaS
companies
that
are
likely
to
IPO.

This
will
show
both
the
variety
of
companies
but
also
reveal
some
of
the
complexity
for
analysts
following
companies.
For
example,
only
recently
have
there
been
FASB
rule
changes
that
make
it
easier
to
match
deployment
service
revenues
directly
with
SaaS
revenues
so
investors
can
really
see
how
expenses
and
revenues
match
in
a
defined
period.
SaaS
companies
are
great
for
public
investors
as
good
SaaS
companies
that
have
strong,
growing
MRR
often
have
the
next
4‐5
quarters
of
revenue
totally
baked
so
their
chance
of
blowing
a
near
term
quarter
is
minimized.

The
SaaS
business
model,
at
growth
and
maturity,
is
a
very
profitable
model,
and
analysts
like
to
look
at
core
free
cash
flow
from
these
companies
as
the
ultimate
measure
of
their
value.
While
this
certainly
is
true,
we
must
not
forget
that
SaaS
companies
still
go
through
periodic
investment
cycles
around
new
products,
international
expansion,
etc.
so
a
rigid
cash
flow
model
can
be
undermined
by
the
realities
of
technology
growth
requirements.

This
brings
us
back
to
the
core
metrics
for
SaaS:
COCA,
MRR,
LTV,
and
COGS
associated
with
the
service.
Lauren:

Larry,
I
absolutely
agree
with
you;
the
relatively
shallow
data
that
you
get
from
public
company
filings
really
isn’t
sufficient
to
assess
the
true
value
of
a
SaaS
company,
which
is
why
we
are
focusing
our
2011
benchmarking
(launching
early
March)
on
exactly
the
metrics
that
you
mentioned
here.

Thank
you
so
much,
Larry,
for
sharing
your
insights.

For
more
information
about
the
2011
software
benchmarking,
go
to
www.opexengine.com

  5. 5. 




×