The document discusses the importance of data-driven decision-making in software management, emphasizing how companies, particularly in the SaaS sector, are increasingly utilizing metrics and benchmarking to improve productivity and profitability. It outlines key metrics for early-stage SaaS companies, including cash burn and customer acquisition costs, and highlights trends in cash flow management and renewal rates among different company sizes. The author encourages participation in a benchmarking program aimed at providing insights into financial and operational data to assist companies in making informed decisions.

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2. We all think that we are incredibly rational in our decision-making, open to new
information, always searching for the best answer regardless of where it takes
us, but the reality is that we tend to have blinders on based on how we’ve
always done things and past experience. This has often been the case in
software management. Recently, though, there’s been a shift in management
away from basing decisions on “gut instinct” and what one Microsoft
researcher called: “HiPPOs” or Highest Paid Person’s Opinions.
Prof. Erik Brynjolfsson at MIT/Sloan has been doing work with very large firms
showing that a one standard-deviation increase toward data and analytics
correlates with a 5-6 percent improvement in productivity and a slightly larger
increase in profitability in those same firms. After benchmarking hundreds of
fast growth software firms over the past 5 years, I would venture to suggest
that with smaller companies, an even stronger result can be seen in
management efficiency, productivity and minimizing risk, as well as making
faster course corrections along the path to growth.
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3. Research shows that the most successful companies use metrics and benchmarking
as a key management process and information tool. The popularity of benchmarking
in this country originally grew out of the manufacturing world, especially in looking at
Japanese manufacturing and comparing best practices. Benchmarking didn’t really
take off in the software industry, or at least for budgeting and management
processes, but was applied to some extent in the software development area to
benchmark the coding and testing process.
After the disruptions of the 2001 and 2008 economic downturns, with the rise of the
SaaS business model, plus extensive use and experience with affordable financial
applications, CRM and other analytics tools, software companies are embracing
benchmarking and metrics today. Especially SaaS vendors. And the investment
community and external shareholders require good data and good peer comparisons
– they are looking at it themselves – to support investments in software ventures.
Evidence of data-driven decision making, and a good grasp of key metrics in a
company helps drive the value of that company, especially any private company.
We find in our own work that our clients that are the most driven to examine the data,
metrics and comparisons, are the ones that tend to perform the best and have the
highest revenue growth. Because we see their data, I know this is a fact; we see that
every day.
Benchmarking has its limits, but is a useful tool to drive decisions based on data
rather than by intuition or how things were done at somebody’s last company. I
always tell companies that deviating from the benchmarks isn’t good or bad, it is just
important to understand how and why you are deviating from a benchmark so that
you are choosing to be higher or lower to fit your particular business, rather than not
even knowing what the benchmark is.
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4. SaaS is all about the numbers. As the SaaS business has evolved,
management has had to dig deeply into the numbers to track how resource
investments are paying off, and how customer numbers are growing, while
examining in detail the cost of acquiring and maintaining a customer. SaaS,
as you all know, is a trickier investment upfront because the vendor has to
build a great product which is turn key for the user, take care of all
infrastructure investments, and get paid on a subscription basis, not all up
front. Gone are the good old days when it was all about building a really cool
product and selling the heck out of it by whatever means possible and moving
on to the next customer. And gone are the days when your customers were
your beta testers and the testers for a variety of environments.
But, with SaaS, gone are the days when you had to start each quarter at zero
and run til you dropped at midnight on the last day of the quarter. So, once
you get past the initial hurdles and get to a scaleable model, a profitable
recurring revenue stream in a SaaS company is very profitable and highly
valuable. The question is: how do you navigate the hurdles to get from start up
to a profitable recurring revenue stream and solid, growing business.
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5. In early stage companies which are still building products, the key metrics for those
companies are around the overall cash burn, cost per employee, and relative costs by
function. For early revenue and early stage companies that are still defining their target
customer profile, and business model, these metrics are important to track closely to ensure
the company has the runway to get to the next stage where it can scale the business.
As the business scales, companies tend to focus mostly on operating expense by department
– what’s the right expenditure on sales, on marketing, on G&A, on support, on R&D at a
particular stage of the company. And companies need to get into greater detail than just the
macro expense per department.
One area that doesn’t get talked about enough where we see companies having to focus on
even as they scale is hosting expense and the cost to maintain a customer. Hosting expense
has come down with the availability of services in the cloud, - for example, this past year, we
found small, private SaaS companies (about $8.5M revenues) spending 3.6% of revenue
on hosting expense, while even in 2009, companies roughly the same size were
spending 8-9% of revenue on hosting expense.
Hosting expense doesn’t seem to have a nice economy of scale trend line down evenly as the
company grows, typically, it goes up as revenue and the number of customer grows, and then
at a point which varies for different types of applications and models, starts to achieve some
economy of scale, but hits bumps as additional data centers are built out, or availability,
security issues, etc. are expanded.
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6. In the early stages of a SaaS company, cash flow is THE critical metric to
track. We’ve watched as SaaS companies have learned to conserve cash
flow over the years, from 2007 and 2008 when the SaaS model was taking off
and companies, especially venture-backed firms, had around 8% negative
cash flow as a percent of revenue, which went up in 2009 as the recession
took hold, but by 2010, we saw early stage companies getting on top of cash
management and becoming almost cash flow positive (and since this is an
average, many were cash flow positive) by the end of 2010.
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7. Here’s data over time for larger SaaS companies, comparing 2010 and 2008,
one peer group averaging $57M and another averaging $61M – so roughly
similar in size. 2008 was a year of spending and growth for a lot of venture-
backed software companies as budgets had been set to expect high growth
even though the recession was getting started, as compared to 2010 when
companies were clearly more careful about spending, even though the
economy, especially markets for successful Saas companies, seems to have
improved. Generally, SaaS companies are showing greater efficiency
reflecting more conservative cash management. Even Successfactors
(SFSF), which as a public company in 2008 at $112M spent 105% of revenue
on SG&A, brought that down to 66% of revenue in 2010 (while doubling
revenue during that time period).
The largest public SaaS companies in 201 showed a large increase in cash
growth, averaging 17.5% cash from operations as a % of revenue. This
benchmark is for companies averaging $186M in 2010 revenues.
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8. Lets look at the key metrics for SaaS companies: customer metrics. In an early
stage company with early customers, the critical metrics to watch are around the cost
of customer acquisition (coca), cost of sale, average deal size, implementation
costs, and costs of maintaining the customer. 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.
One of the metrics which is well discussed in SaaS circles is the “Magic
Number”described by Josh James, CEO of Omniture at an industry summit to explain
how Ominiture tracked their customer profitability and whether or not to add gas in
Sales & Marketing, or not. Basically, you take a quarter’s incremental revenue
growth, multiple by 4 to annualize, then divide by last quarter’s S&M marketing
spend. According to James, anytime the magic number is .75 then you should spend
more and put gas on your sales and marketing to bring in more customers. If your
magic number is 0.5 or less, then there is something wrong with your model. Again,
the key is watching your sales and marketing spend, and revenue growth.
One assumption in this model is that you have very low Churn rates, Omniture was
shooting for 95% renewals or better. The industry average is about 15% churn or
less. We look at both customer renewal rates by number of customers renewing and
by amount of dollars renewed. For example, if you had 100 customers up for renewal
for contracts totalling $10M, and all 100 customers renew, you have a 100% renewal
rate, but they renewed contracts now totalling only $8M, you have an 80% renewal
rate by dollar value (or conversely, they renewed for a total value of $12M, yo u have
a renewal rate of 120%. You can see these benchmarks in the next two slides
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9. Here we have customer renewal rates for smaller, private companies and
larger public companies in 2010 and for small versus larger companies in
2009. As you can see, the renewal rates by customer is higher for the larger
companies, which makes sense as they presumably know their market and
target customers better, so are more likely to keep them, and they have better
resources to support their customers, also helping them keep them. Also, we
tend to find that companies selling subscriptions at a higher average contract
size, for example, over $100k/annually per customer, have less churn than
companies selling a low average contract size.
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10. We typically see renewals by dollar value being slightly higher than the
number of customers renewing. This means that companies are maintaining
the value of contracts and increasing them.
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11. I spent 20 years building businesses for small and large companies, in the PC
software world, in enterprise software and internet infrastructure and
applications and I wish that I had had better information as I was making
decisions, so I started OPEXEngine. We started by developing our own
content through the confidential software benchmarking, and now are starting
to develop information products incorporating a variety of data sources, but all
focused on the small and mid-sized corporate market and giving executives
data reports so that you can spend more time analyzing and making informed
decisions, instead of spending a lot of time and personnel resource compiling
data.
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12. I’d like to encourage that all of you that are building your software company participate in our
next confidential software benchmarking which annually takes place in the Feb/March
timeframe and will cover the previous year’s financial and operating data. We include
companies from $1M to $350M in revenues, so this obviously includes private and public
companies. Over a hundred software companies participate by inputting their data directly into
our secure on-line system. We have a team of accountants and statisticians who help us clean
and sort the data, and we have been doing this for 5 years now, so we have an extensive
database with over 50,000 data points.
Participating companies receive an individual company report, which shows their data against
several peer groups. We look at the data not just by similar sized companies, but companies
with similar types of business models. For example, companies selling SaaS applications to
thousands of customers at a low price point with an inbound internet marketing strategy,
versus a peer group of companies with a higher price point selling more into the enterprise
space. Participating companies also receive the overall Software Industry Benchmarking
Report and we’ve just built out a new interactive custom benchmarking system for participating
companies.
Last year, benchmarking participation cost $999 for companies under $10M, and $1995 for
companies over $10M. Many participants have told me they have easily saved the
participation price through looking at peer expense benchmarks. But more importantly,
companies use the metrics as part of on-going management, which has a far greater value.
Please register at: www.opexengine.com/register if you are interested in being informed
about participating in the 2012 benchmarking.
We work with CFOs and CEOs, as well as investors to define the most useful software and
SaaS metrics to track each year. I invite you to participate, and also to help us define which
benchmarks are most important for you to track in growing your business. Please feel free to
contact me directly at: lauren@opexengine.com Thank you.
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