Click here to close now.




















Welcome!

Microservices Expo Authors: Liz McMillan, Carmen Gonzalez, Yeshim Deniz, Elizabeth White, Ruxit Blog

Related Topics: @CloudExpo, Java IoT, Microservices Expo, Containers Expo Blog, @BigDataExpo, SDN Journal

@CloudExpo: Blog Feed Post

SaaS Metrics 2.0 – A Guide to Measuring and Improving What Matters

SaaS/subscription businesses are more complex than traditional businesses

“If you cannot measure it, you cannot improve it” – Lord Kelvin

This article is a comprehensive and detailed look at the key metrics that are needed to understand and optimize a SaaS business. It is a completely updated rewrite of an older post.  For this version, I have co-opted two real experts in the field: Ron Gill, (CFO, NetSuite), and Brad Coffey (VP of Strategy, HubSpot), to add expertise, color and commentary from the viewpoint of a public and private SaaS company. My sincere thanks to both of them for their time and input.

SaaS/subscription businesses are more complex than traditional businesses. Traditional business metrics totally fail to capture the key factors that drive SaaS performance. In the SaaS world, there are a few key variables that make a big difference to future results. This post is aimed at helping SaaS executives understand which variables really matter, and how to measure them and act on the results.

The goal of the article is to help you answer the following questions:

  • Is my business financially viable?
  • What is working well, and what needs to be improved?
  • What levers should management focus on to drive the business?
  • Should the CEO hit the accelerator, or the brakes?
  • What is the impact on cash and profit/loss of hitting the accelerator?

(Note: although I focus on SaaS specifically, the article is applicable to any subscription business.)

What's so different about SaaS?
SaaS, and other recurring revenue businesses are different because the revenue for the service comes over an extended period of time (the customer lifetime). If a customer is happy with the service, they will stick around for a long time, and the profit that can be made from that customer will increase considerably. On the other hand if a customer is unhappy, they will churn quickly, and the business will likely lose money on the investment that they made to acquire that customer. This creates a fundamentally different dynamic to a traditional software business: there are now two sales that have to be accomplished:

  1. Acquiring the customer
  2. Keeping the customer (to maximize the lifetime value).

Because of the importance of customer retention, we will see a lot of focus on metrics that help us understand retention and churn. But first let's look at metrics that help you understand if your SaaS business is financially viable.

image

The SaaS P&L / Cash Flow Trough

SaaS businesses face significant losses in the early years (and often an associated cash flow problem). This is because they have to invest heavily upfront to acquire the customer, but recover the profits from that investment over a long period of time. The faster the business decides to grow, the worse the losses become. Many investors/board members have a problem understanding this, and want to hit the brakes at precisely the moment when they should be hitting the accelerator.

In many SaaS businesses, this also translates into a cash flow problem, as they may only be able to get the customer to pay them month by month. To illustrate the problem, we built a simple Excel model which can be found here.  In that model, we are spending $6,000 to acquire the customer, and billing them at the rate of $500 per month. Take a look at these two graphs from that model:

image

image

If we experience a cash flow trough for one customer, then what will happen if we start to do really well and acquire many customers at the same time? The model shows that the P&L/cash flow trough gets deeper if we increase the growth rate for the bookings.

image

But there is light at the end of the tunnel, as eventually there is enough profit/cash from the installed base to cover the investment needed for new customers. At that point the business would turn profitable/cash flow positive - assuming you don't decide to increase spending on sales and marketing. And, as expected, the faster the growth in customer acquisition, the better the curve looks when it becomes positive.

Ron Gill, NetSuite:

If plans go well, you may decide it is time to hit the accelerator (increasing spending on lead generation, hiring additional sales reps, adding data center capacity, etc.) in order to pick-up the pace of customer acquisition. The thing that surprises many investors and boards of directors about the SaaS model is that, even with perfect execution, an acceleration of growth will often be accompanied by a squeeze on profitability and cash flow.

As soon as the product starts to see some significant uptake, investors expect that the losses / cash drain should narrow, right? Instead, this is the perfect time to increase investment in the business. which will cause losses to deepen again. The graph below illustrates the problem:

image

Notice in the example graph that the five customer per month model ultimately yields a much steeper rate of growth, but you have to go through another deep trough to get there. It is the concept of needing to re-enter that type of trough after just having gotten the curve to turn positive that many managers and investors struggle with.

Of course this a special challenge early-on as you need to explain to investors why you'll require additional cash to fund that next round of acceleration. But it isn't just a startup problem. At NetSuite, even as a public company our revenue growth rate has accelerated in each of the last three years. That means that each annual plan involves a stepping-up of investment in lead generation and sales capacity that will increase spending and cash flow out for some time before it starts yielding incremental revenue and cash flow in. As long as you're accelerating the rate of revenue growth, managing and messaging around this phenomenon is a permanent part of the landscape for any SaaS company.

Why is growth important?
We have suggested that as soon as the business has shown that it can succeed, it should invest aggressively to increase the growth rate. You might ask question: Why?

SaaS is usually a "winner-takes-all" game, and it is therefore important to grab market share as fast as possible to make sure you are the winner in your space. Provided you can tell a story that shows that eventually that growth will lead to profitability, Wall Street, acquiring companies, and venture investors all reward higher growth with higher valuations. There's also a premium for the market leader in a particular space.

However not all investments make sense. In the next section we will look at a tool to help you ensure that your growth initiatives/investments will pay back:  Unit Economics.

A Powerful Tool: Unit Economics
Because of the losses in the early days, which get bigger the more successful the company is at acquiring customers, it is much harder for management and investors to figure out whether a SaaS business is financially viable. We need some tools to help us figure this out.

A great way to understand any business model is to answer the following simple question:

Can I make more profit from my customers than it costs me to acquire them?

This is effectively a study of the unit economics of each customer. To answer the question, we need two metrics:

  • LTV - the Lifetime Value of a typical customer
  • CAC - the Cost to Acquire a  typical Customer

(For more on how to calculate LTV and CAC, click here.)

Entrepreneurs are usually overoptimistic about how much it costs to acquire a customer. This probably comes from a belief that customers will be so excited about what they have built, that they will beat a path to their doors to buy the product. The reality is often very different! (I have written more on this topic here: Startup Killer: The Cost of Customer Acquisition, and here: How Sales Complexity impacts CAC.)

Is your SaaS business viable?
In the first version of this article, I introduced two guidelines that could be used to judge quickly whether your SaaS business is viable. The first is a good way to figure out if you will be profitable in the long run, and the second is about measuring the time to profitability (which also greatly impacts capital efficiency).

image

Over the last two years, I have had the chance to validate these guidelines with many SaaS businesses, and it turns out that these early guesses have held up well. The best SaaS businesses have a LTV to CAC ratio that is higher than 3, sometimes as high as 7 or 8. And many of the best SaaS businesses are able to recover their CAC in 5-7 months. However many healthy SaaS businesses don't meet the guidelines in the early days, but can see how they can improve the business over time to get there.

The second guideline (Months to Recover CAC)  is all about time to profitability and cash flow. Larger businesses, such as wireless carriers and credit card companies, can afford to have a longer time to recover CAC, as they have access to tons of cheap capital. Startups, on the other hand, typically find that capital is expensive in the early days.  However even if capital is cheap, it turns out that Months to recover CAC is a very good predictor of how well a SaaS business will perform. Take a look at the graph below, which comes from the same model used earlier. It shows how the profitability is anemic if the time to recover CAC extends beyond 12 months.

I should stress that these are only guidelines, there are always situations where it makes sense to break them.

image

Three uses for the SaaS Guidelines

  1. One of the key jobs of the CEO is to decide when to hit the accelerator pedal. The value of these two guidelines is that they help you understand when you have a SaaS business that is in good shape, where it makes sense to hit the accelerator pedal. Alternatively if your business doesn't meet the guidelines, it is a good indicator that there is more tweaking needed to fix the business before you should expand.
  2. Another way to use the two guidelines is for evaluating different lead sources. Different lead sources (e.g. Google AdWords, TV, Radio, etc.) have different costs associated with them. The guidelines help you understand if some of the more expensive lead generation options make financial sense. If they meet these guidelines, it makes sense to hit the accelerator on those sources (assuming you have the cash).Using the second guideline, and working backwards, we can tell that if we are getting paid $500 per month, we can afford to spend up to 12x that amount (i.e. $6,000) on acquiring the customer. If we're spending less than that, you can afford to be more aggressive and spend more in marketing or sales.
  3. There is another important way to use this type of guideline: segmentation. Early-stage companies are often testing their offering with several different uses/types of customers / pricing models / industry verticals. It is very useful to examine which segments show the quickest return or highest LTV to CAC in order to understand which will be the most profitable to pursue.

Unit Economics in Action: HubSpot Example
HubSpot's unit economics were recently published in an article in Forbes:

You can see from the second row in this table how they have dramatically improved their unit economics (LTV:CAC ratio) over the five quarters shown. The big driver for this was lowering the MRR Churn rate from 3.5% to 1.5%. This drove up the lifetime value of the customer considerably.  They were also able to drive up their AVG MRR per customer.

Brad Coffey, HubSpot:

In 2011 and early 2012 we used this chart to guide many of our business decisions at HubSpot. By breaking LTV:CAC down into its components we could examine each metric and understand what levers we could pull to drive overall improvement.

It turned out that the levers we could pull varied by segment. In the SMB market for instance we had the right sales process in place - but had an opportunity to improve LTV by improving the product to lower churn and increasing our average price in the segment. In the VSB (Very Small Business) segment, by contrast, there wasn't as much upside left on the LTV (VSB customers have less money and naturally higher churn) so we focused on lowering CAC by removing friction from our sales process and moving more of our sales to the channel.

Two kinds of SaaS business:

There are two kinds of SaaS business:

  • Those with primarily monthly contracts, with some longer term contracts. In this business, the primary focus will be on MRR (Monthly Recurring Revenue)
  • Those with primarily annual contracts, with some contracts for multiple years. Here the primary focus is on ARR (Annual Recurring Revenue), and ACV (Annual Contract Value).

Most of the time in this article, I will refer to MRR/ACV. This means use MRR if you are the first kind of business, or ACV if you are the second kind of business. The dashboard shown below assumes monthly contracts (MRR). However in the downloadable spreadsheet, there is a tab that shows the same dashboard for the second kind, focusing on ACV instead of MRR.

SaaS Bookings: Three Contributing Elements
Every month in a SaaS business, there are three elements that contribute to how much MRR will change relative to the previous month:

What happened with new customers added in the month:

  • New MRR (or ACV)

What happened in the installed base of customers:

  • Churned MRR (or ACV) (from existing customers that cancelled their subscription. This will be a negative number.)
  • Expansion MRR (or ACV) (from existing customers who expanded their subscription)

The sum all three of these makes up your Net MRR or ACV Bookings:

image

I recommend that you track these using a chart similar to the one below:

image

This chart shows the three components of MRR (or ACV) Bookings, and the Net New MRR (or ACV) Bookings. By breaking out each component, you can track the key elements that are driving your business. The one variation we would recommend making to this chart is to show a dotted line for the plan, so you can track how you are doing against plan for each of the four lines. This is one of the most important charts to help you understand and run your business.

Ron Gill, NetSuite:

This chart is really good. I also like to look at this data in tabular form because I want to know y-o-y growth rates. E.g. "Net new MRR is up 25% over June of last year". The Y-o-Y % is a metric easily compared with increased spending, sales capacity, etc.

The Importance of Customer Retention (Churn)

In the early days of a SaaS business, churn really doesn't matter that much. Let's say that you lose 3% of your customers every month. When you only have a hundred customers, losing 3 of them is not that terrible. You can easily go and find another 3 to replace them. However as your business grows in size, the problem becomes different. Imagine that you have become really big, and now have a million customers. 3% churn means that you are losing 30,000 customers every month! That turns out to be a much harder number to replace. Companies like Constant Contact have run into this problem, and it has made it very hard for them to keep up their growth rate.

Ron Gill, NetSuite:

One oft-overlooked aspect of churn is that the churn rate, combined with the rate of new ARR adds, not only defines how fast you can grow the business, it also defines the maximum size the business can reach (see graph below).

image

It is an enlightening exercise to build a simple model like this for your business and plot where your current revenue run rate sits on the blue line defined by your present rate of ARR adds and churn. Are you near the left-hand side, where the growth is still steep and the ceiling is still far above? Or, are you further to the right where revenue growth will level off and there is limited room left to grow? How much benefit will you get from small improvements in churn or the pace of new business sign-up?

At NetSuite, we've had great success shifting the line in the last few years by both dramatically decreasing churn and by increasing average deal size and volume, thus increasing ARR adds. The result was both to steadily move the limit upward and to steepen the growth curve at the current ARR run rate, creating room for increasingly rapid expansion.

The Power of Negative Churn
The ultimate solution to the churn problem is to get to Negative Churn.

image

There are two ways to get this expansion revenue:

  1. Use a pricing scheme that has a variable axis, such as the number of seats used, the number of leads tracked, etc. That way, as your customers expand their usage of your product, they pay you more.
  2. Upsell/Cross-sell them to more powerful versions of your product, or additional modules.

To help illustrate the power of negative churn, take a look at the following two graphs that show how cohorts behave with 3% churn, and then with 3% negative churn. (Since this is the first time I have used the word Cohort, let me explain what it means. A cohort is simply a fancy word for a group of customers. In the SaaS world, it is used typically to describe the group that joined in a particular month. So there would be the January cohort, February cohort, etc.  In our graphs below, a different color is used for each month's cohort, so we can see how they decline or grow, based on the churn rate.)

In the top graph, we are losing 3% of our revenue every month, and you can see that with a constant bookings rate of $6k per month, the revenue reaches $140k after 40 months, and growth is flattening out. In the bottom graph, we may be losing some customers, but the remaining customers are more than making up for that with increased revenue. With a negative churn rate of 3%, we reach $450k in revenue (more then 3x greater), and the growth in revenues is increasing, not flattening.

imageimage

For more on this topic, you may wish to refer to these two blog posts of mine:

More Stories By David Skok

David Skok joined Matrix Partners as a General Partner in May 2001. He has a wealth of experience running companies. He started his first company in 1977 at age 22. Since then he has founded a total of four separate companies and performed one turn-around. Three of these companies went public.

Skok joined Matrix from SilverStream Software, which he founded in June 1996. Prior to its July 2002 acquisition by Novell, SilverStream was a public company that had reached a revenue run rate in excess of $100M, with approximately 800 employees and offices in more than 20 countries around the world. His work as a value added investor is best known for helping JBoss take its Open Source business to a successful exit with its sale to Red Hat, and for helping AppIQ, Tabblo and Diligent Technologies, which have all had successful exits, from their inceptions to their acquisitions by HP and IBM.

He serves on the boards of Digium (makers of the very popular Asterisk Open Source PBX/telephony software), CloudSwitch, Enservio, OpenSpan, Solidworks, VideoIQ, and HubSpot. In addition to his broad focus on enterprise software, he is specifically focused on the areas of cloud computing, Open Source, Software as a Service (SaaS), marketing automation, virtualization, storage, and data center automation.

@MicroservicesExpo Stories
Containers are not new, but renewed commitments to performance, flexibility, and agility have propelled them to the top of the agenda today. By working without the need for virtualization and its overhead, containers are seen as the perfect way to deploy apps and services across multiple clouds. Containers can handle anything from file types to operating systems and services, including microservices. What are microservices? Unlike what the name implies, microservices are not necessarily small,...
ElasticBox, the agile application delivery manager, announced freely available public boxes for the DevOps community. ElasticBox works with enterprises to help them deploy any application to any cloud. Public boxes are curated reference boxes that represent some of the most popular applications and tools for orchestrating deployments at scale. Boxes are an adaptive way to represent reusable infrastructure as components of code. Boxes contain scripts, variables, and metadata to automate proces...
It’s been proven time and time again that in tech, diversity drives greater innovation, better team productivity and greater profits and market share. So what can we do in our DevOps teams to embrace diversity and help transform the culture of development and operations into a true “DevOps” team? In her session at DevOps Summit, Stefana Muller, Director, Product Management – Continuous Delivery at CA Technologies, answered that question citing examples, showing how to create opportunities for ...
SYS-CON Events announced today that G2G3 will exhibit at SYS-CON's @DevOpsSummit Silicon Valley, which will take place on November 3–5, 2015, at the Santa Clara Convention Center in Santa Clara, CA. Based on a collective appreciation for user experience, design, and technology, G2G3 is uniquely qualified and motivated to redefine how organizations and people engage in an increasingly digital world.
Whether you like it or not, DevOps is on track for a remarkable alliance with security. The SEC didn’t approve the merger. And your boss hasn’t heard anything about it. Yet, this unruly triumvirate will soon dominate and deliver DevSecOps faster, cheaper, better, and on an unprecedented scale. In his session at DevOps Summit, Frank Bunger, VP of Customer Success at ScriptRock, will discuss how this cathartic moment will propel the DevOps movement from such stuff as dreams are made on to a prac...
Docker containerization is increasingly being used in production environments. How can these environments best be monitored? Monitoring Docker containers as if they are lightweight virtual machines (i.e., monitoring the host from within the container), with all the common metrics that can be captured from an operating system, is an insufficient approach. Docker containers can’t be treated as lightweight virtual machines; they must be treated as what they are: isolated processes running on hosts....
SYS-CON Events announced today that DataClear Inc. will exhibit at the 17th International Cloud Expo®, which will take place on November 3–5, 2015, at the Santa Clara Convention Center in Santa Clara, CA. The DataClear ‘BlackBox’ is the only solution that moves your PC, browsing and data out of the United States and away from prying (and spying) eyes. Its solution automatically builds you a clean, on-demand, virus free, new virtual cloud based PC outside of the United States, and wipes it clean...
SYS-CON Events announced today that HPM Networks will exhibit at the 17th International Cloud Expo®, which will take place on November 3–5, 2015, at the Santa Clara Convention Center in Santa Clara, CA. For 20 years, HPM Networks has been integrating technology solutions that solve complex business challenges. HPM Networks has designed solutions for both SMB and enterprise customers throughout the San Francisco Bay Area.
SYS-CON Events announced today the Containers & Microservices Bootcamp, being held November 3-4, 2015, in conjunction with 17th Cloud Expo, @ThingsExpo, and @DevOpsSummit at the Santa Clara Convention Center in Santa Clara, CA. This is your chance to get started with the latest technology in the industry. Combined with real-world scenarios and use cases, the Containers and Microservices Bootcamp, led by Janakiram MSV, a Microsoft Regional Director, will include presentations as well as hands-on...
Microservice architecture is fast becoming a go-to solution for enterprise applications, but it's not always easy to make the transition from an established, monolithic infrastructure. Lightweight and loosely coupled, building a set of microservices is arguably more difficult than building a monolithic application. However, once established, microservices offer a series of advantages over traditional architectures as deployment times become shorter and iterating becomes easier.
The pricing of tools or licenses for log aggregation can have a significant effect on organizational culture and the collaboration between Dev and Ops teams. Modern tools for log aggregation (of which Logentries is one example) can be hugely enabling for DevOps approaches to building and operating business-critical software systems. However, the pricing of an aggregated logging solution can affect the adoption of modern logging techniques, as well as organizational capabilities and cross-team ...
Puppet Labs has announced the next major update to its flagship product: Puppet Enterprise 2015.2. This release includes new features providing DevOps teams with clarity, simplicity and additional management capabilities, including an all-new user interface, an interactive graph for visualizing infrastructure code, a new unified agent and broader infrastructure support.
SYS-CON Events announced today that Pythian, a global IT services company specializing in helping companies leverage disruptive technologies to optimize revenue-generating systems, has been named “Bronze Sponsor” of SYS-CON's 17th Cloud Expo, which will take place on November 3–5, 2015, at the Santa Clara Convention Center in Santa Clara, CA. Founded in 1997, Pythian is a global IT services company that helps companies compete by adopting disruptive technologies such as cloud, Big Data, advance...
In today's digital world, change is the one constant. Disruptive innovations like cloud, mobility, social media, and the Internet of Things have reshaped the market and set new standards in customer expectations. To remain competitive, businesses must tap the potential of emerging technologies and markets through the rapid release of new products and services. However, the rigid and siloed structures of traditional IT platforms and processes are slowing them down – resulting in lengthy delivery ...
The web app is agile. The REST API is agile. The testing and planning are agile. But alas, data infrastructures certainly are not. Once an application matures, changing the shape or indexing scheme of data often forces at best a top down planning exercise and at worst includes schema changes that force downtime. The time has come for a new approach that fundamentally advances the agility of distributed data infrastructures. Come learn about a new solution to the problems faced by software organ...
17th Cloud Expo, taking place Nov 3-5, 2015, at the Santa Clara Convention Center in Santa Clara, CA, will feature technical sessions from a rock star conference faculty and the leading industry players in the world. Cloud computing is now being embraced by a majority of enterprises of all sizes. Yesterday's debate about public vs. private has transformed into the reality of hybrid cloud: a recent survey shows that 74% of enterprises have a hybrid cloud strategy. Meanwhile, 94% of enterprises ar...
Any Ops team trying to support a company in today’s cloud-connected world knows that a new way of thinking is required – one just as dramatic than the shift from Ops to DevOps. The diversity of modern operations requires teams to focus their impact on breadth vs. depth. In his session at DevOps Summit, Adam Serediuk, Director of Operations at xMatters, Inc., will discuss the strategic requirements of evolving from Ops to DevOps, and why modern Operations has begun leveraging the “NoOps” approa...
SYS-CON Events announced today that the "Second Containers & Microservices Expo" will take place November 3-5, 2015, at the Santa Clara Convention Center in Santa Clara, CA. Containers and microservices have become topics of intense interest throughout the cloud developer and enterprise IT communities.
DevOps Summit, taking place Nov 3-5, 2015, at the Santa Clara Convention Center in Santa Clara, CA, is co-located with 17th Cloud Expo and will feature technical sessions from a rock star conference faculty and the leading industry players in the world. The widespread success of cloud computing is driving the DevOps revolution in enterprise IT. Now as never before, development teams must communicate and collaborate in a dynamic, 24/7/365 environment. There is no time to wait for long development...
Akana has announced the availability of the new Akana Healthcare Solution. The API-driven solution helps healthcare organizations accelerate their transition to being secure, digitally interoperable businesses. It leverages the Health Level Seven International Fast Healthcare Interoperability Resources (HL7 FHIR) standard to enable broader business use of medical data. Akana developed the Healthcare Solution in response to healthcare businesses that want to increase electronic, multi-device acce...