the saas business model and metrics
TRANSCRIPT
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The SaaS Business Model & Metrics
David Skok, Matrix Partners
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Before we get started, there’s one useful concept to discuss…
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3 STAGES OF A STARTUPAnd how the CEO should manage the company
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Search for Product/Market Fit
Scaling the Business
Search for Repeatable & Scalable Sales Model
Conserve Cash Invest Aggressively
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The SaaS Business ModelDavid Skok, Matrix Partners
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What we were used to: Licensed Software
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What’s so different about SaaS?
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Month 11
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Cash Flow for a Single Deal
CAC (Cost to acquire the customer) Subscription payments * GM%
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Cash Impact of a typical deal
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Negative Cash Flow
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If cash flow is bad for one customer, what happens when we grow, and add many more customers?
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Modeling a slow increase in the number of customers added every month
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Cash Flows
CAC
SubscriptionPayments
* GM%
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Cumulative Cash Flow
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$(3,000,000)
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The SaaS Cash Flow Trough
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$4,000,000
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$7,000,000
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“The thing that surprises many investors & boards of directors about the SaaS model is that, even with perfect execution, an acceleration of growth will often be accompanied by a squeeze on profitability and cash flow.”
Ron Gill, CFO at Netsuite
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What’s the impact of faster growth?
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$(10,000,000)
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$15,000,000
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2 moreCustomers/Month
5 moreCustomers/Month
10 moreCustomers/Month
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What’s the impact of faster growth?
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$(10,000,000)
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2 moreCustomers/Month
5 moreCustomers/Month
10 moreCustomers/Month
Cash Flow Trough gets deeper
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“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.”
Ron Gill, CFO at Netsuite
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What typically happens…
Courtesy of Ron Gill, CFO at Netsuite
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When your SaaS business is losing money at an increasing rate, how can you tell if the business is going to work eventually?
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UNIT ECONOMICSA Powerful Tool
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Unit Economics
Can I make more profit from my customers than it costs me to acquire them?
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Unit Economics
Cost to Acquire a Customer Lifetime Value of a Customer
CACCAC LTVLTV
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A Viable Business Model
CAC
CAC LTVLTV<
But surprising how many Entrepreneurs underestimate CAC
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Computing the Customer Lifetime
Customer Lifetime = 1
Churn
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How Churn affects LTV
1% 2% 5%$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
$100,000
$50,000
$20,000
LTV vs Churn RateLTV
Monthly Churn
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Customer Churn vs $ Dollar Churn
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Customer Churn vs $ Dollar Churn
Customer 1$1k MRR
Customer 2$5k MRR
Starting period
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Customer 1$1k MRR
Customer Churn vs $ Dollar Churn
Customer 2$5k MRR
Customer 2$5k MRR
Customer 1 Churned50% Customer Churn
17% $Dollar Churn
Starting period A year later
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Customer 1$1k MRR
Customer Churn vs $ Dollar Churn
Customer 2$5k MRR
Customer 1$1k MRR
Customer 2 Churned50% Customer Churn
83% $Dollar Churn
Starting period A year later
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Customer 1$1k MRR
Negative $ Dollar Churn
Customer 2$5k MRR
Customer 2$7k MRR
Customer 1 Churned50% Customer Churn-16% $Dollar Churn
Starting period A year later
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Negative Churn
Expansion Revenue
from Existing Customers
Revenue Lostfrom Churning
Customers>
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Implies another part of the Sales Funnel
Expand, Upsell,
Cross Sell
Top of Funnel
Middle of Funnel
Sales
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How do we get Expansion Revenue?
If we only have one SaaS product, what more can we sell
the customer?
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Variable Pricing AxesA critical factor for expansion revenue
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EnterpriseEdition
ProEdition
BasicEdition
Features
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Users
EnterpriseEdition
ProEdition
BasicEdition
Features
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Users
Depth ofUsage
Examples:- Mailing list size- Database size- Amount of storage used
EnterpriseEdition
ProEdition
BasicEdition
Features
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Revenue from one group of customers (cohort) with no upsell/cross-sell
Time
$’s
Upsell revenuefrom the same cohort N
egat
ive
Ch
urn
Revenue from a single cohort
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CRR and DRR
CRR: Customer Retention RateDRR: Dollar Retention Rate
Annual Numbers – expressed as a percentageLook at the year ago cohort
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WHY CHURN IS SO IMPORTANT
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Revenue Lost with 2.5% monthly Churn
Renewals
Lost dueto Churn
YEAR 3
$3m $7m
Becomes harder & harder to
replace this with new bookings
Renewals
Lost dueto Churn
YEAR 6
$30m $70m
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Impact of Negative Churn
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1 2 3 4 5 6 7
Jan 85% 75% 65% 62% 61% 58% 57%
Feb 87% 78% 70% 67% 63% 59%
Mar 88% 84% 79% 75% 71%
Apr 92% 89% 86% 82%
May 93% 89% 85%
Jun 94% 90%
Jul 96%
Months after starting usage
Coh
ort
Shows improving first month churnShows churn stabilizing
in fourth month
Cohort Analysis
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CUSTOMER SUCCESSAn important new function
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Customer Success
• Not just the responsibility of Customer Success department• Product
• Design• Quality (response time, bugs and downtime)
• Sales• Don’t over sell the product• Don’t sell the product to the wrong customer types
• Marketing• Marketing to customers, not just prospects
• But good to have single executive who has this as their top priority
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Customer Success
Focusing on retention a
month before the contract
expires
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Customer Success
Focusing on retention a
month before the contract
expires
Focusing on successful on-
boarding
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CHI – Customer Happiness Index
• Find a way to predict the likelihood of churn
• Most common and simple technique: Usage
• More sophisticated:• Score usage of specific features higher than others
• E.g.• Commenting on someone else’s posts on Facebook = Low• Creating your own post = High
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High Usage does not correlate with High Value
Usage
Business Value
Optimal
Worst
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My Suggestion
• Consider a CHI score based on Business Value achieved, and find a way to measure automatically in the app• Example:
• How many new leads did you bring the customer?• How much did you improve the lead to customer conversion rate?
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ANOTHER IMPORTANT VARIABLE
Time to Recover CAC
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$(5,000,000)
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$10,000,000
$15,000,000
$20,000,000
$25,000,000
Months to recover CAC: 6.3 Months to recover CAC: 12.5
Months to recover CAC: 18.8
Cumulative Cash Flow
Impact of Months to Recover CAC
6.3 monthsto recover CAC
12.5 monthsto recover CAC
18.8 monthsto recover CAC
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Cumulative Cash Flow
Impact of Months to Recover CAC
6.3 monthsto recover CAC
12.5 monthsto recover CAC
18.8 monthsto recover CAC
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$10,000,000
$15,000,000
$20,000,000
$25,000,000
Months to recover CAC: 6.3 Months to recover CAC: 12.5
Months to recover CAC: 18.8
2x Deeper P&L trough2x longer to reach breakeven
3x Deeper P&L trough3x longer to reach breakeven
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Two Guidelines for SaaS success
LTV CAC> 3x
Months to recover CAC < 12 months
Required for Capital Efficiency
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What Metrics should we use to measure a SaaS business?
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We care about recurring revenue
MRR Monthly Recurring Revenue
ARR Annually Recurring Revenue
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Net NewMRR/ACV
Expansion MRR/ACV (Existing Customers)
Churned MRR/ACV(Lost Customers)
New MRR/ACV(New Customers)
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Always ask to see Bookings over TimeEntrepreneurs always happy to show their MRR over timeBut this doesn’t tell whether their bookings are growing
Jan Feb Mar Apr May Jun
$(15.0)
$(10.0)
$(5.0)
$-
$5.0
$10.0
$15.0
$20.0
$25.0
$30.0
$35.0
MRR Bookings
New MRR
Net New MRR
Expansion MRR
Churned MRR
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Salesperson Unit EconomicsAnother valuable analysis
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How Revenue Builds for a SaaS Salesperson(assuming no ramp up time)
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
$45,000
With Churn of 2.5%
Jan Custs Feb Custs Mar Custs Apr Custs
May Custs Jun Custs Jul Custs Aug Custs
Sep Custs Oct Custs Nov Custs Dec Custs
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
$45,000
With no Churn
Jan Custs Feb Custs Mar Custs Apr Custs
May Custs Jun Custs Jul Custs Aug Custs
Sep Custs Oct Custs Nov Custs Dec Custs
![Page 60: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/60.jpg)
The Cash Flow Gap
Mon
th 1
Mon
th 3
Mon
th 5
Mon
th 7
Mon
th 9
Mon
th 1
1
Mon
th 1
3
Mon
th 1
5
Mon
th 1
7
Mon
th 1
9
Mon
th 2
1
Mon
th 2
3
$(25,000)
$(20,000)
$(15,000)
$(10,000)
$(5,000)
$-
$5,000
$10,000
$15,000
$20,000
$25,000
Net profit - New Sales Hire
Month 1
Month 2
Month 3
Month 4
Month 5
Month 6
Month 7
Month 8
Month 9
Month 10
Month 11
Month 12
$-
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
MRR vs Expenses – New Sales Hire
MRR
Expenses
CashGap
(Slightly later breakeven point, because Gross Profit is less than MRR)
11 months to breakeven
![Page 61: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/61.jpg)
The SaaS Cash Flow Trough
Mon
th 1
Mon
th 3
Mon
th 5
Mon
th 7
Mon
th 9
Mon
th 1
1
Mon
th 1
3
Mon
th 1
5
Mon
th 1
7
Mon
th 1
9
Mon
th 2
1
Mon
th 2
3
Mon
th 2
5
Mon
th 2
7
Mon
th 2
9
Mon
th 3
1
Mon
th 3
3
Mon
th 3
5
$(200,000)
$(100,000)
$-
$100,000
$200,000
$300,000
$400,000
$500,000
Cumulative Net Profit - New Sales Hire
23 Months to get back the investment
Total amount invested:
$110k
But a great return on
investment
![Page 62: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/62.jpg)
Search for Product/Market Fit
Scaling the Business
Search for Repeatable & Scalable Sales Model
Conserve Cash Invest Aggressively
![Page 63: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/63.jpg)
What happens at the company level when we add 2 new sales hires every month?
Mon
th 1
Mon
th 3
Mon
th 5
Mon
th 7
Mon
th 9
Mon
th 1
1
Mon
th 1
3
Mon
th 1
5
Mon
th 1
7
Mon
th 1
9
Mon
th 2
1
Mon
th 2
3
$(250,000)
$(200,000)
$(150,000)
$(100,000)
$(50,000)
$-
$50,000
$100,000
$150,000
Net profit
Mon
th 1
Mon
th 3
Mon
th 5
Mon
th 7
Mon
th 9
Mon
th 1
1
Mon
th 1
3
Mon
th 1
5
Mon
th 1
7
Mon
th 1
9
Mon
th 2
1
Mon
th 2
3
Mon
th 2
5
Mon
th 2
7
Mon
th 2
9
Mon
th 3
1
Mon
th 3
3
Mon
th 3
5
$(3,000,000)
$(2,000,000)
$(1,000,000)
$-
$1,000,000
$2,000,000
$3,000,000
$4,000,000
Cumulative Net Profit
32 Months to get back the investment
Total amount invested:
$2.6m
First profitable month: 21
Worst loss: $190k in month 11
![Page 64: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/64.jpg)
Comparison: hiring one versus two sales people per month
Mon
th 1
Mon
th 4
Mon
th 7
Mon
th 1
0
Mon
th 1
3
Mon
th 1
6
Mon
th 1
9
Mon
th 2
2
Mon
th 2
5
Mon
th 2
8
Mon
th 3
1
Mon
th 3
4
$(400,000)
$(200,000)
$-
$200,000
$400,000
$600,000
$800,000
$1,000,000
Net Profit
1 sales hire a month 2 sales hires a month
Mon
th 1
Mon
th 4
Mon
th 7
Mon
th 1
0
Mon
th 1
3
Mon
th 1
6
Mon
th 1
9
Mon
th 2
2
Mon
th 2
5
Mon
th 2
8
Mon
th 3
1
Mon
th 3
4
$(3,000,000)
$(2,000,000)
$(1,000,000)
$-
$1,000,000
$2,000,000
$3,000,000
$4,000,000
Cumulative Net Profit
1 sales hire a month 2 sales hires a month
The time to breakeven remains
the sameThe cash flow
trough is halved
Not adequately shown, but the acceleration after
breakeven is also halved
![Page 65: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/65.jpg)
Salesperson Unit Economics
CAC
OTE LTVQuota<5x
On Target Earnings
A typical good ratio is around 6x in SaaS
![Page 66: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/66.jpg)
Annual up-front paymentInstead of Monthly
![Page 67: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/67.jpg)
What happens if we collect a year’s payment in advance?
Mon
th 1
Mon
th 4
Mon
th 7
Mon
th 1
0
Mon
th 1
3
Mon
th 1
6
Mon
th 1
9
Mon
th 2
2
Mon
th 2
5
Mon
th 2
8
Mon
th 3
1
Mon
th 3
4 $(5,000,000)
$-
$5,000,000
$10,000,000
$15,000,000
$20,000,000
$25,000,000
$30,000,000
$35,000,000
$40,000,000
Cumulative Cashflow comparision - monthly
payments vs year in advance
Cumulative Net Profit
Cumulative Net Cash Flows
Mon
th 1
Mon
th 4
Mon
th 7
Mon
th 1
0
Mon
th 1
3
Mon
th 1
6
Mon
th 1
9
Mon
th 2
2
Mon
th 2
5
Mon
th 2
8
Mon
th 3
1
Mon
th 3
4
$(500,000)
$-
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
Cashflow comparison - monthly payments vs
year in advance
Net profit Net Cash Flows
Eliminates the cash flow trough, and means $35m more cash in this
scenario
Looking at the whole company picture when hiring 2 sales people per month
![Page 68: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/68.jpg)
MORE ON CACThe impact of sales complexity
![Page 69: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/69.jpg)
Sales Complexity
FreemiumNo Touch
Self-Service
Light TouchInside Sales
High TouchInside Sales
Field Sales Field Sales with SE’s
![Page 70: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/70.jpg)
How I assumed the two would relate
![Page 71: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/71.jpg)
A rough estimate of CAC versusSales Complexity
FreemiumNo Touch
Self-Service
Light TouchInside Sales
High TouchInside Sales
Field Sales Field Sales with SE’s
$0-$40
$30 – $200
$300 - $800
$3,000 - $8,000
$25,000 – $75,000
$75,000 – $200,000
Rough Estimates of Cost of Customer Acquisition (CAC)
![Page 72: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/72.jpg)
The relationship is roughly exponential
Clearly adding Human Touch dramatically
increases costs
![Page 73: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/73.jpg)
Sales Complexity
CAC (logarithmic)
10x
10x
10x
![Page 74: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/74.jpg)
Understanding Public SaaS companies
![Page 75: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/75.jpg)
Example Operating Model
Revenue100%
CoGS24%
Sales & Marketing
51%
R&D15%
G&A13% Loss (6%)
![Page 76: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/76.jpg)
Break apart Sales & Marketing
Revenue100%
CoGS24%
Sales & Marketing
51%
R&D15%
G&A13% Loss (6%)
Expansion &
Retention25%
New Customer
Sales26%
![Page 77: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/77.jpg)
To make it comparable with a traditional software business, eliminate New Customer Sales, as those benefit the future
Revenue100%
CoGS24%
Sales & Marketing
51%
R&D15%
G&A13%
Profit20%
Expansion &
Retention25%
New Customer
Sales26%
CoGS24%
R&D15%
G&A13%
Loss (6%)
Expansion &
Retention25%
![Page 78: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/78.jpg)
Profit20%
Expansion &
Retention25%
CoGS24%
R&D15%
G&A13%
Now look at DRR (Dollar Retention Rate):
• Example DRR = 123% (Zendesk’s number)
• The existing customer base with no additional revenue is growing at 23% annually
• So you have a business growing 23% year-on-year, generating 20% Profit
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SUMMARY
![Page 80: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/80.jpg)
Summary
• Expect to see the P&L / Cash Flow trough
• Use Unit Economics to evaluate the business
• Look for negative churn, (where DRR > 100%)
• Use SaaS metrics, not traditional metrics
![Page 81: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/81.jpg)
The 3 Keys to SaaS Success
1 Acquisition
2 Retention
3 Monetization
![Page 83: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/83.jpg)
APPENDIXSome more adanced topics
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The Magic Number
• In general, I don’t like the Magic Number• Hard to explain and understand
• BUT – a public company may not give:• LTV:CAC ratio• Months to recover CAC
• So use Magic Number to calculate something roughly equivalent• First developed by the Josh James, CEO of Omniture• The key insight - if your Magic Number is:
• Above 0.75 – step on the gas• Below 0.75 – step back and look at your business • Below 0.5 – business probably not ready to expand
![Page 85: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/85.jpg)
The Formula for Magic Number
• QRR[X] = Quarterly Revenue in the current quarter
• QRR[X-1] = Quarterly Revenue in the prior quarter
• Sales & Marketing Expense [X-1] = Sales & Marketing expense in the prior quarter
𝑀𝑎𝑔𝑖𝑐 𝑁𝑢𝑚𝑏𝑒𝑟=(𝑄𝑅𝑒𝑣 [ 𝑋 ]−𝑄𝑅𝑒𝑣 [𝑋 −1 ] )∗4
𝑆𝑎𝑙𝑒𝑠∧𝑀𝑎𝑟𝑘𝑒𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 [𝑋 −1]
𝑀𝑎𝑔𝑖𝑐 𝑁𝑢𝑚𝑏𝑒𝑟=𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛𝑄𝑢𝑎𝑟𝑡𝑒𝑟𝑙𝑦 𝑅𝑒𝑐𝑢𝑟𝑟𝑖𝑛𝑔 𝑅𝑒𝑣𝑒𝑛𝑢𝑒∗4
𝑃𝑟𝑖𝑜𝑟 𝑄𝑢𝑎𝑟𝑡𝑒𝑟 ′ 𝑠𝑆𝑎𝑙𝑒𝑠∧𝑀𝑎𝑟𝑘𝑒𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠
Expressed in a slightly more readable form:
![Page 86: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/86.jpg)
Example Magic Number calculation
Q1 Q2 Q3
Revenue $1,000,000 $1,200,000 $1,500,000
Sales & Marketing Expense $800,000 $900,000
Magic Number 1.0 1.33
![Page 87: The SaaS business model and metrics](https://reader035.vdocument.in/reader035/viewer/2022062320/55b6e2e6bb61eb63268b4867/html5/thumbnails/87.jpg)
2008 Magic Number Graph