SaaSMetrics– AGuidetoMeasuringandImprovingWhatMatters

This is aguest postby DavidSkok. Davidis a fivetime serialentrepreneur

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B R O W S EM A R K E T I N GT O P I C S

entrepreneurturned VC,at MatrixPartners

“If youcannotmeasureit, youcannotimproveit” –LordKelvin

This articleis acomprehensiveanddetailedlook at thekeymetricsthat areneeded tounderstandandoptimize aSaaSbusiness. Itis acompletelyupdatedrewrite ofan olderpost. Forthis

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thisversion, Ihave co-opted tworealexperts inthe field:Ron Gill,(CFO,NetSuite),and BradCoffey (VPof Strategy,HubSpot),to addexpertise,color andcommentaryfrom theviewpointof a publicand privateSaaScompany.My sincerethanks toboth ofthem fortheir timeand input.

SaaS/subscriptionbusinessesare morecomplexthantraditionalbusinesses.

Audits

businesses.Traditionalbusinessmetricstotally failto capturethe keyfactorsthat driveSaaSperformance.In the SaaSworld,there are afew keyvariablesthat makea bigdifferenceto futureresults.This post isaimed athelpingSaaSexecutivesunderstandwhichvariablesreallymatter,and how tomeasurethem andact on theresults.

The goal of

The goal ofthe articleis to helpyouanswer thefollowingquestions:

Is mybusinessfinanciallyviable?

What isworkingwell,andwhatneedsto beimproved?

Whatleversshouldmanagementfocuson todrivethebusiness?

ShouldtheCEO hittheaccelerator,or thebrakes?

What is

What istheimpacton cashandprofit/lossofhittingtheaccelerator?

(Note:although Ifocus onSaaSspecifically,the articleisapplicableto anysubscriptionbusiness.)

What’ssodifferentaboutSaaS?SaaS, andotherrecurringrevenuebusinessesaredifferent

differentbecausetherevenuefor theservicecomesover anextendedperiod oftime (thecustomerlifetime). Ifa customeris happywith theservice,they willstickaround fora longtime, andthe profitthat can bemade fromthatcustomerwillincreaseconsiderably.On theother handif acustomerisunhappy,they will

they willchurnquickly,and thebusinesswill likelylosemoney ontheinvestmentthat theymade toacquirethatcustomer.Thiscreates afundamentallydifferentdynamic toatraditionalsoftwarebusiness:there arenow twosales thathave to beaccomplished:

1. Acquiringthecustomer

2. Keepingthecustomer(tomaximize

maximizethelifetimevalue).

Because oftheimportanceofcustomerretention,we will seea lot offocus onmetricsthat helpusunderstandretentionand churn.But firstlet’s look atmetricsthat helpyouunderstandif yourSaaSbusiness isfinanciallyviable.

TheSaaS

TheSaaSP&L /CashFlowTroughSaaSbusinessesfacesignificantlosses inthe earlyyears (andoften anassociatedcash flowproblem).This isbecausethey haveto investheavilyupfront toacquire thecustomer,butrecoverthe profitsfrom thatinvestmentover a longperiod oftime. Thefaster thebusinessdecides to

grow, theworse thelossesbecome.Manyinvestors/boardmembershave aproblemunderstandingthis, andwant to hitthe brakesatpreciselythemomentwhen theyshould behitting theaccelerator.

In manySaaSbusinesses,this alsotranslatesinto a cashflowproblem,as theymay onlybe able toget thecustomerto paythem

themmonth bymonth. Toillustratetheproblem,we built asimpleExcelmodelwhich canbe foundhere. Inthatmodel, wearespending$6,000 toacquire thecustomer,and billingthem atthe rate of$500 permonth.Take alook atthese twographsfrom thatmodel:

If weexperiencea cash flowtrough foronecustomer,then whatwillhappen ifwe start todo reallywell andacquiremanycustomersat thesametime? Themodelshows thattheP&L/cashflowtroughgetsdeeper ifweincreasethe growthrate for thebookings.

But thereis light atthe end ofthe tunnel,aseventuallythere isenoughprofit/cashfrom theinstalledbase tocover theinvestmentneeded fornewcustomers.At thatpoint thebusinesswould turnprofitable/cashflowpositive –assumingyou don’tdecide toincreasespendingon salesandmarketing.And, asexpected,

the fasterthe growthincustomeracquisition,the betterthe curvelookswhen itbecomespositive.

Ron Gill,NetSuite:

Ifplansgowell,youmaydecideitistimetohittheaccelerator(increasingspendingonleadgeneration,hiring

hiringadditionalsalesreps,addingdatacentercapacity,etc.)inordertopick-upthepaceofcustomeracquisition.ThethingthatsurprisesmanyinvestorsandboardsofdirectorsabouttheSaaSmodel

modelisthat,evenwithperfectexecution,anaccelerationofgrowthwilloftenbeaccompaniedbyasqueezeonprofitabilityandcashflow.

Assoonastheproductstartstoseesome

somesignificantuptake,investorsexpectthatthelosses/cashdrainshouldnarrow,right?Instead,thisistheperfecttimetoincreaseinvestmentinthebusiness.whichwillcauselossestodeepenagain.

again.Thegraphbelowillustratestheproblem:

Noticeintheexamplegraphthatthefivecustomerpermonthmodelultimatelyyieldsamuchsteeperrateofgrowth,butyouhave

havetogothroughanotherdeeptroughtogetthere.Itistheconceptofneedingtore-enterthattypeoftroughafterjusthavinggottenthecurvetoturnpositive

thatmanymanagersandinvestorsstrugglewith.

Ofcoursethisaspecialchallengeearly-onasyouneedtoexplaintoinvestorswhyyou’llrequireadditionalcashtofundthatnextround

roundofacceleration.Butitisn’tjustastartupproblem.AtNetSuite,evenasapubliccompanyourrevenuegrowthratehasacceleratedineachofthelastthreeyears.Thatmeansthat

thateachannualplaninvolvesastepping-upofinvestmentinleadgenerationandsalescapacitythatwillincreasespendingandcashflowoutforsometimebeforeitstartsyieldingincrementalrevenue

revenueandcashflowin.Aslongasyou’reacceleratingtherateofrevenuegrowth,managingandmessagingaroundthisphenomenonis apermanentpartofthelandscapeforanySaaScompany.

Why is

Why isgrowthimportant?We havesuggestedthat assoon asthebusinesshas shownthat it cansucceed, itshouldinvestaggressivelyto increasethe growthrate. Youmight askquestion:Why?

SaaS isusually a“winner-takes-all”game, andit isthereforeimportantto grabmarketshare asfast aspossible tomake sureyou are the

you are thewinner inyourspace.Providedyou cantell a storythat showsthateventuallythatgrowth willlead toprofitability,WallStreet,acquiringcompanies,andventureinvestorsall rewardhighergrowthwith highervaluations.There’salso apremiumfor themarketleader in aparticularspace.

Howevernot allinvestments

investmentsmakesense. Inthe nextsection wewill look ata tool tohelp youensurethat yourgrowthinitiatives/investmentswill payback: UnitEconomics.

APowerfulTool:UnitEconomicsBecause ofthe lossesin the earlydays,which getbigger themoresuccessfulthecompanyis atacquiringcustomers,it is much

it is muchharder formanagementandinvestorsto figureoutwhether aSaaSbusiness isfinanciallyviable. Weneed sometools tohelp usfigure thisout.

A greatway tounderstandanybusinessmodel is toanswer thefollowingsimplequestion:

Can Imakemoreprofitfrommycustomersthan itcosts

costsme toacquirethem?

This iseffectivelya study ofthe uniteconomicsof eachcustomer.To answerthequestion,we needtwometrics:

LTV –theLifetimeValueof atypicalcustomer

CAC –theCost toAcquireatypicalCustomer

(For moreon how tocalculate

calculateLTV andCAC, clickhere.)

Entrepreneursare usuallyoveroptimisticabout howmuch itcosts toacquire acustomer.Thisprobablycomesfrom abelief thatcustomerswill be soexcitedaboutwhat theyhave built,that theywill beat apath totheir doorsto buy theproduct.The realityis oftenverydifferent! (Ihavewrittenmore onthis topic

this topichere:StartupKiller: TheCost ofCustomerAcquisition,and here:How SalesComplexityimpactsCAC.)

IsyourSaaSbusinessviable?In the firstversion ofthis article,Iintroducedtwoguidelinesthat couldbe used tojudgequicklywhetheryour SaaSbusiness isviable. Thefirst is agood way

good wayto figureout if youwill beprofitablein the longrun, andthe secondis aboutmeasuringthe time toprofitability(which alsogreatlyimpactscapitalefficiency).

Over thelast twoyears, Ihave hadthe chanceto validatetheseguidelineswith manySaaSbusinesses,and itturns outthat theseearlyguesseshave held

have heldup well.The bestSaaSbusinesseshave a LTVto CACratio thatis higherthan 3,sometimesas high as7 or 8. Andmany ofthe bestSaaSbusinessesare able torecovertheir CACin 5-7months.HowevermanyhealthySaaSbusinessesdon’t meettheguidelinesin the earlydays, butcan seehow theycanimprovethe

businessover timeto getthere.

Thesecondguideline(Months toRecoverCAC) is allabout timetoprofitabilityand cashflow.Largerbusinesses,such aswirelesscarriersand creditcardcompanies,can affordto have alongertime torecoverCAC, asthey haveaccess totons ofcheapcapital.Startups,on the

on theotherhand,typicallyfind thatcapital isexpensivein the earlydays.Howevereven ifcapital ischeap, itturns outthatMonths torecoverCAC is avery goodpredictorof how wella SaaSbusinesswillperform.Take alook at thegraphbelow,whichcomesfrom thesamemodelusedearlier. Itshows howthe

theprofitabilityis anemic ifthe time torecoverCACextendsbeyond 12months.

I shouldstress thatthese areonlyguidelines,there arealwayssituationswhere itmakessense tobreakthem.

ThreeusesfortheSaaSGuidelines

Guidelines1. One

of thekeyjobsof theCEO istodecidewhento hittheacceleratorpedal.Thevalueofthesetwoguidelinesis thattheyhelpyouunderstandwhenyouhave aSaaSbusinessthat isingoodshape,whereitmakes

makessenseto hittheacceleratorpedal.Alternativelyif yourbusinessdoesn’tmeettheguidelines,it is agoodindicatorthatthereismoretweakingneededto fixthebusinessbeforeyoushouldexpand.

2. Anotherway tousethetwoguidelinesis forevaluating

evaluatingdifferentleadsources.Differentleadsources(e.g.GoogleAdWords,TV,Radio,etc.)havedifferentcostsassociatedwiththem.Theguidelineshelpyouunderstandifsomeof themoreexpensiveleadgenerationoptionsmakefinancialsense.If theymeetthese

theseguidelines,itmakessenseto hittheacceleratoronthosesources(assumingyouhavethecash).Usingthesecondguideline,andworkingbackwards,wecantellthat ifwe aregettingpaid$500permonth,wecanaffordtospend

spendup to12xthatamount(i.e.$6,000)onacquiringthecustomer.Ifwe’respendinglessthanthat,youcanaffordto bemoreaggressiveandspendmoreinmarketingorsales.

3. Thereisanotherimportantway tousethis

typeofguideline:segmentation.Early-stagecompaniesareoftentestingtheirofferingwithseveraldifferentuses/typesofcustomers/pricingmodels/industryverticals.It isveryusefultoexaminewhichsegmentsshowthequickestreturnorhighest

highestLTV toCAC inordertounderstandwhichwill bethemostprofitabletopursue.

UnitEconomicsinAction:HubSpotExampleHubSpot’suniteconomicswererecentlypublishedin anarticle inForbes:

You cansee from

see fromthe secondrow in thistable howthey havedramaticallyimprovedtheir uniteconomics(LTV:CACratio) overthe fivequartersshown.The bigdriver forthis wasloweringthe MRRChurn ratefrom 3.5%to 1.5%.This droveup thelifetimevalue ofthecustomerconsiderably.They werealso ableto drive uptheir AVGMRR percustomer.

BradCoffey,

Coffey,HubSpot:

In2011andearly2012weusedthischarttoguidemanyofourbusinessdecisionsatHubSpot.BybreakingLTV:CACdownintoitscomponentswecouldexamineeachmetricand

andunderstandwhatleverswecouldpulltodriveoverallimprovement.

Itturnedoutthattheleverswecouldpullvariedbysegment.IntheSMBmarketforinstancewehadthe

therightsalesprocessinplace–buthadanopportunitytoimproveLTVbyimprovingtheproducttolowerchurnandincreasingouraveragepriceinthesegment.IntheVSB(Very

(VerySmallBusiness)segment,bycontrast,therewasn’tasmuchupsideleftontheLTV(VSBcustomershavelessmoneyandnaturallyhigherchurn)sowefocusedonloweringCACbyremovingfriction

frictionfromoursalesprocessandmovingmoreofoursalestothechannel.

TwokindsofSaaSbusiness:There aretwo kindsof SaaSbusiness:

Thosewithprimarilymonthlycontracts,withsomelongerterm

contracts.In thisbusiness,theprimaryfocuswill beon MRR(MonthlyRecurringRevenue)

Thosewithprimarilyannualcontracts,withsomecontractsformultipleyears.Heretheprimaryfocus ison ARR(AnnualRecurringRevenue),andACV(AnnualContractValue).

Most ofthe time inthis article,I will refertoMRR/ACV.Thismeans useMRR if youare thefirst kindofbusiness,or ACV ifyou are thesecondkind ofbusiness.Thedashboardshownbelowassumesmonthlycontracts(MRR).Howeverin thedownloadablespreadsheet,there is atab thatshows thesamedashboardfor thesecond

secondkind,focusingon ACVinstead ofMRR.

SaaSBookings:ThreeContributingElementsEverymonth in aSaaSbusiness,there arethreeelementsthatcontributeto howmuch MRRwill changerelative tothepreviousmonth:

Whathappenedwith newcustomersadded inthe month:

NewMRR (orACV)

Whathappenedin theinstalledbase ofcustomers:

ChurnedMRR (orACV)(fromexistingcustomersthatcancelledtheirsubscription.This willbe anegativenumber.)

ExpansionMRR (orACV)(fromexistingcustomerswhoexpandedtheirsubscription)

The sumall three ofthesemakes upyour NetMRR orACVBookings:

Irecommendthat youtrack theseusing achartsimilar tothe onebelow:

This chartshows thethreecomponentsof MRR (orACV)Bookings,and theNet NewMRR (orACV)Bookings.

Bookings.Bybreakingout eachcomponent,you cantrack thekeyelementsthat aredrivingyourbusiness.The onevariationwe wouldrecommendmaking tothis chartis to showa dottedline for theplan, soyou cantrack howyou aredoingagainstplan foreach of thefour lines.This is oneof themostimportantcharts tohelp you

understandand runyourbusiness.

Ron Gill,NetSuite:

Thischartisreallygood.IalsoliketolookatthisdataintabularformbecauseIwanttoknowy-o-ygrowthrates.E.g.

E.g.“NetnewMRRisup25%overJuneoflastyear”.TheY-o-Y%is ametriceasilycomparedwithincreasedspending,salescapacity,etc.

TheImportanceofCustomerRetention(Churn)

(Churn)In the earlydays of aSaaSbusiness,churnreallydoesn’tmatterthat much.Let’s saythat youlose 3% ofyourcustomerseverymonth.When youonly havea hundredcustomers,losing 3 ofthem isnot thatterrible.You caneasily goand findanother 3to replacethem.Howeveras yourbusinessgrows insize, theproblem

problembecomesdifferent.Imaginethat youhavebecomereally big,and nowhave amillioncustomers.3% churnmeansthat youare losing30,000customerseverymonth!That turnsout to be amuchhardernumber toreplace.CompanieslikeConstantContacthave runinto thisproblem,and it hasmade itvery hardfor them

for themto keep uptheirgrowthrate.

Ron Gill,NetSuite:

Oneoft-overlookedaspectofchurnisthatthechurnrate,combinedwiththerateofnewARRadds,notonlydefineshowfastyoucan

cangrowthebusiness,italsodefinesthemaximumsizethebusinesscanreach(seegraphbelow).

Itisanenlighteningexercisetobuildasimplemodellikethis

thisforyourbusinessandplotwhereyourcurrentrevenuerunratesitsonthebluelinedefinedbyyourpresentrateofARRaddsandchurn.Areyouneartheleft-

handside,wherethegrowthisstillsteepandtheceilingisstillfarabove?Or,areyoufurthertotherightwhererevenuegrowthwillleveloffandthereislimited

limitedroomlefttogrow?Howmuchbenefitwillyougetfromsmallimprovementsinchurnorthepaceofnewbusinesssign-up?

AtNetSuite,we’vehadgreatsuccessshiftingtheline

lineinthelastfewyearsbybothdramaticallydecreasingchurnandbyincreasingaveragedealsizeandvolume,thusincreasingARRadds.Theresultwasbothtosteadilymovethelimitupward

upwardandtosteepenthegrowthcurveatthecurrentARRrunrate,creatingroomforincreasinglyrapidexpansion.

ThePowerofNegativeChurnTheultimatesolution tothe churnproblem isto get toNegativeChurn.

Churn.

There aretwo waysto get thisexpansionrevenue:

1. Use apricingschemethathas avariableaxis,suchas thenumberofseatsused,thenumberofleadstracked,etc.Thatway,asyourcustomersexpandtheirusageof

ofyourproduct,theypayyoumore.

2. Upsell/Cross-sellthemtomorepowerfulversionsofyourproduct,oradditionalmodules.

To helpillustratethe powerof negativechurn, takea look atthefollowingtwo graphsthat showhowcohortsbehavewith 3%churn, andthen with

3%negativechurn.(Since thisis the firsttime I haveused thewordCohort, letme explainwhat itmeans. Acohort issimply afancy wordfor agroup ofcustomers.In the SaaSworld, it isusedtypically todescribethe groupthat joinedin aparticularmonth. Sotherewould betheJanuarycohort,Februarycohort, etc.In ourgraphs

graphsbelow, adifferentcolor isused foreachmonth’scohort, sowe can seehow theydecline orgrow,based onthe churnrate.)

In the topgraph, weare losing3% of ourrevenueeverymonth,and youcan seethat with aconstantbookingsrate of $6kper month,therevenuereaches$140kafter 40months,andgrowth is

growth isflatteningout. In thebottomgraph, wemay belosingsomecustomers,but theremainingcustomersare morethanmaking upfor thatwithincreasedrevenue.With anegativechurn rateof 3%, wereach$450k inrevenue(more then3x greater),and thegrowth inrevenuesisincreasing,notflattening.

For moreon thistopic, youmay wishto refer tothese twoblog postsof mine:

WhyChurnis SOcriticaltosuccessin SaaS

Multi-axisPricing:a keytool forincreasingSaaSrevenue

DefiningaDashboard

Dashboardfor aSaaSCompanyThefollowingsectionshould bemostuseful forreaderswho areinterestedputtingtogether adashboardto helpthemmanagetheir SaaSbusiness.To this, wecreated anexcel filefor animaginarySaaScompany,and laidout atraditionalnumericreport onone tab,and then adashboard

dashboardof graphson asecond tab(seebelow).Theserepresentone viewon how todo this.You mayhave averydifferentapproach.Buthopefullythis willgive yousomeideas. Iwouldrecommendadding adotted linewith theplannumber toall graphs.This willallow youto quicklysee howyou aredoingversus

versusplan.

There aretwoversions oftheDashboard:the oneshownbelow,which isdesignedforcompaniesusingprimarilymonthlycontracts(focusedon MRR).And asecondversionthat can befound herewhich isdesignedforcompaniesusingannualcontracts,focusingon ACV(AnnualContractValue).

Value).

BradCoffey,HubSpot:

HubSpot:

AtHubSpotweobsessoverthesemetrics–andwatchmanyofthemeveryday.Eachnightwesendouta‘waterfall’chartthattracksourprogressagainstourtypicalprogress

progressgiventhenumberofbusinessdaysleftinthemonth.Hereisanexampleofwhatwelookattoensurewe’reontracktomeetournetMRRgoals.

By lookingat thisdaily wecan takeactionimmediatelyif we’retrackingtowards abad monthor quarter.Things likeservicespromotion(forchurnedMRR) orsalescontests &promotions(for new &expansionMRR) areadjustmentswe makewithin agivenmonth inorder tonail ourgoals. (Inthis modelwecombineexpansion

andchurnedMRR intoonechurnedMRR line).

Detaileddefinitionsof thevariousmetricsusedDetaileddefinitionsfor each ofthe variousmetricsused canbe foundin thisreferencedocument:

RevenueChurnvsCustomerChurn– whyarethey

theydifferent?You mightbewonderingwhy it’snecessaryto trackbothCustomerChurn andRevenueChurn.Imagine ascenariowhere wehave 50smallaccountspaying us$100 amonth,and 50largeaccountspaying us$1,000 amonth. Intotal wehave 100customers,and anMRR of$55,000 atthe start ofthe month.Now

Nowimaginethat welose 10 ofthem. OurCustomerchurn rateis 10%. Butif out ofthe tenchurnedcustomers,9 of themwere smallaccounts,and onlyone was alargeaccount.We wouldonly havelost $1,900in MRR.Thatrepresentsonly 3.4%RevenueChurn. Soyou cansee thatthe twonumberscan bequitedifferent.But each isimportant

importanttounderstandif we wanta completepicture ofwhat isgoing on inthebusiness.

GettingpaidinadvanceGettingpaid inadvance isreallysmart ideaif you cando itwithoutimpactingbookings,as it canprovidethe cashflow thatyou needto coverthe cashproblemthat wedescribedearlier in

earlier inthe article.It is oftenworthprovidinggoodfinancialincentivesin the formofdiscountstoencouragethisbehavior.The metricthat weuse totrack howwell yoursales forceis doing inthis area isMonths upFront.

Gettingpaid moreupfrontusuallyalso helpslowerchurn. Thishappensbecausethecustomerhas made

has madea greatercommitmentto yourservice,and ismore likelyto spendthe timegetting itup andrunning.You alsohave moretime toovercomeissues thatmight arisewith theimplementationin the earlydays.CalculatingLTV andCAC

The Metric“Monthsup Front”has beenused atbothHubSpotandNetSuite inthe past asa way to

incentsalespeople toget morepaid upfront whena newcustomeris signed.Howeverasking formoremoney upfront mayturn offcertaincustomers,and resultin fewernewcustomers,so becarefulhow youbalancethese twoconflictinggoals.

CalculatingCACandLTVDetailedinformation

informationon how tocalculateLTV andCAC isprovidedin thesupplementaldocumentthat can beaccessedby clickinghere.

MoreonChurn:CohortAnalysisSincechurn issuch acriticalelementfor successin a SaaScompany,it is anarea thatrequiresdeeperexplorationtounderstand.Cohort

CohortAnalysis isone of theimportanttechniquesthat weuse to gaininsight.

Asmentionedearlier, acohort issimply afancyname for agroup. InSaaSbusinesses,we usecohortanalysis toobservewhathappensto thegroup ofcustomersthat joinedin aparticularmonth. Sowe willhave aJanuarycohort, aFebruarycohort, etc.

cohort, etc.We wouldthen beable toobservehow ourJanuarycohortbehavesover time(seeillustrationbelow).

This canhelpanswerquestionssuch as:

Are welosingmost ofthecustomersin thefirstcoupleofmonths?

DoesChurnstabilizeaftersome

someperiodof time?

Then iftook someactions totry to fixchurn inearlymonths,(i.e withbetterproductfeatures,easier on-boarding,bettertraining,etc.) wewouldwant toknow ifthosechangeshad beensuccessful.The cohortanalysisallows usto do thisbycomparinghow morerecentcohorts(e.g. July in

(e.g. July inthe tableabove)comparedagainstJanuary.The tableaboveshows thatwe made abigimprovementin the firstmonthchurngoing from15% to 4%.

Twowaysto runCohortAnalysisThere aretwo waysto runCohortAnalysis:the firstlooks atthenumber ofcustomers,and thesecondlooks at

theRevenue.Eachteaches ussomethingdifferentandvaluable.Theexamplegraphbelowsimplylooks atthenumber ofcustomersin eachcohortover time:

Theexamplegraphbelowlooks athow MRRevolvesover timefor eachcohort.Thisparticularexample

exampleillustrateshow thegraphwould lookif there isvery strongnegativechurn. Asyou cansee, theincrease inrevenuefrom thecustomersthat arestill usingthe serviceis easilyoutpacingthe lostrevenuefromchurnedcustomers.It is prettyrare to seethings lookthis good,but it is theidealsituationthat we arelooking for.For thosewonderingif this can

if this canbeachieved,onecompanyin ourportfolio,Zendesk,that hasnumbersthat areevenbetter thanthoseshown intheexamplebelow.

In thesituationabove, youwill need amorecomplexformula tocalculateLTV, as thevalue oftheaveragecustomerisincreasing

increasingover time.For moreon thattopic, youmay wantto checkout theaccompanyingdefinitionsdocument.

PredictingChurn:CustomerEngagementScoreSincechurn is soimportant,wouldn’t itbe useful ifwe couldpredict inadvancewhichcustomerswere mostlikely tochurn?That waywe couldput ourbestcustomer

customerservicereps towork in aneffort tosave thesituation. Itturns outthat wecan do thatbyinstrumentingour SaaSapplicationsandtrackingwhetherour usersareengagedwith thekey stickyfeatures oftheproduct.Differentfeatureswilldeservedifferentscores. Forexample ifyou wereFacebook,you mightscoresomeonewho

whouploaded apicture asfar moreengaged(andthereforeless likelyto churn),thansomeonewhosimplylogged inandviewed onepage.

Similarly ifyou soldyour SaaSproduct toa 100persondepartment,and only10 peoplewere usingit, youwouldscore thatdifferentlyto 90peopleusing it. Sotherecommendationis that you

is that youcreate aCustomerEngagementScore,based onallocatingpoints fortheparticularfeaturesused.Allocatemorepoints forthefeaturesyou believeare moststicky.(Later onyou can goback andlook at thecustomerswhoactuallychurned,andvalidatethat youpicked therightfeatures asa predictorof whowould

wouldchurn.)Andseparatelyscore howmanyusers areengagedwithspecificscores.

Over timeyou’ll alsocome todiscoverwhichtypes ofuse are thebestindicatorsof possibleupsell.(HubSpotwas thefirstcompanythat Iworkedwith whofigured thisout, andthey calledit their CHIscore. CHIstands forCustomerHappiness

HappinessIndex. Itevolved tobe a verygoodpredictorfor churn.)

BradCoffey,HubSpot:

AtHubSpotwehadalotofsuccesslookingatthismetric–wecalledinCustomerHappinessIndex(CHI).First–by

byrunningtheanalysisweidentifiedthepartsofourapplicationthatprovidethemostvaluetocustomersandcouldinvestaccordinglyindrivingadoptioninthoseareas.Second–weusedthis

thisaggregatescoreasanearlyproxyforsuccessasweexperimentedwithdifferentsalesandonboardingprocesses.If asetofcustomersgoingthroughanexperimenthadalowCHIscorewecould

couldkilltheprojectwithoutwaiting6or12monthstoanalyzethecohortretention.

NPS –NetPromoterScoreSince it islikely thatcustomersatisfactionis likely tobe goodpredictorof futurechurn, itwould beuseful tosurveycustomersatisfaction.

satisfaction.Therecommendedway tomeasurecustomerhappinessis to useNetPromoterScore(NPS). Thebeauty ofNPS is thatit is astandardizednumber,so you cancompareyourcompanyto others.For moredetails onNetPromoterScore, clickhere.

GuidelinesforChurnIf your NetRevenueChurn ishigh

high(above 2%permonth) it isanindicatorthat thereissomethingwrong inyourbusiness.At 2%monthlychurn, youare losingabout 22%of yourrevenueevery year.That isnearly aquarter ofyourrevenue!It’s a clearindicationthat thereissomethingwrong withthebusiness.As thebusinessgetsbigger, this

bigger, thiswillbecome amajor dragon growth.

Werecommendthat youwork onfixing theproblemsthat arecausingthis beforeyou go onto worryaboutother partsof yourbusiness.Some ofthepossiblecauses ofchurn are:

You arenotmeetingyourcustomersexpectations.

Theproductmaynotprovide

provideenoughvalue

Instabilityorbugginess

Yourproductis notsticky.It mightprovidesomevalue inthe firstfewmonths,andthenoncethecustomerhasthatvalue,theymayfeeltheydon’tneed tokeeppaying.Tomakeyour

yourproductsticky,trymakingit a keypart oftheirmonthlyworkflow,and/orhavethemstoredata inyourproductthat ishighlyvaluabletothem,wherethevaluewouldbe lostof theycancelled.

Youhavenotsuccessfullygot thecustomer’susersto

adopttheproduct.Or theymaynot beusingcertainof thekeystickyfeaturesin theproduct.

Yoursalesforcemayhaveoversoldtheproduct,or soldit to acustomerthat isnot wellsuitedto getthebenefits

Youmay besellingtoSMB’s

wherea lot ofthemgo outofbusiness.It isn’tenoughthatwhatyou’resellingissticky.Whoyou’resellingit tomustalso besticky.

You arenotusing apricingschemethathelpsdriveexpansionbookings

The bestway to findout whycustomers

arechurning isto get onthe phonewith themand askthem. Ifchurn is asignificantpart ofyourbusiness,werecommendthat thefoundersthemselvesmakethese calls.They needto hearfirst handwhat theproblem is,as this is soimportantfor thesuccess ofthebusiness.And theyare likelyto be thebestpeople todesign afix for the

fix for theproblem.

TheImportanceofCustomerSegmentationIn all SaaSbusinessesthere willlikely comea momentwhere theyrealize thatnot allcustomersarecreatedequal. Asanexample,biggercustomersare harderto sell to,but usuallyplacebiggerorders,and churnlessfrequently.We need away to

way tounderstandwhich ofthese aremostprofitable,and thisrequiresus tosegmentthecustomerbase intodifferenttypes, andcomputethe uniteconomicsmetrics foreachsegmentseparately.Commonsegmentsare thingssize of ofcustomer,verticalindustry,etc.

Despitethe addedwork toproducethemetrics,there is

there ishigh valueinunderstandingthedifferentsegments.This tellsus whichparts ofthebusinessareworkingwell, andwhich arenot. Inaddition toknowingwhere tofocus andinvestresources,we mayrecognizethe needfordifferentmarketingmessages,productfeatures.As soon asyou startdoing thissegmentedanalysis,

thebenefitswillbecomeimmediatelyapparent.

For eachsegment,werecommendtrackingthefollowingmetrics:

ARPA(AverageRevenueperAccountpermonth)

NetMRRChurnrate(includingMRRexpansion)

LTV

CAC

LTV:CACratio

Months

MonthstorecoverCAC

CustomerEngagementScore

BradCoffey,HubSpot:

AtHubSpot,westartedtoseesomeofourbiggestimprovementsinuniteconomicswhenwestartedsegmentingourbusinessandcalculatingthe

theLTVtoCACratioforeachofourpersonasandgotomarketstrategies.

Asonegoodexample–whenwestartedthisanalysis,wehad12repssellingdirectlyinto

intotheVSBmarketand4repssellingthroughValueAddedResellers(VARs).WhenwelookedatthemathwerealizedwehadaLTV:CACratioof1.5sellingdirect,andaLTV:CAC

LTV:CACratioof5sellingthroughthechannel.Thesolutionwasobvious.Twelvemonthslaterwehadflippedourapproach–keepingjust2repssellingdirectand25repssellingthroughthe

thechannel.Thisdramaticallyimprovedouroveralleconomicsinthesegmentandallowedustocontinuegrowing.

WeendedmakingsimilarinvestmentsinotherhighLTV:CACsegments.Wewentsofaras

astoincentivizeoursalesmanagerstogrowtheirteams–butthenwouldonlyplacenewsaleshiresintothesegmentswiththebesteconomics.Thisensuredwecontinuedtoinvestin

inthebestsegmentsandalignedincentivesthroughoutthecompanyonourLTV:CACgoals.Italsoallowedustopushinnovationdowntothesalesmanagerlevel.Managerscouldexperimentwithorgstructure,

structure,andsalesprocesses–buttheyknewthatiftheydidn’thittheirLTV:CACgoalstheywouldn’tbeabletogrowtheirteams.

CalculatingLTV:CACbysegmentcanbechallenging,especially

especiallyontheCACside.It’srelativelyeasyatthetopleveltoaddupallthemarketingandsalesexpenseinaperiodanddivideitbythetotalnumberofcustomers

customers(togetCAC).Onceyoutrytosegmentdownyourspendyourunintoquestionslike‘howmuchmarketingexpensedoIallocatetoagivensegment’,‘howmuchofthesales

salesexpense’?

Wesolvedthisbyallocatingmarketingexpensebasedonnumberofleadsandsalesexpensebasedonheadcountbutit’snotperfect.Forusthekeysare:1)Needstoaccount

accountforallcosts–nofreelunch,2)Itneedstobeconsistentovertime.Progressonimprovingthemetricismoreimportantthantheactualvalue.

FunnelMetricsThe

Themetricsthat matterfor eachsalesfunnel,vary fromonecompanyto the nextdependingon thestepsinvolved inthe funnel.Howeverthere is acommonway tomeasureeach step,and theoverallfunnel,regardlessof yoursalesprocess.Thatinvolvesmeasuringtwo thingsfor eachstep: thenumber ofleads thatwent intothe top of

the top ofthat step,and theconversionrate to thenext stepin thefunnel (seebelow).

In thediagramabove,(mirroredin thedashboard),we show averysimplethreephasesalesprocess,withvisitorscoming toa web site,and someportion ofthemsigning upfor a trial.Then someof the trials

of the trialsconvert topurchases.As you cansee in thedashboard,we willwant totrack thenumber ofvisitors,trials andcloseddeals. Ourgoalshould beto increasethosenumbersover time.And we willalso wantto track theconversionrates, withthe goal ofimprovingthose overtime.

UsingFunnelMetricsinForwardPlanning

PlanningAnotherkey valueof havingtheseconversionrates is theability tounderstandtheimplicationsof futureforecasts.Forexample,lets sayyourcompanywants todo $4m inthe nextquarter.You canworkbackwardsto figureout howmanydemos/trialsthatmeans,and giventhe salesproductivitynumbers –how many

salespeoplearerequired,and goingback astageearlier,how manyleads aregoing to berequired.These arecrucialplanningnumbersthat canchangestaffinglevels,marketingprogramspendlevels, etc.

SalesCapacityIn manySaaSbusinesses,sales repsplay a keyrole inclosingdeals. Inthose

thosesituations,thenumber ofproductivesalespeople(SalesCapacity)will be akey driverofbookings.It isimportantto workbackwardsfrom anyforecaststhat aremade, toensurethat thereis enoughsalescapacity.I’ve seenmanybusinessesmiss theirtargetsbecausethey failedto hireenoughproductivesalespeopleearly

earlyenough.

It’s alsoworthnoting thatsomepercentageof newsales hireswon’t meetexpectations,so thatshould betaken intoconsiderationwhensettinghiringgoals.Typicallywe haveseenfailureratesaround 25-30% forfield salesreps, butthis variesbycompany.The failurerate islower forinsidesales reps.

WhencomputingSalesCapacity, ifa newerrep is stillrampingand onlyexpectedto deliver50% ofquota,they canbe countedas half of aproductiverep. That isoftenreferred toas FullTimeEquivalentor FTE forshort.

Anotherimportantmetric tounderstandis thenumber ofleadsrequired tofeed asales rep. Ifyou areadding

addingsales reps,make sureyou alsohave aclear planof how youwill drivetheadditionalleadsrequired.

There ismuchmore thatcould besaid onthis topic,but since itis all verysimilar tomanaginga salesforce in atraditionalsoftwarecompany,we willleave thatfor otherblog posts.

Saa

aSMetrics–AGuidetoMeasur

ringandImprovingWhatMatt

Understanding

ters#contentmarketing

CLICKTOTWEET

UnderstandingtheROIfordifferentLeadSourcesOurexperienceswith SaaSstartupsindicatethat theyusuallystart with acouple ofleadgenerationprogramssuch asPay PerClickGoogle Ad-words,radio ads,etc. Whatwe havefound isthat eachof theseleadsourcestends tosaturateover time,and

andproduceless leadsfor moredollarsinvested.As a result,SaaScompanieswill needto beconstantlyevaluatingnew leadsourcesthat theycan layerin on topof the oldto keepgrowing.

Since theconversionrates andcosts perlead varyquiteconsiderably,it isimportantto alsomeasurethe overall

the overallROI byleadsource.

Growingleads fastenough tofeed thefront endof thefunnel isone of theperennialchallengesfor anySaaScompany,and islikely to beone of thegreatestlimitingfactors togrowth. Ifyou arefacing thatsituation,the mostpowerfuladvice wecan giveyou is tostartinvestingin InboundMarketingtechniques

techniques(see GetFoundusingInboundMarketing).This willtake timeto rampup, but ifyou can doit well, willlead to farlower leadcosts, andgreaterscalingthan otherpaidtechniques.Additionallythe typicalSaaS buyeris clearlyweb-savvy,andthereforevery likelytoembraceinboundmarketingcontentandtouchlesssellingtechniques.

WhatLeversareavailabletodriveGrowthSaaSbusinessesare morenumericallydriventhan mostotherkinds ofbusiness.Making asmalltweak to anumberlike thechurn ratecan have avery bigimpact onthe overallhealth ofthebusiness.Because ofthis wefrequentlysee a

see a“quant”(i.e. anumbersoriented,spreadsheetmodeling,type ofperson) asa valuablehire in aSaaSbusiness.AtHubSpot,BradCoffeyplayed thatrole, andhe wasable to runthe modelstodeterminewhichgrowthplaysmade themostsense.

Understandingthese SaaSmetrics isa key steptowardsseeing howyou can

you candrive yourbusinessgoingforward.Let’s lookat some ofthe leversthat theseimply asgrowthdrivers foryourbusiness:

ChurnGetChurnandcustomerhappinessrightfirst (ifthisisn’tright,thebusinessisn’tviable,so nopoint indrivinggrowthelsewhere.You willsimply

simplybefilling aleakybucket.)

ProductYou’rein aproductbusiness– firstandforemost:fix yourproduct.

Ifyou’reusingafreetrial,focusongettingtheconversionrateforthatright(ideallyaround15–20%).

20%).Ifthisisn’tright,yourvaluepropositionisn’tresonating,oryoumayhaveamarketwherethereisnotenoughpaintogetpeopletobuy.

Win/Lossratioshouldbegood

TrialorSalesconversion

ratesonqualifiedleadsshouldbegood

Funnelmetrics

Increasethenumberof rawleadscomingin tothe Topof yourfunnel

Identifytheprofitableleadsourcesandinvestin thoseasmuchaspossible.Converselystopinvesting

in poorleadsourcesuntiltheycan betweakedtomakethemprofitable.

IncreasetheConversionRates atvariousstagesin thefunnel

SalesMetrics

Salesproductivity(focusongettingthisrightconsistentlyacrossa broadset ofsalesfolksbefore

beforehittingthe gas)

AddSalesCapacity.But firstmakesureyouknowhow toprovidethemwiththerightnumberofleads.Thisturnsout tobe oneof thekeyleversthatmanycompaniesrely onforgrowth.Wehavelearnedfrom

fromexperiencehowimportantit is tomeetyourtargetsforsalescapacitybyhiringontime,andhiringtherightqualityof salespeoplesotherearefewerfailures.

Increaseretentionforyoursalespeople.Sinceyouhaveinvested

investeda lot inmakingthemfullyproductive,get themaximumreturnon thatinvestmentbykeepingthemlonger.

Look ataddingBusinessDevelopmentReps.Theseareoutboundsalesfolkswhospecializeinprospectingto atargetedlist ofpotentialbuyers.Formoreon this

topic,clickhere.

Pricing/Upsell/CrossSell

Multi-axispricing

Additionalproductmodules(easierto sellmoretoexistingcustomersthan itis to selltobrandnewcustomers)

BradCoffey,HubSpot:

Turnsoutthepricingyourproduct

productrightcanhaveahugeimpactontheuniteconomics.NotsimplybygettingtheaverageMRRright,orbyprovidingupsellopportunities–butalsobysignalingwhatpiecesofthe

theproductaremostvaluable.

AtHubSpotwechangedourpricingin2011tobetieredbasedonthenumberofcontactsinthesystem–andactuallysawanincreaseinadoption

adoptionofthecontactsapplicationafterwemadethechange.Thisiscounter-intuitivebutmakessensegiventhatwesellthroughaninsidesalesteam.Afterthepricingchange,salesrepsnow

nowcouldmakealotmoremoneybysellingthecontacts.Andtheyquicklybecomemuchbetteratpositioningthatpartoftheproduct,aswellasfindingcompanieswithacontacts-based

basedusecase.Productqualitywillremainparamount–butit’sremarkablehowmuchimpactpricing,packagingandsalescommissionstructurecanhaveonproductadoptionanduniteconomics.

CustomerSegmentation

CustomerSegmentationanalysiswill helppoint outwhich areyour mostprofitablesegments.Twoimmediateactionsthat aresuggestedby thisanalysisare:

Doubledownon yourmostprofitablesegments

Look atyourlessprofitablesegmentsandconsiderchangesthatwouldmakethemmore

moreprofitable:lowercostmarketing& salesapproaches,higherpricing,productchanges,etc. Ifnothingseemstomakesense,spendlesseffortonthesesegments.

InternationalMarketsExpansioninternationallyis onlyrecommendedfor fairlymatureSaaScompaniesthatalreadyhave

havehonedtheirbusinesspracticesin theirprimarymarket. Itis farharder toexperimentand tune abusiness infar offregions,withlanguageandculturaldifferences.

BradCoffey,HubSpot

Oneofthebiggestchallengeswefaceisthetrade-offbetween

betweengrowthanduniteconomics(specificallychurn).Manyofthethingsthatwehavedonetoreducechurnhave(potentially)comeattheexpenseofloweringourgrowthrate.Thosehavebeen

someofourhardestdecisions:e.g.requiringupfrontpayments,requiringcustomersbuyconsulting,holdingsalesrepsaccountableforchurn,etc.Wearealwayslookingatthingsthatgiveusgrowthwithoutthe

thetradeoffoflowergrowth.Forexampleproductimprovementisanobviousone– abetterproductiseasiertosellandprovidesmorevaluetothecustomer.Servicespromotionsactuallyworkwelltoo.

too.ManyoftheoptionsthatSaaScompanieshavetoadjusttheirbusinessarenotsimplyawin-winbutarestillworthexploring.Toomanycompaniesthinkthateveryproblemis aproduct

productproblemandeverysolutionisthattheproductmustgetbetter.

Theotherthingthat’sreallyimportantisthatcompaniesdon’ttrytospinthesenumbers.Thereissomuchpressureto

todismissabadcustomer(whohurtyourchurnnumber)orexcludecosts(onlycountmarketing‘program’spend–notheadcount).Ifyoucangettheaccountingcloseenoughtorightit

actuallyfreesmanagementfromneedingtomakeeverydecision.Iftheaccountingisrightmanagementcanobsessoversettinggoals(growth,LTV:CAC),holdpeopleaccountabletothosegoalsandthengiveautonomy

autonomytotheirteamonhowtoachievethosegoals.

PlanaheadIt takestime formostinitiativesto have animpact.We’velearnedfrom sometoughlessonsthatplanninghas to bedone wellin advanceto drive aSaaSbusiness.Forexample ifyou arenot happy

not happywith yourcurrentgrowthrate, it willoften takenine totwelvemonthsfrom thepoint ofdecisionbefore thegrowthresultingfromincreasedinvestmentin salesandmarketingwillactually beobserved.

TheHighLevelPicture:HowtoRun aSaaSBusiness

BusinessHopefullywhat youwill havegatheredfrom thediscussionabove isthat thereare reallythreethings thatreallymatterwhenrunning aSaaSbusiness:

1. Acquiringcustomers

2. Retainingcustomers

3. Monetizingyourcustomers

Theseconditemshould befirst onyour list ofthings toget right. Ifyou can’tkeep your

keep yourcustomershappy, andkeep themusing theservice,there is nopoint inworryingacquiringmore ofthem. Youwill simplybe filling aleakybucket.Ratherfocus yourattentiononpluggingthe leaks.

SaaSbusinessesareremarkablyinfluencedby a fewkeynumbers.Makingsmallimprovementsto thosenumberscandramatically

dramaticallyimprovethe overallhealth ofthebusiness.

Once youknow yourSaaSbusiness isviableusing theguidelinesprovidedforLTV:CAC,and Timeto recoverCAC, hittheacceleratorpedal. Butbepreparedto raise thecashneeded tofund thegrowth.

Althoughthis articleis long andoccasionallycomplex,we hopethat it has

helpedprovideyou withanunderstandingof whichmetrics arekey, andhow youcan goaboutimprovingthem.

AcknowledgementsI wouldlike tothank RonGill, theCFO ofNetSuite,and BradCoffey &BrianHalligan ofHubspotfor theirhelp inwritingthis. Iwould liketo thanktheHubSpotmanagement

teamwithoutwhomnone ofthis wouldbepossible.Most of mylearningson SaaShave comefromworkingwith them.I wouldalso like tothank GailGoodman,the CEO ofConstantContactwho alsotaught usmany ofthe keymetrics inher role asboardmember ofHubSpot.

AboutDavidSkok

David SkokjoinedMatrixPartnersas aGeneralPartner inMay 2001.He has awealth ofexperiencerunningcompanies.Davidstarted hisfirstcompanyat age 22.Since thenDavid hasfounded atotal offourseparatecompaniesandperformedone turnaround.Three ofthesecompanieswentpublic. HejoinedMatrix

fromSilverStreamSoftware,which hefounded inJune 1996.Prior to itsacquisitionby Novell,SilverStreamwas apubliccompanythat hadreached arevenuerun rate inexcess of$100m,withapproximately800employeesand officesin morethan 20countriesaround theworld.

David’swork as avalueaddedinvestor isbestknown for

known forhelpingJBoss,Netezza,AppIQ,CloudSwitch,Tabblo andDiligentTechnologiestosuccessfulexits.Davidserves onthe boardsofCloudBees,Digium(makers ofthepopularAsteriskOpenSourcePBX/telephonysoftware),Enservio,GrabCad,HubSpot,OpenSpan,andVideoIQ.He is alsoan investorin Meteor.

Davidwrites a

writes ablog forentrepreneursandstartupson topicssuch asviralmarketing,SaaSmetrics,building asales andmarketingmachine,techniquesforloweringcost ofcustomeracquisition,etc. Theblog canbe foundhere:www.forEntrepreneurs.com.

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