SaaS Math: Why “I” love SaaS! Hey folks, this is the 1st post in the SaaS Math series.
Today I’d like to start with I love SaaS. And when I say “I”, I mean investors. When I entered the startup World, most companies sold software under a perpetual license. Software was downloaded and maintained on the customers’ servers. It was sold by big expensive direct sales forces. From an investor’s perspective there were several things that sucked about this goto market approach: - Costs: Outside sales reps are expensive (think $ 120K base + commissions + travel) and many of them don’t work out long term. Also on the cost side when you sell client side software you have to build and maintain multiple versions and often need more sales engineering or support resources. - No visibility: Enterprise sales are lumpy. SaaS has none of these drawbacks.
In some cases, especially with enterprise SaaS, customers sign-up to fixed term contracts. Certainty Premium Let’s say I have 1,000 customers paying me $ 50/ month. The ABCs of SaaS Math. The Saas Math Funnel: Acquisition. For the 3rd instalment of SaaS Math, we’re going to dig into the 1st step in the conversion funnel: acquiring users.
For this and all posts on the conversion funnel, I recommend you read/ watch Dave McClure’s excellent talk on Metrics for Pirates. As the name suggests, acquisition is all about driving new users, readers or buyers depending on whether you’re running a SaaS, media or e-commerce business respectively. We’re just focusing on SaaS here but many of these principles flow into the other business types.
This is not a ‘how to’ acquire users post. Though I will share some thoughts on that. The image to the left is a mockup of a custom dashboard we built for a startup I used to work with. When you are working “in” your business, making changes to copy, A/B testing, updating your application, etc, etc, then you should be looking at your data daily. What To Measure. SaaS Math: Activation, Retention and Churn. So far in the SaaS Math series, we have looked at why investors love SaaS, definitions of the key terms in SaaS math and last week we looked at user acquisition math.
This week we’re talking about activation, retention and its polar opposite – churn. As you will see, churn and retention are the most important metrics to the long-term success of a SaaS business. To recap, activation is just getting that 1st use of your product or service. Churn is the % of users / customers that abandon the service over time. This can be measured weekly, monthly, quarterly, etc. Let’s look at an example of a freemium business. The beauty and the challenge of freemium is that in the absence of having to pay money there are no barriers to users trying you out.
Saas Math Case Study: Dropbox. Saas Math: Why are you NOT spending on marketing? Often when I meet new SaaS startups they tell me proudly that they have grown their user base without “spending a dime on marketing”.
While that is a great accomplishment and a testament to the quality of the product (product = marketing for great web services), it does lead me to ask why! Did the entrepreneurs not want to grow faster? Do they not want to own the market? Fast growth and market leadership are key criteria for any potential investor, especially a VC. And from my perspective as an investor you cannot optimize for growth and scale without investing in customer acquisition. With known lifetime revenue, why would you not invest in growth? This brings up a related thought: often entrepreneurs talk about one round of financing getting them to cashflow break even. Also, bear in mind that valuation is heavily influenced by the pace and scale of your revenue growth. So, if you want to approach VCs, by definition you should be going after a big opportunity and market leadership. Saas Math: Customer vs. Revenue Churn. As I’ve mentioned many times before: churn (the rate at which customers cancel their subscription) is the most important metric for any recurring revenue business.
This should make sense. The longer a customer keeps paying you, the more valuable that customer is. In a previous post, we looked in depth at churn. Most companies when they look at churn look at customer counts: how many customers did we start the month with? How many of those did we lose? While it’s important to understand this and to look at these patterns over time on a cohort basis (i.e. for customers who joined in a given month, from a common source, or linking them via any other common attribute to find patterns), you need to also look at revenue churn.
Customer churn then is a count of customers who cancel their accounts. Here is a simple example: This example looks at changes in customer count per month. . - How much MRR the company had at the beginning of each month;