MRR & SaaS Terms

% Churn Rate

Definition: % of customers lost per month.

Cohort

Definition: 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, February, etc

ACV

Definition: Annual Contract Value of a subscription agreement. The annualized version of MRR (Monthly Recurring Revenue).

ARR

Definition: Annualized Run Rate = MRR x 12ARR is annual run-rate of recurring revenue from the current installed base. This is annual recurring revenue for the coming twelve months if you don't add or churn anything.

Average Contract Length

Definition: Assuming a mix of different contract lengths, this gives you the average duration in months or years.

ARPA

Definition: Average monthly recurring Revenue per Account. This number is tells you the average monthly revenue per customer. It is useful to look at this for just the new customers booked in the month. Plot a trend line to show you the average price point that your new customers have chosen.

Billings

Definition: Billings is the amount that you have invoiced that is due for payment shortly.

% MRR Churn

Definition: Defined as lost revenue due to churned customers as a percentage of total recurring revenue.

% MRR Expansion

Definition: Defined as the expansion revenue from existing customers as a percentage of total revenue.

Customer Lifetime

Definition: If you start with a cohort of 100 customers and apply a constant churn rate every month, you'll get an exponential decay, as shown in the following graph (which uses a 3% monthly churn rate): http://goo.gl/tGDDsb Note that if the Customer Churn rate is a monthly % or yearly %, then the Customer Lifetime will be for the same time period. Here is a monthly and annual example to illustrate the point: a) If the Monthly customer churn rate is 3%, then the Customer Lifetime will be 1/0.03 which is 33 months. b) if the Annual customer churn rate is 20%, then the Customer Lifetime will be 1/0.20 which is 5 years.

LTV

Definition: Lifetime Value of a Customer. (To truly get an accurate picture of LTV, you should take into consideration Gross Margin. However in most SaaS businesses, the gross margin % is high (above 80%), and it's quite common to use the simpler version of the formula that is not Gross Margin adjusted. Assumes ARPA is constant; if not, see: http://goo.gl/U413PX)

MOF

Definition: Months up Front; Average of months (or years) of payment received in-advance with new bookings. Getting paid in advance has a big positive impact on cash flow. This metric has been used at both HubSpot and NetSuite in the past as a way to incent sales people to get more paid up front when a new customer is signed. However asking for more money up front may turn off certain customers, and result in fewer new customers, so be careful how you balance these two conflicting goals.

Net New Customers

Definition: Net New Customers = # of new Customers - # of churned CustomersThis is the net number of new customers added once lost customers due to churn has been taken into account.

Net New MRR

Definition: Net New MRR = New MRR + Expansion MRR - Churned MRR This is the sum of the three different components that will change MRR during each month.

Revenue

Definition: Revenue is amount of money that can be recognized according to accounting policy. Even if it is paid for upfront, usually subscription revenue can only be recognized ratably over time as the service is delivered.If more money has been paid than can be recognized, the difference goes into a balance sheet item called Deferred Revenue.

% Renewal Rate ($'s)

Definition: Similar to the number above, but instead of looking at the number of customers, it looks at the dollar value of the renewed contracts. It's important to look at both, as they each tell an useful part of the story. If you were losing a lot of customers, you'd want to know why. Similarly, if you were only losing a few customers, but they were your biggest $ value customers, you'd also want to know that as well.

LTV:CAC Ratio

Notes: Our guideline for a successful SaaS business is that this number should be higher than 3.

Months to Recover CAC

Notes: To be perfectly accurate, this should include a Gross Margin adjustment, however in our guideline which states that Months to Recover CAC should be less than 12, we are assuming that you are using the simpler formula, and have a Gross Margin of 80% or higher.

Net Promoter Score

Definition: Since it is likely that customer satisfaction is likely to be good predictor of future churn, it would be useful to survey customer satisfaction. The recommended way to measure customer happiness is to use Net Promoter Score (NPS). The beauty of NPS is that it is a standardized number, so you can compare your company to others. (http://www.netpromoter.com/why-net-promoter/know/) The Net Promoter Score, or NPS®, is based on the fundamental perspective that every company's customers can be divided into three categories: Promoters, Passives, and Detractors. By asking one simple question — How likely is it that you would recommend [your company] to a friend or colleague? — you can track these groups and get a clear measure of your company's performance through your customers' eyes. Customers respond on a 0-to-10 point rating scale and are categorized as follows: Promoters (score 9-10) are loyal enthusiasts who will keep buying and refer others, fueling growth. Passives (score 7-8) are satisfied but unenthusiastic customers who are vulnerable to competitive offerings. Detractors (score 0-6) are unhappy customers who can damage your brand and impede growth through negative word-of-mouth. To calculate your company's NPS, take the percentage of customers who are Promoters and subtract the percentage who are Detractors.

SaaS Growth

Definition: So why is SaaS growth so 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.

SaaS

Definition: Software as a Service. SaaS/subscription businesses are more complex than traditional businesses; traditional business metrics totally fail to capture the key factors that drive SaaS performance.

MRR

Definition: The Monthly Recurring Revenue at the end of each month. Computed by taking the MRR from the previous month and adding Net New MRR.

New MRR

Definition: The increase in MRR (Monthly Recurring Revenue) from new customers in the current month/year.

Expansion MRR

Definition: The increase in MRR from expansion in your installed base in the current month.

Churned MRR

Definition: The lost MRR from churning customers in the current month.

# of churned Customers

Definition: The number of customers lost due to churn this month

# of new Customers

Definition: The number of new customers added this month

Bookings

Definition: The total dollar value of all new contracts signed. Usually taken as an annualized number even if the contract period is longer than one year.Since the bookings number might have a mix of different durations (e.g. month-to-month; 6 months; 12 months) this number is not very helpful for understanding the business.To really understand what is going on in your SaaS Business, you should look at the following components: a) What happened with new customers: - New MRR/ACV from new customer contracts b) What happened in your installed base: - Renewals - Churned MRR/ACV - Expansion bookings c) The sum of all of the above: - Net New MRR/ACV

CAC

Definition: There is a problem with using this formula in the early days, as you may several expensive people in the team that should scale to handle a far number of customers as you grow. In that case, your CAC will be too high. I suggest doing a very simple adjustment to the Sales & Marketing expenses to take only a portion of those salaries and expenses in the early days. That will give a better indication of how CAC will look in the future when you are at scale.

% Net MRR Churn

Definition: This is the number that will go negative if the Expansion revenue from existing customers starts to outstrip the lost revenue from churn. Getting to negative Net MRR Churn is a great goal for a SaaS company.

% Renewal Rate (Customers)

Definition; It can be confusing to look at both your renewal rate (which should be just 1- Churn) in addition to churn. However in a model where you have yearly contracts being renewed, the two numbers can actually be different. For example, in the early days of a startup, you might have low churn because many of your customers have not yet reached the point where they could drop your service because of the length of their contract. In that situation, your churn number will not accurately predict what is really going to happen when you reach steady state. So a better number to look at is how many of your customers are renewing at the point where their contract expires. That is what this number measures. When you reach steady state, this number should be equal to 1 - % Customer Churn.

Negative Churn

Explanatin: The ultimate solution to the churn problem is to get to Negative Churn. 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. http://goo.gl/5kIeZX http://goo.gl/dnoHHA (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.

Multi-axis Pricing

Explanation:

Uses for SaaS Guidelines

Explanation: 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

Explanation: 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: 1) LTV - the Lifetime Value of a typical customer 2) CAC - the Cost to Acquire a typical Customer 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!

SaaS Bookings

Explanation: Every month in a SaaS business, there are three elements that contribute to how much MRR will change relative to the previous month: 1) What happened with new customers added in the month: New MRR (or ACV) 2) 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.) 3) 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.

Months Up Front

Explanation: Getting paid in advance is really smart idea if you can do it without impacting bookings, as it can provide the cash flow that you need to cover the cash problem that we described earlier in the article. It is often worth providing good financial incentives in the form of discounts to encourage this behavior. The metric that we use to track how well your sales force is doing in this area is Months up Front. Getting paid more upfront usually also helps lower churn. This happens because the customer has made a greater commitment to your service, and is more likely to spend the time getting it up and running. You also have more time to overcome issues that might arise with the implementation in the early days. The Metric "Months up Front" has been used at both HubSpot and NetSuite in the past as a way to incent sales people to get more paid up front when a new customer is signed. However asking for more money up front may turn off certain customers, and result in fewer new customers, so be careful how you balance these two conflicting goals.

Impact of Success on P&L/Cash Flow

Explanation: However, even though there is a trough in the short-term, 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 illustrates the problem. 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.

Unit Economics: Hubspot Example

Explanation: 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."

Impact of Faster Growth on P&L/Cash Flow

Explanation: 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.

Guidelines for Churn

Explanation: If your Net Revenue Churn is high (above 2% per month) it is an indicator that there is something wrong in your business. At 2% monthly churn, you are losing about 22% of your revenue every year. That is nearly a quarter of your revenue! It's a clear indication that there is something wrong with the business. As the business gets bigger, this will become a major drag on growth. We recommend that you work on fixing the problems that are causing this before you go on to worry about other parts of your business. Some of the possible causes of churn are: 1) You are not meeting your customers expectations. -The product may not provide enough value - Instability or bugginess 2) Your product is not sticky. It might provide some value in the first few months, and then once the customer has that value, they may feel they don't need to keep paying. To make your product sticky, try making it a key part of their monthly workflow, and/or have them store data in your product that is highly valuable to them, where the value would be lost of they cancelled. 3) You have not successfully got the customer's users to adopt the product. Or they may not be using certain of the key sticky features in the product. 4) Your sales force may have oversold the product, or sold it to a customer that is not well suited to get the benefits 5) You may be selling to SMB's where a lot of them go out of business. It isn't enough that what you're selling is sticky. Who you're selling it to must also be sticky. 6) You are not using a pricing scheme that helps drive expansion bookings The best way to find out why customers are churning is to get on the phone with them and ask them. If churn is a significant part of your business, we recommend that the founders themselves make these calls. They need to hear first hand what the problem is, as this is so important for the success of the business. And they are likely to be the best people to design a fix for the problem.

Customer Segmentation

Explanation: In all SaaS businesses there will likely come a moment where they realize that not all customers are created equal. As an example, bigger customers are harder to sell to, but usually place bigger orders, and churn less frequently. We need a way to understand which of these are most profitable, and this requires us to segment the customer base into different types, and compute the unit economics metrics for each segment separately. Common segments are things size of of customer, vertical industry, etc. Despite the added work to produce the metrics, there is high value in understanding the different segments. This tells us which parts of the business are working well, and which are not. In addition to knowing where to focus and invest resources, we may recognize the need for different marketing messages, product features. As soon as you start doing this segmented analysis, the benefits will become immediately apparent. For each segment, we recommend tracking the following metrics: - ARPA (Average Revenue per Account per month) - Net MRR Churn rate (including MRR expansion) - LTV - CAC - LTV: CAC ratio - Months to recover CAC - Customer Engagement Score Brad Coffey, HubSpot: "At HubSpot, we started to see some of our biggest improvements in unit economics when we started segmenting our business and calculating the LTV to CAC ratio for each of our personas and go to market strategies. As one good example - when we started this analysis, we had 12 reps selling directly into the VSB market and 4 reps selling through Value Added Resellers (VARs). When we looked at the math we realized we had a LTV:CAC ratio of 1.5 selling direct, and a LTV:CAC ratio of 5 selling through the channel. The solution was obvious. Twelve months later we had flipped our approach - keeping just 2 reps selling direct and 25 reps selling through the channel. This dramatically improved our overall economics in the segment and allowed us to continue growing. We ended making similar investments in other high LTV:CAC segments. We went so far as to incentivize our sales managers to grow their teams - but then would only place new sales hires into the segments with the best economics. This ensured we continued to invest in the best segments and aligned incentives throughout the company on our LTV:CAC goals. It also allowed us to push innovation down to the sales manager level. Managers could experiment with org structure, and sales processes - but they knew that if they didn't hit their LTV:CAC goals they wouldn't be able to grow their teams. Calculating LTV:CAC by segment can be challenging, especially on the CAC side. It's relatively easy at the top level to add up all the marketing and sales expense in a period and divide it by the total number of customers (to get CAC). Once you try to segment down your spend you run into questions like 'how much marketing expense do I allocate to a given segment', 'how much of the sales expense'? We solved this by allocating marketing expense based on number of leads and sales expense based on headcount but it's not perfect. For us the keys are: 1) Needs to account for all costs - no free lunch, 2) It needs to be consistent over time. Progress on improving the metric is more important than the actual value."

Sales Capacity

Explanation: In many SaaS businesses, sales reps play a key role in closing deals. In those situations, the number of productive sales people (Sales Capacity) will be a key driver of bookings. It is important to work backwards from any forecasts that are made, to ensure that there is enough sales capacity. I've seen many businesses miss their targets because they failed to hire enough productive salespeople early enough. It's also worth noting that some percentage of new sales hires won't meet expectations, so that should be taken into consideration when setting hiring goals. Typically we have seen failure rates around 25-30% for field sales reps, but this varies by company. The failure rate is lower for inside sales reps. When computing Sales Capacity, if a newer rep is still ramping and only expected to deliver 50% of quota, they can be counted as half of a productive rep. That is often referred to as Full Time Equivalent or FTE for short. Another important metric to understand is the number of leads required to feed a sales rep. If you are adding sales reps, make sure you also have a clear plan of how you will drive the additional leads required. There is much more that could be said on this topic, but since it is all very similar to managing a sales force in a traditional software company, we will leave that for other blog posts.

Single Customer Cash Flow

Explanation: 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.

Single Customer Cumulative Cash Flow

Explanation: 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.

Customer Retention (Churn)

Explanation: 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).

Cohort Analysis

Explanation: Since churn is such a critical element for success in a SaaS company, it is an area that requires deeper exploration to understand. Cohort Analysis is one of the important techniques that we use to gain insight. As mentioned earlier, a cohort is simply a fancy name for a group. In SaaS businesses, we use cohort analysis to observe what happens to the group of customers that joined in a particular month. So we will have a January cohort, a February cohort, etc. We would then be able to observe how our January cohort behaves over time (see illustration below). This can help answer questions such as: 1) Are we losing most of the customers in the first couple of months? 2) Does Churn stabilize after some period of time? Then if took some actions to try to fix churn in early months, (i.e with better product features, easier on-boarding, better training, etc.) we would want to know if those changes had been successful. The cohort analysis allows us to do this by comparing how more recent cohorts (e.g. July in the table above) compared against January. The table above shows that we made a big improvement in the first month churn going from 15% to 4%.

SaaS Viability

Explanation: 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). 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: http://goo.gl/BFG1yC I should stress that these are only guidelines, there are always situations where it makes sense to break them.

Running a SaaS Business

Explanation: It takes time for most initiatives to have an impact. We've learned from some tough lessons that planning has to be done well in advance to drive a SaaS business. For example if you are not happy with your current growth rate, it will often take nine to twelve months from the point of decision before the growth resulting from increased investment in sales and marketing will actually be observed; it is important to plan ahead. Hopefully what you will have gathered from the discussion above is that there are really three things that really matter when running a SaaS business: 1) Acquiring customers 2) Retaining customers 3) Monetizing your customers The second item should be first on your list of things to get right. If you can't keep your customers happy, and keep them using the service, there is no point in worrying acquiring more of them. You will simply be filling a leaky bucket. Rather focus your attention on plugging the leaks. SaaS businesses are remarkably influenced by a few key numbers. Making small improvements to those numbers can dramatically improve the overall health of the business. Once you know your SaaS business is viable using the guidelines provided for LTV:CAC, and Time to recover CAC, hit the accelerator pedal. But be prepared to raise the cash needed to fund the growth.

Lead Source ROI

Explanation: Our experiences with SaaS startups indicate that they usually start with a couple of lead generation programs such as Pay Per Click Google Ad-words, radio ads, etc. What we have found is that each of these lead sources tends to saturate over time, and produce less leads for more dollars invested. As a result, SaaS companies will need to be constantly evaluating new lead sources that they can layer in on top of the old to keep growing. Since the conversion rates and costs per lead vary quite considerably, it is important to also measure the overall ROI by lead source. Growing leads fast enough to feed the front end of the funnel is one of the perennial challenges for any SaaS company, and is likely to be one of the greatest limiting factors to growth. If you are facing that situation, the most powerful advice we can give you is to start investing in Inbound Marketing techniques (see Get Found using Inbound Marketing). This will take time to ramp up, but if you can do it well, will lead to far lower lead costs, and greater scaling than other paid techniques. Additionally the typical SaaS buyer is clearly web-savvy, and therefore very likely to embrace inbound marketing content and touchless selling techniques.

Growth Levers

Explanation: SaaS businesses are more numerically driven than most other kinds of business. Making a small tweak to a number like the churn rate can have a very big impact on the overall health of the business. Because of this we frequently see a "quant" (i.e. a numbers oriented, spreadsheet modeling, type of person) as a valuable hire in a SaaS business. At HubSpot, Brad Coffey played that role, and he was able to run the models to determine which growth plays made the most sense. Understanding these SaaS metrics is a key step towards seeing how you can drive your business going forward. Let's look at some of the levers that these imply as growth drivers for your business: 1) Churn Get Churn and customer happiness right first (if this isn't right, the business isn't viable, so no point in driving growth elsewhere. You will simply be filling a leaky bucket.) 2) Product You're in a product business - first and foremost: fix your product. - If you're using a free trial, focus on getting the conversion rate for that right (ideally around 15 - 20%). If this isn't right, your value proposition isn't resonating, or you may have a market where there is not enough pain to get people to buy. - Win/Loss ratio should be good - Trial or Sales conversion rates on qualified leads should be good 3) Funnel metrics - Increase the number of raw leads coming in to the Top of your funnel - Identify the profitable lead sources and invest in those as much as possible. Conversely stop investing in poor lead sources until they can be tweaked to make them profitable. - Increase the Conversion Rates at various stages in the funnel 4) Sales Metrics - Sales productivity (focus on getting this right consistently across a broad set of sales folks before hitting the gas) - Add Sales Capacity. But first make sure you know how to provide them with the right number of leads. This turns out to be one of the key levers that many companies rely on for growth. We have learned from experience how important it is to meet your targets for sales capacity by hiring on time, and hiring the right quality of sales people so there are fewer failures. - Increase retention for your sales people. Since you have invested a lot in making them fully productive, get the maximum return on that investment by keeping them longer. - Look at adding Business Development Reps. These are outbound sales folks who specialize in prospecting to a targeted list of potential buyers. For more on this topic, click here. 5) Pricing/Upsell/Cross Sell - Multi-axis pricing - Additional product modules (easier to sell more to existing customers than it is to sell to brand new customers) 6) Customer Segmentation Customer Segmentation analysis will help point out which are your most profitable segments. Two immediate actions that are suggested by this analysis are: - Double down on your most profitable segments - Look at your less profitable segments and consider changes that would make them more profitable: lower cost marketing & sales approaches, higher pricing, product changes, etc. If nothing seems to make sense, spend less effort on these segments. 7) International Markets - Expansion internationally is only recommended for fairly mature SaaS companies that already have honed their business practices in their primary market. It is far harder to experiment and tune a business in far off regions, with language and cultural differences.

SaaS P&L / Cash Flow Trough

Explanation: 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: http://dskok.wpengine.netdna-cdn.com/wp-content/uploads/2012/09/SaaS-Economics-101.zip (Data used in following graphs; explains the Cash Flow Trough)

SaaS Success Factors

Explanation: 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 they will stick around for a long time, increasing profits. On the other hand if a customer is unhappy, they will leave quickly, and the business will lose money on the investment made to acquire that customer; Retention is the key, the customer is the product.

Customer Engagement Score

Explanation: Since churn is so important, wouldn't it be useful if we could predict in advance which customers were most likely to churn? That way we could put our best customer service reps to work in an effort to save the situation. It turns out that we can do that by instrumenting our SaaS applications and tracking whether our users are engaged with the key sticky features of the product. Different features will deserve different scores. For example if you were Facebook, you might score someone who uploaded a picture as far more engaged (and therefore less likely to churn), than someone who simply logged in and viewed one page. Similarly if you sold your SaaS product to a 100 person department, and only 10 people were using it, you would score that differently to 90 people using it. So the recommendation is that you create a Customer Engagement Score, based on allocating points for the particular features used. Allocate more points for the features you believe are most sticky. (Later on you can go back and look at the customers who actually churned, and validate that you picked the right features as a predictor of who would churn.) And separately score how many users are engaged with specific scores. Over time you'll also come to discover which types of use are the best indicators of possible upsell. (HubSpot was the first company that I worked with who figured this out, and they called it their CHI score. CHI stands for Customer Happiness Index. It evolved to be a very good predictor for churn.) Brad Coffey, HubSpot: "At HubSpot we had a lot of success looking at this metric - we called in Customer Happiness Index (CHI). First - by running the analysis we identified the parts of our application that provide the most value to customers and could invest accordingly in driving adoption in those areas. Second - we used this aggregate score as an early proxy for success as we experimented with different sales and onboarding processes. If a set of customers going through an experiment had a low CHI score we could kill the project without waiting 6 or 12 months to analyze the cohort retention."

Funnel Metrics

Explanation: The metrics that matter for each sales funnel, vary from one company to the next depending on the steps involved in the funnel. However there is a common way to measure each step, and the overall funnel, regardless of your sales process. That involves measuring two things for each step: the number of leads that went into the top of that step, and the conversion rate to the next step in the funnel (see below). In the diagram above, (mirrored in the dashboard), we show a very simple three phase sales process, with visitors coming to a web site, and some portion of them signing up for a trial. Then some of the trials convert to purchases. As you can see in the dashboard, we will want to track the number of visitors, trials and closed deals. Our goal should be to increase those numbers over time. And we will also want to track the conversion rates, with the goal of improving those over time. Another key value of having these conversion rates is the ability to understand the implications of future forecasts. For example, lets say your company wants to do $4m in the next quarter. You can work backwards to figure out how many demos/trials that means, and given the sales productivity numbers - how many salespeople are required, and going back a stage earlier, how many leads are going to be required. These are crucial planning numbers that can change staffing levels, marketing program spend levels, etc.

Kinds of SaaS Business

Explanation: 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.

Cohort Analysis (Customer)

Explanation: There are two ways to run Cohort Analysis: the first looks at the number of customers, and the second looks at the Revenue. Each teaches us something different and valuable. The example graph below simply looks at the number of customers in each cohort over time.

Cohort Analysis (Revenue)

Explanation: There are two ways to run Cohort Analysis: the first looks at the number of customers, and the second looks at the Revenue. The example graph below looks at how MRR evolves over time for each cohort. This particular example illustrates how the graph would look if there is very strong negative churn. As you can see, the increase in revenue from the customers that are still using the service is easily outpacing the lost revenue from churned customers. It is pretty rare to see things look this good, but it is the ideal situation that we are looking for. For those wondering if this can be achieved, one company in our portfolio, Zendesk, that has numbers that are even better than those shown in the example below.

MMR Bookings

Explanation: 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."