Tuesday, September 19, 2017

Some Numbers on SaaS

It's money that matters
You know that it's true
It's money that matters
Whatever you do
               --From "It's Money That Matters" by Randy Newman

So we've just gotten through earnings announcements for several SaaS companies, including my own employer (Oracle).  And as the numbers come out, I see lots of different voices interpreting those numbers inaccurately.  Because SaaS has an entirely different business model from that of the legacy enterprise applications market.  So let me throw out some numbers on SaaS for your consideration.  

Before I jump into numbers, I should note that all of the numbers provided here come from one of my favorite industry reports:  the annual Pacific Crest Securities Private SaaS Company Survey Results.  I'm using the most recent issue, which came out in October 2016.  So I won't be disclosing any special Oracle margin numbers...only industry averages.

Now about those numbers:

  • New Customer Acquisition Cost:  The average industry cost of acquiring a new SaaS customer is around $1.12 for every dollar of revenue from the initial subscription.  So wait a second.  We're losing 12 cents for every revenue dollar received from a new customer over the life of their subscription?  Why would anyone in their right mind want to do that?  Read on and you'll see...
  • Upsell Customer Acquisition Cost:  The industry average for acquiring a customer through upselling (roughly defined here as selling SaaS products from a different application suite or pillar) is about 22 cents for every revenue dollar realized.  Now we're talking!  That leaves me a margin after CAC ("Customer Acquisition Cost") of 78 cents on the revenue dollar.  But it gets better...
  • Expansion CAC:  The average CAC for expansion selling (expanding the customer footprint through selling additional products and services within the same application suite or pillar) is 20 cents on the revenue dollar.  Wow, a margin of 80 cents on the revenue dollar after CAC...let's book that trip to Vegas!  But now let's look at the real winner...
  • Renewal CAC:  The CAC for an existing customer who simply renews their subscription is roughly 12 cents.  That's right, an 88 cent margin on the revenue dollar after CAC!
Before we get too giddy with our visions of wealth beyond our wildest dreams, keep in mind that we still need to cover operating costs, R&D, and other traditional P&L costs from those margins.  But I'm disregarding those costs for the purposes of this discussion.  Head to your local junior college for an introductory course in Accounting if you want a feel for this stuff.

So when you hear about or read over financial results from SaaS vendors or SaaS product lines, keep in mind the following concepts:

  • Grow in new customers (usually expressed as new customer or new account revenue, both in dollars and percentages) is a great leading indicator of potential future profitability, but it's more than likely a drag on margins in the present.  As we see above, acquiring new customers is expensive.
  • The key to determining how well a company will generate profits or earnings in the short term is to look at the trend for upsells, expansion sales, and customer renewals...especially the latter. Renewals are often expressed through a rather negative metric...Account Churn.  The lower the Account Churn, the higher the renewal rate.
  • Working through the logic here, you may come to the conclusion that a SaaS company or product line could become extremely profitable with minimal growth in new customers.  And you would be correct.  So long as the growth in new accounts roughly replaces the accounts lost in churn, one can still do quite well by simply tending to your current stable of SaaS customers.  Because the money is in the renewals, the upsells, and the expansion sales.

The next time you read an annual or quarterly report, or when you see a press release touting growth through acquiring new customers, your immediate thought should be something along the lines of "That's a nice indicator of future earnings potential.  But before I take that too seriously, tell me about your customer retention.  How is your renewal rate?  How much revenue growth are you realizing from your existing customers?"  '

This is why having a Center of Excellence focused on customer success is so very important in the SaaS world.  Because successful customers are happy customers.  And happy customers renew their subscriptions.  And folks, that's where the profits are found.  That's where the money is.  And it's money that matters.

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