Saturday, August 9, 2014

SaaS 101


This post introduces basic concepts behind the SaaS (or Cloud if you prefer) recurring revenue business model. The purpose is to provide a basic understanding of key performance metrics that drive a SaaS business and as a foundation for future posts covering more in-depth topics. Initially, I’m going to keep things really simple. We’ll cover Customer Acquisition Cost (CAC) and Customer Lifetime Value (LTV).

Basic SaaS Metrics:
  • MRR – Monthly Recurring Revenue 
  • ACV – Annual Contract Value (Bookings)
  • OTR - One Time Revenue (One Time Bookings) 
  • Churn – Lost MRR Revenue or ACV (%) 

MRR & ACV
Monthly Recurring Revenue (MRR) is the revenue a customer pays per month for access to a service. Annual Contract Value (ACV) is the value of a signed contract over a year. So, if a sales rep signs a 2-year contract for $100k, the ACV is $50k, while the Total Contract Value (TCV) would be $100k.

One Time Revenue
One Time Revenue (or One Time Bookings) is non-recurring revenue. Common examples typically involve services like set-up costs, integration, etc. At Delve, we had several services that fell into this category. Here are a few examples:
  • Video MigrationMigration of video from the where the customer to Delve platform in the cloud. This involved uploading video files, encoding each file into different video formats and bit-rates, and handling pre-existing meta-data. We charged based on the number of videos migrated.
  • CDN Connection FeeIf a customer wanted to use his or her own CDN contract from a different vendor then we charged them a connection fee.
  • Video Player Customization - We would customize the standard video player based on a customer’s requirements. We had a Basic Customization option that was capped at 20 hours and an Advanced Customization option, which was based on the total number of hours.
These can be thought of as packaged services or “product-ized” services. They are recognized as revenue in the month they were delivered.

These services are often viewed as a form of sales enablement that not only helped close the deal but also increases sales velocity by reducing the sales cycle.  Reducing the sales cycle is important because increases the efficiency of your sales team, which the customer acquisition costs. Customers who used these services tended to be more satisfied. There services also made the Delve sticky by increasing switching costs. 

Churn
There are different types of churn:
  • Customer Churn - A customer fails to renew her contract. This results in complete loss of MRR for this customer. 
  • Feature Churn – A customer renews her contract, but chooses an edition of the product with fewer features, which results in lower MRR for this customer.
For example, Delve included basic analytics in the Standard Edition butmore advanced analytics came with the Enterprise Edition. If a customer concluded there was no value in the advanced analytics they might still renew but for Standard Edition. The customer isn’t lost, but there MRR is reduced.

How Churn Hurts
To start with a simple example, let’s take a company that starts off the year with $1B in MRR and compare the negative impact of churn at 2.5% and 5% over the course of 12 months without taking anything else into consideration. 
  • Churn of 2.5% reduces $1B MRR to $738M MRR by the end of the year. 
  • Churn of 5% reduces $1B MRR to $540M MRR by the end of the year
That 2.5% difference in Churn, which might not seem like much, results in an additional loss of 26.8% in MRR. In order for MRR to stay constant over the course of a single year the lost MRR with with new new customer bookings (ACV). Early on the difference isn’t significant, but as a company scales, mitigating churn with new customer bookings will become increasingly difficult.

MRR Expansion
MRR Expansion can be thought of Good Churn (or Negative Churn) where MRR instead of decreases. There are a few basic ways to achieve MRR Expansion. 

Usage Expansion 
Revenue increases as a result of a customer’s increased usage of the product. In the case of Salesforce Sales Cloud this could be adding additional seats. Dropbox charges more per month as the volume of storage increases. At Delve, we charged more based on how much video was streamed.

Up-Sell 
Customers are sold an enhanced version of your product with additional benefits. For example, a customer upgrading from the Professional Edition to the Enterprise Edition to take advantage of additional features like Custom Application Development or Salesforce Identity. An Up-Sell doesn’t always have to be about new features in the product itself. Instead, it could be purchasing a higher quality of service. For example, upgrading from Salesforce’s Standard Success customer support to its Premium Success customer support package.

Cross-Sell
Customers are sold an additional product. So, sticking with Salesforce as an example, this would be selling a customer Work.com or Data.com after they’ve  purchased Sales Cloud.
This can be very attractive for a company with a large installed base.The rational is that is costs more to acquire a new customer than to sell an additional product to an existing customer.

Increasing ACV
All three of the methods for achieving Good Churn (Usage Expansion, Up-Sell, Cross-Sell) can also increase the ACV when initially signing up a customer. For example, at Delve our sales reps would often attempt to up-sell a prospect from the Standard Edition to the Professional Edition if she felt it would better meet the customer’s needs.

Net Bookings

Net Bookings = New Bookings(ACV)+Expansion Bookings(ACV)+One Time Bookings – Churn(ACV)

Here is an example for Net Bookings using Salesforce Sales Cloud:

New Bookings 
  • 1 new customer, ABC Inc., who purchased Sales Cloud Professional (@ $65/month/user) for its 10 sales reps 
  • New Bookings = ACV = $7,800 ($65 * 10 users * 12 months) 
Expansion Bookings
  • 1 customer renewal, ACME Corp., renewed their Sales Cloud Professional contract with 5 users and added an additional 10 users. 
  • 1 customer renewal, XYZ LLC, renewed their Sales Cloud Professional contract with 10 users and upgraded from Standard Success support to Premium Support (20% add to ACV). Since Premium Support is a subscription it is spread out of the 12-month term of the contract.
  • Expansion Bookings = ACV = $9,360 = [($65 * 10 users * 12 months) * 1.20] 
One Time Bookings = $0 

ACV Churn 
  • 1 customer lost, WOW Corp., failed to renew their 10 user contract for Sales Cloud Enterprise (@ $125/month/user)
  • ACV Churn = ($125 * 10 * 12) = $15,000
Net Bookings = $7,800 + $9,360 + $0 - $15,000 = $2,160

Ending MRR

Ending MRR = Starting MRR – MRR Churn + MRR Expansion + New MRR

Translating the above Net Bookings example to Ending MRR:
  • Starting MRR = $10,000 (MRR from the previous month)
  • MRR Churn = $1,250
  • MRR Expansion = $780
  • New MRR = $650 
  • Ending MRR = $10,000 - $1,250 + $780 + $650 = $10,180
Ouch, loosing Wow Corp. really hurt. Despite renewing 2 customers and adding a new customer, MRR barely increased.

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