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Value Creation in SaaS Businesses

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Presentation from Peter Weed, McKinsey at CloudNY

Publicada em: Tecnologia
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Value Creation in SaaS Businesses

  1. 1. 0 Value Creation in SaaS Businesses CloudNY
  2. 2. 1 The basic SaaS business modelToday’s agenda ▪ What drives value in a SaaS business? Efficient Growth! ▪ What simple, holistic operational metrics predict efficient growth? ▪ What practical operating levers create the most impact? ▪ Double click on two operating levers: – Customer acquisition efficiency – Pricing and packaging
  3. 3. 2 Growth matters a lot – software/SaaS players with a >50% growth rate through $50- 100MM revenue… >50% of reaching $0.5-1B revenue1 Have a 4-5x greater 3-year equity return1 Deliver a 1: 2016 data; all public software companies since 1980; 3-year returns on equity from the point they passed the $50-100MM range
  4. 4. 3 It’s not just valuation, it’s survival: growth is critical to outpace the competition Mobile payments Is your market space feeling crowded? E.g., Content Communications Task / calendar mgmt Common trend 1. Proliferation of “differentiated” market specific players 2. Players move into direct competition through adjacent geo/feature entry 3. “Weaker” players wash out
  5. 5. 4 2x 3x 4x 5x 6x 7x 1/11 7/11 1/12 7/12 1/13 7/13 1/14 7/14 1/15 7/15 1/16 7/16 But growth is expensive! Efficient growth is critical to reduce market-timing risk in fund raising and to manage dilution SOURCE: Battery Ventures Analysis, Capital IQ Index since January 2011 SaaS Revenue Multiple
  6. 6. 5 The sheer number of SaaS metrics can be overwhelming! “Magic Number” Quick Ratio Revenue Growth “Rule of 40”
  7. 7. 6 What do we propose? Break down a SaaS business into two components Growth Engine Key Metric: “Growth Efficiency” How much net new ARR you add per $1 of sales & marketing. Calculation:  ((GAAP Revenue in Period 3) – (GAAP Revenue in Period 2 ) x 4  Divided by: S&M in Period 1 Cash Engine Key Metric: “Recurring Margin” How much free cash you generate from $1 of ARR on your platform. Calculation:  Gross Margin (% revenue)  less: R&D (% revenue)  less: G&A (% revenue) COGS R&D G&A Gross ARR Churn Expansion ARR Customer Acquisition
  8. 8. 7 Why do we like it? It can be treed down into actionable operating metrics Cash engine Growth engine COGS G&A R&D Net New ARR Average ARR # Customers Current ARR Recurring Costs S&M Spend ARR From New Customers Expansion ARR Gross ARR Churn Sales Marketing + # New Customers Avg ARR x # Qualified Leads Win Rate x Sales Reps Sales Ops/Mgmt + Base Commissions Travel, etc. Personnel Program Spend + + Content Mktg Paid Advertising Other channels… + ARR From Existing Customers +
  9. 9. 8 Creating more efficient growth in SaaS: the “first four” places to look Customer acquisition “Efficiently add more customers” Success “Increase ACV, decrease churn” Recurring Margins “Improve offering’s profitability” Pricing “Participate more fairly in the value you create”
  10. 10. 9 “Free-cash-flow” impact of improving each Growth Efficiency lever 25%? A “common” high-growth, $20MM ARR SaaS business will see the most impact in... 1.00 4.40 4.40 1.40 Retention Reducing churn from 10% to 7.5%; increasing upsell from 10% to 12.5% Customer Acquisition Improving GE from 1 to 1.25 Pricing Increasing price by 25% for all new customers and 10% of existing customers Recurring Margin Increasing recurring margins from 25% to 32% Approximate change in Free Cash Flow (FCF), dollars in year 1 Example Growth-Stage SaaS Business ▪ $20M ARR ▪ 100% ARR Growth target ▪ 10% Gross ARR Churn ▪ 0% Net ARR Churn ▪ 1.0x Growth Efficiency ▪ 25% “Recurring Margins”
  11. 11. 10 Let’s explore example opportunities: Acquisition “Free-cash-flow” impact of improving each Growth Efficiency lever 25%? 1.00 4.40 4.40 1.40 Retention Reducing churn from 10% to 7.5%; increasing upsell from 10% to 12.5% Customer Acquisition Improving GE from 1 to 1.25 Pricing Increasing price by 25% for all new customers and 10% of existing customers Recurring Margin Increasing recurring margins from 25% to 32% Approximate change in Free Cash Flow (FCF), dollars in year 1 Example Growth-Stage SaaS Business ▪ $20M ARR ▪ 100% ARR Growth target ▪ 10% Gross ARR Churn ▪ 0% Net ARR Churn ▪ 1.0x Growth Efficiency ▪ 25% “Recurring Margins”
  12. 12. 11 CUSTOMER ACQUISITION We tested several points of conventional wisdom on sales efficiency ‘Land and expand’ strategies (i.e., upselling)1 Confirmed Deals with larger Annual Contract Value (ACV)2 Confirmed Using channel partnerships to sell3 Busted Higher % of quota bearing salespeople4 Busted More scale (i.e., ARR of the SaaS company)5 It depends + Conventional wisdom on what drives higher efficiency What data shows
  13. 13. 12 Greater upsell leads to higher sales efficiency % of customers upsold per quarter 10-25% of sales team farming is sweet spot % of sales force focused on existing customers Land and expand strategy is good… but not too much 1.64 1.03 0.90 <10% >25%10-25% 1.011.08 1.65 0.49 25-50% >50%10-25%<10% SOURCE: McKinsey SaaS Radar Growth efficiency (higher is better) Growth efficiency (higher is better) CUSTOMER ACQUISITION
  14. 14. 13 % of customers acquired through channel partners Customer growth, % 58 50 52 35 27 >25%10-25% 0.480.48 5-10% 0.92 1-5% 1.13 0% 1.39 SaaS companies relying on channel partners for customer acquisition see lower customer growth and thus lower sales efficiency Growth efficiency (higher is better) Using channel partnerships to sell does not always correlate with growth CUSTOMER ACQUISITION
  15. 15. 14 Medium sized SaaS companies see lower sales efficiency Growth efficiency (higher is better) Size of SaaS company ($M of ARR) Size of the SaaS company – how to avoid the “valley of death”? 2.36 0.72 0.94 1.13 <$10M $10-25M >$50M$25-50M SOURCE: McKinsey SaaS Radar CUSTOMER ACQUISITION
  16. 16. 15 Let’s explore example opportunities: Pricing “Free-cash-flow” impact of improving each Growth Efficiency lever 25%? 1.00 4.40 4.40 1.40 Retention Reducing churn from 10% to 7.5%; increasing upsell from 10% to 12.5% Customer Acquisition Improving GE from 1 to 1.25 Pricing Increasing price by 25% for all new customers and 10% of existing customers Recurring Margin Increasing recurring margins from 25% to 32% Approximate change in Free Cash Flow (FCF), dollars in year 1 Example Growth-Stage SaaS Business ▪ $20M ARR ▪ 100% ARR Growth Target ▪ 10% Net ARR Churn ▪ 0% Gross ARR Churn ▪ 1.0x Growth Efficiency ▪ 25% Recurring Margins
  17. 17. 16 Weighted average Won 72.6 Lost 60.7 Remember: lower prices do not necessarily mean more wins 0 20 40 60 80 100 120 140 160 100,000 1,000,000 10,000,000 100,000,000 Deal size Dollars Relative price vs. total deal size Percent of benchmark price DISGUISED EXAMPLE PRICING & PACKAGING
  18. 18. 17 Pricing challenge is especially tough for SaaS innovators Highly dynamic environment Rapid innovation + competitive pressure “Winner takes all” phenomena Discipline can be lost in rush to capture market Communication of value Sometimes hard to quantify; discounting pressure due to customers’ cost assumptions Complexity over lifecycle So many aspirations to balance (paid up front, upgrades, etc.), so many possible approaches PRICING & PACKAGING
  19. 19. 18 How do we approach SaaS Pricing? 5 major components PRICING & PACKAGING Pricing organization and infrastructure Packaging/ bundling (“Package to value”) Model/ architecture (“Structure to value”) Price levels (“Price to value”) Getting the price Price execution (“Sell to value”) 1 2 3 4 5 Setting the price
  20. 20. 19 Clear rules for what to bundle… PRICING & PACKAGING Items that address the same customer need, pain point, or use case Items that target the same buying center Lower-value items that would be a distraction to the customer conversation or sales motion Highly valuable or differentiated functionality as part of base bundles Items that have high value only for small subset of customers What to bundle What not to bundle Items that create difficulty aligning with perceived value and paradox of choice
  21. 21. 20 Willingness-to-pay premium for value- aligned units1 Percent of customers Examples Buyers’ business metrics ▪ Employees ▪ Annual Revenue ▪ Annual COGS Success- based ▪ Increase in MROI ▪ Reduction in “days outstanding” ▪ Not sys- tematically used HW-linked usage ▪ Cores ▪ Devices ▪ Data volume Software Usage ▪ # of Marketing campaigns ▪ Subscription revenue ▪ API calls Seats ▪ Named users ▪ Concurrent users ▪ Time used …and how to design scalar units: 2/3 of customers will pay a premium when unit scales closest to value 26% 10% Premium 5% Premium 25% 0% Premium 17% 32% 15% or more PRICING & PACKAGING SaaS businesses use a wide variety of price units… …customers will pay a premium when units scale with value received
  22. 22. 21 Have you drawn this chart? Often significant (and hard to justify) discount variation SOURCE: Pricing service line 0 10 20 30 40 50 60 70 80 100 1,000 10,000 100,000 1,000,000 Discount, % Customer contract value, $ What is justification for such widely varying discounts for similar-size customers? Why do low value customers received such large discounts? Deal level pricing analysis PRICING & PACKAGING DISGUISED EXAMPLE Significant “banding” – are reps offering max discounts without rationale? Dedicating “deal desk” resources, and building “deal scoring” tools can pay for itself many times over
  23. 23. 22 Thank you! Peter Weed Partner Global Co-head Growth Tech peter_weed@mckinsey.com Junaid Mohiuddin Global SaaS Market Lead Growth Tech Practice Junaid_mohiuddin@ mckinsey.com

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