Category Archives: SaaS

Is Another SaaSacre In The Offing?

I’m not a financial analyst and I don’t make stock recommendations [1], but as a participant and observer in the software investing ecosystem, I do keep an eye on macro market parameters and I read a fair bit of financial analyst research.  Once in an while, I comment on what I’m seeing.

In February 2016, I wrote two posts (SaaS Stocks:  How Much Punishment is in Store and The SaaSacre Part II:  Time for the Rebound?).  To remind you how depressed SaaS stocks were back then:

  • Workday was $49/share, now at $192
  • Zendesk was $15/share, now at $85
  • ServiceNow was $47/share, now at $247
  • Salesforce was $56/share, now at $160

Those four stocks are up 342% over the past 3 years and two months.  More broadly, the Bessemer Emerging Cloud Index is up 385% over the same period.  Given the increase, a seemingly frothy market for stocks (P/E of the S&P 500 at ~21), and plenty of global geopolitical and economic uncertainty, the question is whether there is another SaaSacre (rhymes with massacre) in the not-too-distant future?

Based just on gut feel, I would say yes.  (Hence my Kellblog prediction that markets would be choppy in 2019.)  But this morning, I saw a chart in a Cowen report that helped bring some data to the question:

cowen

I wish we had a longer time period to look at, but the data is still interesting.  The chart plots enterprise value (EV) divided by next twelve month (NTM) sales.  As a forward multiple, it’s already more aggressive than a trailing twelve month (TTM) multiple because revenue is growing (let’s guess 25% to 30% across the coverage universe), thus the multiple gets deflated when looking forward as opposed to back.

That said, let’s look at the shape of the curve.  When I draw a line through 7x, it appears to me that about half the chart is above the line and half below, so let’s guesstimate that median multiple during the period is 7x.  If you believe in regression to the mean, you should theoretically be a bearish when stocks are trading above the median and bullish when they’re below.

Because the average multiple line is pretty thick, it’s hard to see where exactly it ends, but it looks like 8.25x to me.  That means today’s multiples are “only” 18% above the median [2].  That’s good news, in one sense, as my gut was that it would be higher.  The bad news is:  (1) when things correct they often don’t simply drop to the line but well through it and (2) if anything happens to hurt the anticipated sales growth, the EV/NTM-sales multiple goes up at constant EV because  NTM-sales goes down.  Thus there’s kind of a double whammy effect because lower future anticipated growth increases multiples at a time when the multiples themselves want to be decreasing.

This is a long way of saying, in my opinion, as a chartist [3] using this chart, I would conclude that multiples are somewhat frothy, about 20% above the median, with a lot predicated on future growth.

This exercise shows that looking only at price appreciation presents a more dangerous-looking picture than looking at prices as related to revenues:  looking across the whole chart, prices are up a lot since April 2014 but so are forward-looking revenues, and the multiple is roughly the same at the start as at the end:  8x. [4]  Looking at things differently, of the ~350% gain since April 2016, half is due to multiple expansion (from a way-below-median ~4x to an above-median ~8x), and half is to stock revenue growth.

For me, when I look at overall markets (e.g., PE of the S&P), geopolitical uncertainty, price appreciation, and SaaS multiples, I still feel like taking a conservative position.  But somewhat less than so than before I saw this chart.  While it’s totally subjective:  SaaS is less frothy than I thought when looking only at price appreciation.

Switching gears, the same Cowen report had a nice rule of 40 chart that I thought I’d share as well:

r40 cowen

Since the R^2 is only 0.32, I continue to wonder if you’d get a higher R^2 using only revenue growth as opposed to rule of 40 score on the X axis.  For more on this topic, see my other Rule of 40 posts here.

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Notes
[1] See disclaimers in my FAQ and terms of use in the blog license agreement.

[2] Nevertheless, 18% is a lot to lose if multiples instantly reset to the median.  (And they often don’t just drop to the median, but break well through it — e.g., in Jan 2016, they were as low as 4x.)

[3] And chartism doesn’t work.

[4] If you ignore most of the first month where it appeared to be falling from 10x to 8x.

Are You Counting Payments as Renewals?

Enterprise SaaS has drifted to a model where many, if not most, companies do multi-year contracts on annual payment terms.  How did we get here?

  • Most enterprise SaaS products are high-consideration purchases. Buyers typically perform a thorough evaluation process before purchasing and are quite sure that the software will meet their needs when they deploy.  These are not try-and-buy or wing-it purchases.
  • Most SaaS vendors will jump at the opportunity to lock in a longer subscription term. For example, with an 85% gross retention rate you can offer a 5% discount for a two-year contract and end up mathematically ahead [1].  Moreover, with a default annual increase of 5 to 10% built into your standard contact, you can offer a “price lock” without any discount at all (i.e., the customer locks in the price for two years in exchange for a two-year commitment).

When you combine the vendor’s desire to lock in the longer term with the customer’s belief that the solution is going work, you find a fertile ground for doing two- or three-year contracts.  But these multi-year deals are almost always done on annual payment terms.

Most SaaS vendors don’t want to take the next step and ask for a multi-year prepayment.  The upside for the vendor would be to eliminate the need for collections in years 2 and 3, and eliminate the chance that the customer — even if unhappy — won’t make the out-year payments.  But most vendors refrain from this because:

  • It’s seen as an unusual practice that’s frowned upon by investors
  • Most investors believe you could better maximize ARR by simply raising more capital and sticking with annual payments
  • It can lead to lumpy renewals and cash flows that are both hard to manage and understand
  • It can lead to large long-term deferred revenues which can hinder certain M&A discussions.  (Think:  large balance of cashless revenue from suitor’s perspective.)
  • It complicates the calculation of SaaS metrics, sometimes confusing investors into believing that good metrics are bad ones. (I think I am literally the only person in Silicon Valley who is quick to point out that a 75% three-year retention rate is better than a 90% one-year one [2].)

Thus, we end up in a situation where the norm has become a two- or three-year contract with annual payments.  This begs a seemingly simple “if a tree falls in the forest and no one hears it, did it make any noise” kind of question:

Quick, what’s the difference between a one-year contract that’s renewing for the first time and a three-year contract that’s coming up for its first downstream annual payment?

I’ve often quipped that they’re both “renewals,” but in the former case they’re handled Customer Success and in the latter they’re handled by Legal. [3]

But let’s be clear, regardless of the process you use to manage them [4], they are not the same, and should not automatically be treated as such for the purposes of calculating SaaS metrics. One is the voluntary renewal of a subscription contract; the other is the payment of a contractual commitment.

If you don’t want to renew your subscription, there’s nothing I can do to force you.  If you don’t want to make a contractually committed payment I can sue you.

Let’s consider an example.  We have six customers, Alpha through Foxtrot.  The first three did one-year deals, the second three did three-years deals.  The simple question is:  what’s your gross dollar retention?  A merely acceptable 83% or a very healthy 95%?

payment renewal

If you calculate on an available-to-renew (ATR) basis, the rate is 83%.  There were 300 units up for renewal and you renewed 250 of them.  If you include the payments, the rate is 95%.  1,050 units were up for renewal or payment, and you invoiced 1,000.

This is a case that feels a little bit wrong both ways.  Including the payments uplifts the rate by mixing involuntary payments with voluntary renewals; to the extent you want to use the rate as a satisfaction indicator, it will be over-stated [5].  However, excluding the payments seems to fail to credit the company with the auto-renewing nature of multi-year deals.

One thing is clear:  payments certainly cannot be included in any ATR-based rate.  You cannot view making a contractually required payment as the same thing as voluntarily renewing a contract. 

Because of prepaid multi-year deals, I have always calculated retention rates two ways:  ATR-based and ARR-based.  The former is supposed to give you an idea of how often, given the chance, people want to renew their contacts.  The latter is supposed to show you, mathematically, what’s happening to your ARR pool [6].

I have an issue, which is highly subjective, when it comes to out-payments on non-prepaid, multi-year deals:

  • On one hand, I can argue they are contractual commitments that the vast majority of customers will honor and thus are effectively – save for a few rare cases – identical to prepaid multi-year deals. Think:  the money’s good as in the bank.
  • On the other hand, I can argue that a dissatisfied customer – particularly one who blames the vendor and/or the software for their failure – will not want to pay, even if the contract says they’re supposed to. Think:  it’s a toothless contract that the vendor will not likely not enforce against an angry customer.

Philosophically, I can argue that these out-year payments are either “good as in the bank” or I can argue that they’re “basically renewals that will ‘churn’ if the customer is not happy.”  The first argument says to treat them like prepaid multi-year deals and put them in ARR-based retention rates.  The second argument says they’re effectively voluntary renewals and should be counted as such.

In reality, you need to know what happens at your business.

I believe for the vast majority of businesses, customers honor the contracts and we should treat them like prepaid, multi-year deals in ARR-based rates — and you should always publish in parallel ATR-based rates, so people can see both.  However, if your company is an outlier and 10% of those payments are never collected, you’re going to need to look at them differently – perhaps like renewals because that’s how they’re behaving.  Or get better lawyers.  Or stop doing non-prepaid, multi-year deals because, for whatever reason, your customers are not honoring the commitment they made in exchange for you to give them a price lock.

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Notes

[1] Over 2 years you get 190 units versus an expected 185.  (Not counting any expansion.)

[2] 0.75 > 0.9^3 = 0.73 – you need to compound annual rates to compare them to multi-year ones.

[3] Or, really, Accounts Receivable but that doesn’t sound as funny.

[4] I’d argue that when you define your customer success process that you should treat these two customers identically.  Whether it’s a payment or a renewal, in a good customer success process you should constantly monitor customer progress with the hope that the renewal (or the payment) is not some big decision, but merely incidental.  (“Yes, of course, we want to keep using the software – is it just a payment year or do we need to renew the contract?”)  This might increase your cost to renew a bit – because you’ll be paying CSMs or renewals reps to do collection work that could theoretically have been done by Accounts Receivable – but it’s still the right answer if you want to maximize ARR.

[5] While payment does not necessarily indicate satisfaction, it probably does indicate the absence of intense dissatisfaction.

[6] e.g., I’d use the the churn rate (1 minus the retention rate) as the discount rate in a present value calculation.

What It Takes to Make a Great SaaS Company

I’ve been making a few presentations lately, so I thought I’d share the slides to this deck which I presented earlier this week at the All Hands meeting of a high-growth SaaS company as part of their external speaker series.

This one’s kind of a romp — it starts with some background on Kellblog (in response to some specific up-front questions they had), takes a brief look back at the “good old days” of on-premises software, introduces my leaky bucket concept of a SaaS company, and then discusses why I need to know only two things to value your SaaS company:  the water level of your bucket and how fast it’s increasing.

It kind of runs backwards building into the conclusion that a great SaaS company needs four things.

  1. An efficient sales model.  SaaS companies effectively buy customers, so you need to figure out how to do it efficiently.
  2. A customer-centric culture.  Once you’ve acquired a customer your whole culture should be focused on keeping them.  (It’s usually far cheaper than finding a new one to back-fill.)
  3. A product that gets the job done.  I like Clayton Christensen’s notion that customers “hire products to do jobs for them.”  Do yours?  How can you do it better?
  4. A vision that leaves the competition one step behind.  Done correctly, the competition is chasing your current reality while you’re out marketing the next level of vision.

Here are the slides:

Video of my SaaStr 2019 Presentation: The Five Questions Startup CEOs Worry About

A few days ago, Jason Lemkin from SaaStr sent me a link to the video of my SaaStr Annual 2019 conference presentation, The Five Questions Startup CEOs Worry About. Those questions, by the way, are:

  1. When do I next raise money?
  2. Do I have the right team?
  3. How can I better manage the board?
  4. To what extent should I worry about competition?
  5. Are we focused enough?

Below is the video of the thirty-minute presentation.  The slides are available on Slideshare.

As mentioned in the presentation, I love to know what’s resonating out there, so if you ever have a moment where you think –“Hey, I just used something from Dave’s presentation!” — please let me know via Twitter or email.

Book Review: Enablement Mastery by Elay Cohen

I had the pleasure of working with Elay Cohen during my circa year at Salesforce.com and I reviewed SalesHood, his first book, over four years ago.  We were early and happy customers of the SalesHood application at Host Analytics.  I’m basically a big fan of Elay’s and what he does.  With the average enterprise SaaS startup spending somewhere between 40% to 80%+ of revenue on sales, doesn’t it make sense to carve off some portion of that money into a Sales Enablement team, to make sure the rest is well spent?  It sure does to me.

I was pleased to hear that Elay had written a second book, Enablement Mastery, and even more pleased to be invited to the book launch in San Francisco several weeks back.  Here’s a photo of Cloudwords CEO Michael Meinhardt and me at the event.

50023900_10157090392582028_3547117110700277760_o

I have to say I simply love salesops and sales productivity people.  They’re uniformly smart, positive, results-oriented, and — unlikely many salespeople — process-oriented.  A big part of the value of working with SalesHood, for a savvy customer, is to tap into the network of amazing sales enablement professionals Elay has built and whose stories are profiled in Enablement Mastery.

I read the book after the event and liked it.  I would call it a holistic primer on sales enablement which, since it’s a relatively new and somewhat misunderstood discipline, is greatly in need in the market.

Elay’s a great story-teller so the book is littered with stories and examples, from his own considerable experience building the impressive Salesforce.com sales productivity team, to the many stories of his friends and colleagues profiled in the book.

Some of the more interesting questions Elay examines in Enablement Mastery include:

  • Why sales enablement?
  • Where to plug it organizationally?  (With pros and cons of several choices.)
  • What to do in your first 90 days in a new sales enablement role?
  • What to look for when hiring sales enablement professionals?
  • How to get organizational (and ideally strong CEO) buy-in to the sales enablement program?
  • How sales enablement can work best with marketing?  (Hint:  there is often tension here.)
  • What is a holistic process map for the sales enablement function?
  • How to measure the sales enablement function?  (And it better be more than instructor ratings on the bootcamp.)
  • How to enable front-line managers to be accountable for their role enabling and developing their teams?  (Elay wrote a whole chapter on this topic.)
  • How to conduct a quarterly business review (QBR)?
  • How managers can use basic Selling through Curiosity principles to coach using curiosity as well?
  • How to build an on-boarding plan and program?
  • What core deliverables need to be produced by the marketing and sales productivity teams?

Elay, never one to forget to celebrate achievement and facilitate peer-level knowledge sharing, also offers tips on how to runs sales kickoffs and quota clubs.

Overall, I’d highly recommend Enablement Mastery as a quick read that provides a great, practical overview of an important subject.  If you’re going to scale your startup and your sales force, sales enablement is going to be an important part of the equation.

Price Qualification: The Tiffany Way

Most salespeople are familiar with so-called BANT qualification:  does the prospect have Budget, Authority, Need, and Timeframe in order to make a purchase?  While Solution Selling purists dislike BANT (arguing that it’s great way to find existing deals that have been already rigged for the competition), most sales organizations today use BANT, or some form of it, for lead qualification and scoring.  Typically, in an enterprise SaaS company, a sales development rep (SDR) will not pass an opportunity to sales unless some form of BANT qualification has been performed.

The purpose of this post is to drill into how you should do price (i.e., budget) qualification, which I believe is far more subtle than it appears:

  • People can sometimes spend far more than they are spending (and/or imagine they can spend) once they realize the total cost of owning their current system and/or the total benefits of owning a superior one.  Great salespeople, by the way, help them do precisely that.
  • SDRs barking average configuration prices or, worse yet, price list items (e.g., “enterprise edition has a base fee of $100K/year plus $2.5K per admin user/year”) can either scare away or anchor bias prospects to given price points.

For example, let’s say that your company sells a high-end planning/budgeting system (average cost $250K/year) and you find a prospect who is spending $50K/year for their existing planning/budgeting system, which isn’t delivering very good results.

  1. It’s inflexible and doesn’t allow the VP of Finance to make the reports the CFO repeatedly requests.
  2. It’s arcane and requires highly paid consultants to come several weeks/quarter in order to make changes and performance maintenance on the basic setup.
  3. It’s slow, so users are frustrated trying to load their budgets, and instead mail them to Finance via spreadsheets, asking Finance to do the loads, creating a significant amount of incremental work for the finance team.

How are we supposed to price qualify this opportunity?  Ask the prospect:

  • How much they want to spend?  Answer:  as little as possible.
  • How much budget they have?  Answer:  $50K.
  • How much they are paying for the existing system?  Answer:  $50K.

As an SDR, are you supposed to pass this ostensibly $50K opportunity to a salesrep who normally does $250K deals [1]?  If you’re smart, you know they have the money — those consultants in problem 2 might run $100K/year, they probably have to hire an extra analyst or two to solve problem 3 at $80K/year each, and problem 1 — which is career threatening for the VP of Finance — is, as Mastercard likes to say, “priceless.”

What’s more, what do you say if the prospect tries to price qualify you?

You know, we don’t have a lot of money for this project so I need to know the typical price of your system?

What do you say then?  $50K and jeopardize the deal downstream when the salesrep proposes $250K?  $250K and possibly scare them off at the start — even though you know the total cost of their existing system might be bigger than that today?

Capture

I’ve always liked Tiffany’s as a reference point for this.  As you may know, most Tiffany’s stores are divided in two.  On one side — typically the smaller, more crowded one — you can buy jewelry from $200 to $2,000.  Then there’s the other side, where the security guard hangs out, that’s bigger and less crowded, and where the jewelry costs from $10K to $200K+.

The thing I find funny about Tiffany’s is that somehow, magically, most people seem to figure out what side they belong on.  And when they don’t, the staff don’t ask you how much money you have — they tell you broad price ranges on each side of the store.

The keywords, in an enterprise software context, being “broad” and “ranges.”  So, in our scenario, I think the best initial answer to the pricing question is:

That’s a hard question to answer at this point.  Each customer and every situation is different.  Our systems scale across a broad range of needs and, as a result, prices typically range from $50K on the low end to $500K+ on the high-end.  Based upon what I know about your situation, I’d recommend that you have a conversation with one of our account managers so we can better understand your challenges, our ability to meet them, and establish a clearer price point for so doing.

Your goal is to neither scare them off nor anchor bias them to a lower price (“sure we can do that for $50K”) that later results in disappointment or, worse yet, a feeling your company can’t be trusted.

Finally, the great part about the Tiffany analogy is that most enterprise software companies actually do have both sides of the store — corporate sales and enterprise sales, often each selling different and appropriately priced editions of the software. While few SaaS companies actually segment between the two based on deal size, they typically use other variables that are intended to act as direct proxies for it.

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Notes

[1] The answer in most SDR models would be “yes, just pass it” so the hard part isn’t the decision to pass it, but how to do so without anchor biasing the prospect to a $50K price.  (“Whoa, the SDR told me you could do this for $50K; he asked how much budget I had and I told him precisely that.”)

 

Slides from My SaaStr Annual 2019 Presentation (5 Questions CEOs Struggle With)

Thanks to everyone who attended my session today at the amazing — and huge — SaaStr Annual 2019 conference in San Jose.  In this post, I’ll share the slides from my presentation, Five Questions SaaS CEOs Wrestle With (and some thoughts on how to answer them).

The folks at SaaStr recorded the session, so at some point a video of it will be available (but that probably won’t be for a while).  When it is up, I will also post it to Kellblog.

In some sense definitionally, there were two types of people in the audience:

  • CEOs, who hopefully received some fresh perspective on these age-old, never-quite-put-to-bed questions.
  • Those who work for them, who hopefully received some insights into the mind of the CEO that will help make you more valuable team members and help you advance your career.

As mentioned, please send me feedback if you have examples where something in the presentation resonated with you, you applied it in some way, and it made a positive impact on your working life.  I’d love to hear it.

Here are the slides from the presentation.