I recently did a consulting project where I worked with an experienced executive to provide a crash course in SaaS metrics. In order to perform that assignment, I decided not to make an entire course, but simply the syllabus for one, as a way to guide our conversations.
While I have no intention of attempting the Herculean task of turning this ten-page outline into a course, I do think sharing the outline itself is potentially useful for two reasons:
It took a large amount of effort to map things into a structure. I think the structure itself adds value both because it is logical and fairly comprehensive.
It provides a lot of embedded links (often but not always to Kellblog) that can help the reader get deeper on various topics.
Here is a link to the outline. As a teaser, here’s the first part it:
Yes, assume they’re similar size, growing at similar rates, and both at scale. Pick A or B. Thelonious can’t help because there’s no third option.
C’mon. You know you want to pick A.
Company A has a leaner services business at 10% of revenue, where company B’s is kind of hefty at 25%.
Both companies have barely profitable services businesses (2% gross margin), but at least company A’s is relatively smaller so that services boat anchor does relatively less damage.
Company A has much higher gross margins – by 13 percentage points – at 81% vs. 68%. Additionally, that 81% is above the public company median of 76%.
Company A has somewhat higher operating expenses, but in the end they both produce the same 3% operating margin.
It seems clear that Company A is superior. And not just by a little — look at the gross margins. Think of the impact on CAC Payback Period.
Here’s the trick, though. Company B is company A with one, single difference: $100M additional services revenue. Here’s a deeper look showing both dollars and percentages.
Company B has $100M more in total revenue, $2M more in gross profit, and $2M more in operating profit. Every other figure (not derived from those differences) is the same. For example:
The same subscription revenue of $450M
The same subscription COGS of $45M
The same S&M spend at $180M
The same R&D spend at $140M
The same G&A spend at $70M
What’s jamming our radar here? What’s making them look so different? Percent of sales analysis. Normally our friend, but here it’s working against us.
While Company B looks less efficient at gross margin level, it looks more efficient at an opex level because we’re dividing by $600M, not $500M. That 13% less efficient gross margin is exactly offset by 13% more efficient total opex. But we didn’t really notice that. Why? Because we were stuck on gross margin. Think: Company A’s clearly the better business – look at those gross margins – so it’s fine to spend a bit more to build it.
Through a purely financial lens, I might still like Company A better than Company B. Yes, B has $2M extra in operating income, but it’s having to take on the hassle of managing a $100M larger services business. Is it worth all that for an extra $2M in operating profit? Maybe not.
This is how investors tend to think. With 2% margins, it’s a crappy services business anyway, so why not let someone else do it? Heck, they can probably do it more profitably than us, anyway. I sometimes call this the Mikey likes it argument, referring to the ancient TV commercial where two brothers force their little brother to try a new cereal. Think: we don’t want to do our services ourselves, but I’m sure we can find partners who will just love doing them. Maybe Mikey will like it, just like the commercial.
This argument overlooks a few key points:
The nature of the services business. If it’s a bunch of $20K deployments, the odds are that partners won’t be too excited. If it’s $1M transformations that consume consultants by the busload, they’ll probably like it a lot.
The training and certification process. If you want to outsource all of your associated services, then who is going to build curriculum, train, and certify your services partners? It’s hard to train people on best practices you don’t know and have never developed.
Customers who insist on a single point of accountability (fka, one throat to choke). Some customers, especially in big deals with complex deployments, will want the software vendor to commit to their success. It’s impossible to promise “no fingerpointing” when there are two parties involved.
Competitors who exploit your weakness. Once your competition determines that you don’t provide services, they will likely sell deployment and adoption FUD relentlessly, find and tell your customer horror stories, and emphasize the importance of vendor-provided services to customers.
Customer success as a driver of renewal. Successful deployment avoids inception churn. Success adoption drives renewal and expansion. Reducing customer success to avoid the hassle of managing a breakeven services business is myopic.
Services as the saves team. When a customer fails in deployment and is up for renewal in 6 months, do you think a partner is going to provide free services to save the renewal? Like relief pitchers in baseball, your services team is in the business of saves.
Here’s the catch — while boards generally love to hear that you’re selling solutions, they don’t want to hear that you’re building a services business to actually deliver those solutions. They want you to sell solutions, but deliver software. In the absence of real, committed partners, that message is going to ring hollow with customers.
But partners are generally unwilling to make strategic come-bets on your category creation strategy. Once you’ve created a massive market, they’ll be happy to come along and suck up services. But taking strategic risk to do that? Building a services practice on the come? No thanks. Services firms are unapologetic opportunists.
That means there are times when only you can deliver the services needed to execute a transformation strategy. Qualtrics had to do this as part of their strategic transformation from survey software to customer experience management (CXM) to experience management (XM) platform. And they provided plenty of services along the way, running in that uncomfortable 25% of revenues range (and perhaps higher in the earlier days, but I don’t have the numbers).
So, all that considered, which company do I like better? I need to know the answer to two more questions. Are they executing a strategic transformation from software to solutions? Are they upleveling their message and creating a new, broader category (i.e., Playing Bigger)?
If no, I like A better for all the standard reasons.
If yes, I like B better and I’m fine with the “excessively large” services business
Yikes, I’m a few weeks later than usual and now slipping into February, so let’s jump right into our ninth annual predictions post before it’s too late to publish. A quick reminder that I do these for fun and fun alone. See my FAQ for my terms, disclosures, disclaimers, and the like.
Kellblog 2022 Predictions Review
Let’s start with a review of last year’s predictions which, as it turns out, were pretty good.
1. Covid transitions from pandemic to endemic. Hit. We can debate the semantics. Epidemiologists would surely differ. And the billionaires at Davos still don’t treat it like a cold. But nevertheless, I think people now generally treat Covid as endemic.
2. Web3 hype peaks. Hit. I don’t think I’ve ever nailed a prediction harder than this one. My new#boi weeps for its loss in financial, if not aesthetic, value.
3. Disruptors get disrupted. Hit. The point here was that just as we become our parents, that Salesforce becomes Oracle, Nvidia becomes Intel, and so on. This is more the ebb and flow of a natural cycle than a specific prediction — but given Salesforce’s rather dismal year end, I’ll give myself a hit.
4. VC continues to flow. Miss. Well, while VC funding was down dramatically in 2022 compared to 2021, but remember that 2021 funding was at all all-time high.
The more interesting point is that all this didn’t slow VC fundraising, which hit a record high in 2022.
5. The metaverse remains meta. Hit. Big companies periodically catch self-boredom-itis and attempt to cure it with top-down pivots, dreamed up in corporate offsites with no regard for existing customers and no recollection of the organic, bottom-up processes that helped them become big in the first place. IBM Watson. Salesforce Chatter. Oracle Network Computer. Informatica Analytic Applications. BusinessObjects Sundance. Some companies treat these as publicity stunts, talking a big vision, but not really investing. Others get confused, believe their own marketing, and bet the ranch. Meta is in that situation: customers don’t care, the market doesn’t look attractive, and key employees are leaving. Yet on they plow. A+ commitment to a C+ strategy.
6. PLG momentum builds. Hit. I think PLG momentum built — and peaked — in 2022. Former Redpoint VC Tomasz Tunguz pointed out that product-led growth (PLG) firms are less profitable than sales-led growth firms, poking a hole in the “product sells itself” myth, and clouding dreams of liberation from costly S&M departments. (What drove people to the trial again, anyway?) PLG is a good strategy for certain categories, but VCs have a tendency, with all good intentions, to ram strategies down the throats of portfolio companies. As it turns out, PLG is like Nebraska: “honestly, it’s not for everyone.”
7. Year of the privacy vault. Partial. While it’s hard to back this with data, I believe both Okta and Hashicorp are doing well with their secrets vaults, which continues to validate the vault design pattern. I remain excited about vaults as applied to privacy (for all the reasons I detailed last year) and my friends at Skyflow continued to make great progress with their privacy vault business and the evangelization of it. What if privacy had an API? Well, it should.
8. MSDS is the new MBA. Partial. I don’t know how to easily measure this (irony not lost), so the scoring is entirely subjective. The in-hindsight obvious thing I hadn’t seen coming was the integration of the two — e.g., CMU’s Tepper school offers both an MBA in Business Analytics and an MS in Business Analytics, as do many others. So the new MBA just might be an MBA in Business Analytics or an MSDS.
9. Get ready for social impact. Partial. I was right about the things that concern younger generations. I was wrong to the extent that those things now matter somewhat less as the downturn transfers power from employees to employers. Social change isn’t just about what people believe, it’s about their power to get it. This is not to stay the new agenda will be completely ignored, but simply that change will come more slowly because the balance of power has shifted.
10. The rise of causal inference. Hit. I continue to believe that causal inference will be to the 2020s what data science was to the 2010s. Read The Book of Why to learn more. Or take this causal data science course on Udemy.
Kellblog Predictions for 2023
With that warm up, here are my predictions for 2023.
1. The great pendulum of Silicon Valley swings back. If you look at Silicon Valley over long periods of time, you see a series of pendulums that swing over decades, all loosely coupled to a great pendulum. In 2022, that great (fkamaster) pendulum started to reverse its course and that will continue in 2023.
The valuation pendulum: 10x is the new 20x, flat is the new up. That means a lot of companies need to double their size in order to earn their last-round valuation. Some have raised enough and/or spent sufficiently little that they can do so on existing cash. Others are not so fortunate. Runway extension is the watchword of the day.
The structure pendulum: it’s back. One way to maintain a flat headline valuation is to raise money with what’s commonly called structure. Structure generally means financing terms, such as multiple liquidation preferences or participation (definitions here), that favor new investors over existing investors and the common stockholders in a liquidation. During boom times, structure falls out of favor. During slowdowns, structure, and the so-called dirty term sheets that propose it, come back. Caveat emptor. Think hard and model multiple scenarios before doing a structured round — a dilutive downround or a clean company sale just might drive more long-term value.
The growth vs. profit pendulum: balance is in, growth at all costs is out. Formerly backseat metrics like ARR/FTE, free cashflow (FCF) margin, R40 score, and gross dollar retention (GDR) come to the front seat joining net dollar retention (NDR) and ARR growth. ARR growth still predicts enterprise value (EV) multiples well — but particularly if FCF margins are better than 15%. That means growth is great — but only if you’re profitable.
The founder friendliness pendulum: the invisibility cloak loses some power. In the 2000s you’d routinely hear VCs whinging about “founder issues” at Buck’s. But in 2009, with the founding of A16Z, came a new era of founder friendliness and along with it a founder invisibility cloak (or should I say invincibility cloak) whereby the presumption that the founder should run the company became nearly absolute. That pendulum will start to swing back in 2023.
The employee friendliness pendulum. This is basic Michael Porter, but the new environment has reduced the bargaining power of employees. We’ll discover that many of those perks and policies that were ostensibly rooted in culture and values were actually rooted in competition for labor. We’re already hearing, “get back to the office” from Benioffet alia. Or unlimited PTO — the ultimate perverse benefit — from Microsoft. More companies will follow.
The diligence pendulum: FOMO gives way to FOFU. In the past five years, I’ve never seen deals done faster in Silicon Valley, driven by a competitive market, growth investors with pre-conducted diligence, and a fear of missing out on investments. As the market cools, deals become less competitive, and stories like FTX emerge, things should return more to normal.
2. The barbarians at the gate are back. Valuations are down. Growth headwinds are up. S&M costs are high. Stock-based compensation (SBC) is increasingly controversial. That means activist investors will increasingly be swooping in to shake things up. And PE giants will increasingly be jumping in to clean things up. Anaplan and Zendesk were taken private in 2022. Salesforce is under pressure from two activist investors. Expect more of this activity to follow in 2023.
The downturn obviously puts cost pressure on customers. Must-have items can become nice-to-have overnight.
SaaS sprawl. Per Statista, the average company uses over 100 SaaS apps and for many CFOs that’s too many.
SaaS rationalization. There’s an entire emerging category of vendors (e.g., Cledara, Vendr, Vertice) who work to reduce SaaS spend. Their mission is to drive your churn.
Consumption pricing. Consumption purists (without ratchets in their contracts) may well find themselves swimming naked as the tide goes out.
Bankruptcy. Companies who sell to SMB may see increased amounts of uncontrollable churn as customers cease operations.
Consolidation. Increased M&A can result in fewer, larger customers with larger discounts and lower costs per unit.
Companies increasingly have internalized the cost of churn. Namely that:
Cost to backfill churn = CAC ratio * churn ARR
That is, with a CAC ratio of 1.6, it costs $16M to backfill $10M in churn ARR.
While this bodes well for the customer success (CS) discipline, it does not automatically bode well for the customer success department.
Those business-oriented CS teams who thought customer advocacy meant generating customers who advocate for the company will continue to thrive. But those checklist-oriented CS teams who thought customer advocacy meant internal advocacy on behalf of customers may well find themselves restructured. With new cost pressure, the idea of funding an internal K Street is unattractive compared to redeploying those resources to the underlying engines of customer success, such as product, services, and support.
There are, after all, two sides to being in the spotlight.
4. The Crux becomes strategy book of the year. Frequent readers already know that Good Strategy, Bad Strategy is my favorite book on corporate strategy. But my favorite part is how it eviscerates all the garbage that passes for strategy in corporate America.
I believe The Crux will become strategy book of the year in 2023 because:
It takes a positive approach more than a critical one. Readers generally prefer that, and I think it’s the one thing that held back Good Strategy, Bad Strategy.
It frames strategy around the plan to overcome a critical strategic challenge. I believe 2023 will provide many companies with clear strategic challenges that need overcoming. Demand will be strong.
He is logical, consistent, and practical in his thinking. Ruthlessly so. It’s literally therapeutic to read Rumelt if you’ve spent enough years in the C-suite.
Unlike business books that promise a magical answer (i.e., if you could just get <blank> right, then everything else will work), Rumelt offers a magical question: if you could just figure out the crux of your strategic challenge, then everything else can work.
The last point is not just verbal sleight of hand. Most business books preach a magical hammer (e.g., positioning, storybranding, category creation) — learn to use this one tool and it will fix all of your problems. Rumelt does the opposite. He sets you on a search for the magical nail. Find that one problem — that central knot or apparent paradox — that, if overcome, will enable your success.
As he said in his first book, “a great deal of strategy work is trying to figure out what is going on. Not just deciding what to do, but the more fundamental problem of comprehending the situation.” So true, yet so rarely admitted.
5. The professionals take over for Musk. While he’s calmed down a fair bit since I wrote my original draft in December, I nevertheless believe that Elon Musk will hand over the CEO reins of Twitter in 2023. The announcement of his intentions isn’t exactly news, but the question is will he actually do it? I think he will, largely because it won’t continue to capture him the attention he needs and because the shareholders of Tesla will basically demand it.
I disclaim that I am not a Musk fanboy and that, in general, I am disappointed by the PayPal mafia, which I once saw as so full of promise. Perhaps my expectations were too high, but as both the Book of Luke and JFK have said, “to whom much is given, much will be required.” Particularly, in Silicon Valley, where early success can launch a virtuous cycle of opportunity.
6. The bloom comes off the consumption pricing rose. Consumption pricing has been a hot topic for the past few years with many boards pressing companies to adopt consumption-based models. The conventional wisdom was roughly: if you want Snowflake’s NRR of 160-180%, then you need to adopt their consumption-based model; you can’t get there with per-seat annual SaaS or editions and upsells.
While consumption-based pricing tends to break SaaS metrics and while Snowflake is quick to explain that they are not a SaaS model, there has been significant pressure on enterprise software vendors to include at least a consumption-based component in their pricing. While this makes sense when passing along cloud-based infrastructure charges that scale with usage, when done in general, they forgot two things:
To ask the customers. Wall Street loves 180% NRR, but what about Main Street? Do CFOs like when their software bill compounds upwards at an 80% rate? Methinks not.
In 2023, we’ll see there are two types of consumption-based vendors: those with crafty CROs and those with purists. The crafties will have already structured ratcheted deals that can only go up year over year. The purists will not have built in that protection and will see consumption-driven churn as a result. By the end of 2023, we’ll have many more crafty CROs and a lot fewer purists.
The early returns indicate that while consumption-based companies are seeing bigger hits to NRR, that they are nevertheless driving higher overall growth than their subscription-based counterparts.
7. The rise of unified ops. The last decade has seen the rise of the “ops” function. Back when I was young, we didn’t have ops. If you wanted reporting or analytics, you’d go to finance. But as functions become more automated, as each VP got their own app, and as CEOs and boards applied more pressure for quality reporting and analytics, each function got their ops person. Salesops, marketingops, supportops, servicesops, and successops. Sometimes these consolidated into revops or bizops. Often, however, they didn’t.
What ensued was depressing. Siloed ops led to QBRs that resembled tag-team cagefights. When the CRO and the CMO were fighting, they’d tap in their respective ops heads to continue the brawl. My CXO versus your CXO. My ops person versus your ops person. My numbers versus your numbers. My model versus your model.
During an interim CMO gig, I worked with the CRO to unify the sales and marketing ops teams into a single revops team. Even though we were separate organizations both reporting to the CEO, we would have one unified ops team — and we didn’t care who it reported to. Attend both our staff meetings, but one set of numbers, one model, one forecast. What that gig ended, the first thing the new CMO did was disband it. Let the cage fights begin again. It’s human nature.
That story notwithstanding, I think 2023 will see the rise of unified ops. Why?
Cost pressures, and the need to increase efficiency. One single ops team, driving one set of modeling and reporting is cheaper to operate.
CRO consolidation. As some customer success teams are integrated under the CRO, there will be a natural tendency to integrate salesops and successops.
Model wars. CEOs get tired of having to say, “which model?” The saleops model? The FP&A model? The marketingops model? Why isn’t there just one? There should be.
Battle fatigue. Siloed ops isn’t just inefficient, the conflicts it generates are highly visible. Over time, people get tired. A great ops leader should be an independent trusted advisor to the business, not a personal pit bull in each CXO’s corner.
Resource flexibility. A single team can move resources dynamically to meet the challenges at hand.
Software standardization. Rationalizing SaaS costs and eliminating stack redundancy is easier when the various ops functions are in a single team.
End-to-end funnel analysis. Breakpoints in the funnel cause problems — e.g., sales doesn’t just want 500 oppties generated this quarter, they want the good ones. But which are the good ones? The ones that close. But which are the good ones for success? The ones that renew and expand. How can we generate those? One team, looking end to end, is in the best position to do this analysis.
For all these reasons, I believe (and hope) that 2023 will see the rise of unified ops.
8. Data notebooks as the data app platform. I’ll preface this by saying I’m an angel investor in Hex, who raised a $52M round from A16Z last year, so I’m excited about data notebooks for more than one reason.
While data notebooks are old hat to most data scientists, for business analysts and business users, they are still relatively unknown. Descended from Jupyter notebooks, today’s data notebooks (e.g., Hex, Notable) generally position as something larger, platforms for collaborative analytics and data science.
When it comes to Jupyter notebooks, this tweet was my introduction to the subject, which got me reading the underlying notebook by Kevin Systrom.
The highest quality Jupyter notebook I’ve ever seen was just posted by… <checks notes>… ex-CEO of Instagram, Kevin Systrom?
All of us data scientists can hang our heads in shame.
Systrom’s notebook is basically a research paper, built in collaboration, with equations; embedded, executable code; its outputs; configuration management; dependency graphs; and more. Compare that to the unmanaged spreadsheets you probably use to run your business today.
So the idea of generalizing this to data problems and data users of all types was instantly appealing to me. I remember when I first met with Barry at Specialty’s, he framed the problem as wrapping models. As data scientists, we can build models, but we need to wrap them in apps — what we’d now call data apps — so users can use them. Much as a spreadsheet has a builder and a user (think: lock down all the cells but a few inputs), a more sophisticated model can and needs to be wrapped as well. But wrapping a model means effectively building an application, and with that comes a dreaded backlog for building and maintaining those applications. It was a flashback to enterprise reporting circa 2000 (back when you had the report backlog) and I was instantly hooked.
While I’m not sure I agree with Martin Casado that all SaaS apps will be remade as data apps, I do believe the world is ready for data apps. I see them, perhaps in a more pedestrian fashion, as these integrated notebooks of code (including not only Python but SQL), no code alternatives, sequencing, models, narrative, metadata, and collaboration — and wrapped and ready for consumption. That’s why I’m a big believer in data apps and I see data notebooks as the platform for building the first generation of them. Check out the Hex demo on their home page for a five-minute look.
9. Meetings somehow survive. To paraphrase Twain, reports of the death of meetings have been greatly exaggerated. While I’ll confess to the imprudence of giving Death By Meeting to my boss shortly after its publication, the death of meetings is an entirely different matter. In January, Shopify announced what appeared to be a total meeting ban, but in reality was a ban on scheduled recurring meetings with three or more people along with a two-week cooling-off period before meetings could be added back to calendars. Nevertheless, this resulted in the cancellation of 10,000 meetings.
That online alternatives can replace meetings. The limitations of email and Slack are well known. They’re great for some things and rotten for others. My personal rule: never try to resolve a hard issue over either.
That cadence is unimportant. I believe that the cadence of regular meetings says a lot about a company — e.g., a weekly vs. a monthly forecast call, or a monthly vs. quarterly sales close.
That meetings cannot be improved. In reality, the goal with meetings, as with any tool, is to use them when appropriate. The quest is to focus on making them better. I say quest because to do so is both difficult and endless: as this article from 1976 demonstrates.
10. Silicon Valley thrives again in 2024. While I believe 2023 will be a tough, character-building year for startups, we must remember that this is simply another cycle of creation and destruction in Silicon Valley. The bad news is that companies will be increasingly faced with difficult, sometimes existential, decisions. The good news for me (at least) is that demand for gray hair seems to go up when the markets go down. The good news for everyone is that this is simply a cycle, one from which we shall emerge, and when we do so, the world we emerge into will be more rational and fundamentals-focused.
 I inadvertently published an incomplete version of this post on 2/1/23 around mid-day. While I instantly removed it from the blog, LinkedIn, and Twitter, I was unable to recall the post sent to email subscribers. Please accept my apologies for this mistake. While there are a few tricks one can use to avoid such problems (e.g., publish later, don’t create in the WordPress editor), I was on approximately draft 67 of this post, meaning that 66 times I correctly hit “save draft,” but alas once hit “publish” and off it went.
I’m Dave Kellogg, advisor, director, consultant, angel investor, and blogger focused on enterprise software startups. I am an executive-in-residence (EIR) at Balderton Capital and principal of my own eponymous consulting business.
I bring an uncommon perspective to startup challenges having 10 years’ experience at each of the CEO, CMO, and independent director levels across 10+ companies ranging in size from zero to over $1B in revenues.
From 2012 to 2018, I was CEO of cloud EPM vendor Host Analytics, where we quintupled ARR while halving customer acquisition costs in a competitive market, ultimately selling the company in a private equity transaction.
Previously, I was SVP/GM of the $500M Service Cloud business at Salesforce; CEO of NoSQL database provider MarkLogic, which we grew from zero to $80M over 6 years; and CMO at Business Objects for nearly a decade as we grew from $30M to over $1B in revenues. I started my career in technical and product marketing positions at Ingres and Versant.
I love disruption, startups, and Silicon Valley and have had the pleasure of working in varied capacities with companies including Bluecore, FloQast, GainSight, Hex, MongoDB, Pigment, Recorded Future, and Tableau.
I currently serve on the boards of Cyber Guru (cybersecurity training), Jiminny (conversation intelligence), and Scoro (work management).
I previously served on the boards of Alation (data intelligence), Aster Data (big data), Granular (agtech), Nuxeo (content services), Profisee (MDM), and SMA Technologies (workload automation).
I periodically speak to strategy and entrepreneurship classes at the Haas School of Business (UC Berkeley) and Hautes Études Commerciales de Paris (HEC).