David Cummings on Startups

Category: SaaS

  • Hidden Challenges with SaaS

    Software as a Service (SaaS) has been touted for several years now as the promise land for software companies due to rapid application deployment, consistent cash flow, and market growth prospects. Recently, the jargon has changed to be cloud computing but the general idea remains: SaaS is a multi-tenant applications hosted remotely and accessed through the web.

    Now, for traditional software vendors making the transition, or new companies, SaaS has some hidden challenges that should be considered. Let’s look at a few of them now:

    • Multi-tenant applications are more complicated than single tenant applications (multi-tenant means multiple customers share the same application and database)
    • Applications need to be monitored 24/7 requiring more labor
    • Choosing the wrong hosting provider, or a hosting provider that goes down regularly, reflects poorly on you and customers don’t care if the downtime isn’t your fault
    • Billing is complicated — billing schedules, up-sells, credit cards, etc require a fair amount of work to maintain
    • Growing the business is more capital intensive as customers are essentially financed over the life of their involvement since they don’t pay for everything up front

    I recommend evaluating these hidden challenges when evaluating the creation of a SaaS business.

  • Layering SaaS Revenue

    One of the common themes I’ve heard from software entrepreneurs over the years is that their company hit a revenue ceiling and they were never able to break through it. By software company, I’m referring to installed software vendors, which have the challenge, like most businesses, of having to sell a number of new deals annually to maintain their revenue size. Generally, installed software vendors have a certain percentage of recurring revenue via maintenance and support contracts (invented by MSA of Atlanta in the 1970s) so they don’t have to resell the entire revenue base, but the percent of revenue that is recurring is generally less than half.

    With Software as a Service (SaaS) vendors, assuming a high renewal rate (90% is considered very good), new customers represent additional recurring revenue that is layered onto the existing revenue base. One of the benefits of SaaS, besides the obvious things like more predictable cash flow, growth, etc is that there’s no limit on revenue growth as long as new customers are signed up faster than customers leave (churn). This presents an opportunity for SaaS companies to grow indefinitely — something that was historically much more difficult for installed software companies.

  • Bessemer 5 Cs of SaaS Finance

    Continuing my series of posts of on software as a service (SaaS) financials from yesterday, let’s take a look at Bessemer’s great set of slides online titled the 5 Cs of SaaS Finance. SaaS really is a very different business model when compared to traditional software and Bessemer highlights some of the critical metrics. The Bessemer 5 Cs of SaaS finance include the following:

    • CMMR – Committed Monthly Recurring Revenue
    • Churn
    • Cash
    • CAC – Customer Acquisition Costs
    • CLTV – Customer LifeTime Value

    My recommendation is to pay close attention to these key performance indicators and to read through Bessemer’s slides for all the details.

  • SaaS Financials – Cost of Goods Sold

    After reaching out to one of our company advisors today about advice on software as a service (SaaS) financial metrics, I felt it would be prudent to start documenting them in a series of posts. SaaS, being a newer delivery model, when compared to traditional, installed software, isn’t as well understood with regard to financial metrics.

    Generally, cost of goods sold (CoGS) for SaaS companies will include:

    • Hosting and monitoring of the application
    • Licenses and royalties for products embedded in the application
    • Services related to on-boarding the customer
    • Support and account management
    • Credit card fees and commissions to partners

    For more SaaS CoGS info, please see the Dealer Ignition post or the LinkedIn Q&A.

  • SaaS With No Contracts, Oh My!

    When I tell people we don’t have a contract with our software as a service (SaaS) product, they are often surprised. So many companies require a one or two year contract (much like a cell phone), that it is almost expected for mid-to-high end business software. Here’s why we don’t have a contract:

    • Tightly aligns our interests with our customers since they can leave at will
    • Requires us to get customers up and running quickly providing value within the first week
    • Helps reduce our sales cycle and establish a nice cadence with our sales team

    I recommend evaluating ways to achieve to these types of catalytic mechanisms.

  • SaaS Hidden Problem: On-Boarding Costs

    Software-as-a-Service (SaaS) really is an amazing delivery model for software in that it better aligns interests of vendors and customers compared with installed software that requires a large, up-front fee. In reality, the monthly or annual fees for SaaS make it so that the vendor is financing the customer due to the fact that the customer needs to hang around long enough to become profitable. If you sell a large enterprise installed product and the customer isn’t happy, it can still be profitable (though isn’t good business practice). With SaaS, if you have difficulty on-boarding the customer and making them successful, they can walk away.

    A hidden problem with SaaS is the on-boarding and switching costs relative to the cost of the solution don’t usually match up.

    Think about it: if you charge $1,000/month for a SaaS product, you need to be able to make customers successful with almost no effort, otherwise you need to have additional implementation fees for thousands of dollars, driving up the pain of switching, increasing the sales cycle, and increasing the non-scalable labor aspect of the business. Many SaaS companies don’t adequately account for the on-boarding costs to their business model as well as how it impacts the amount of time it takes for a customer to become profitable. SaaS is a more capital intensive model for entrepreneurs compared to installed software.

    My challenge for entrepreneurs is to incorporate the on-boarding costs into their model and really think about how they can remove the enormous friction that comes with switching over to their system.

  • SaaS Magic Number

    The term “magic number” in the Software-as-a-Service (SaaS) world has come up several times over the past month in casual conversations. Early last year, the term was popularized on Will Price’s blog via a guest post from Lars Leckie titled Magic Number for SaaS Companies. Generally, the magic number is a reflection of how efficiently a company is growing their recurring revenue relative to sales and marketing expenses.

    To calculate your magic number, take the difference in quarterly recurring revenue between your last quarter and the one before, multiple that by four, and then divide everything by all the sales and marketing costs of the  quarter before last.

    Magic Number = (((Last Quarter Recurring Revenue) – (Quarter-Before-Last Recurring Revenue)) * 4) / (Quarter-Before-Last Sales and Marketing Expense)

    The general idea is that if the magic number is greater than one, more should be invested in sales and marketing. If the magic number is less than .7, additional energy should be invested in making customer acquisition more cost effective.

    I’d recommending reading the original article and evaluating the equivalent magic number for your company.