Transforming Your Saas Business

Transforming your SaaS business

A strategic guide for optimizing business performance

kpmg.com/SaaS Contents

2 Executive Summary 4 Background: Evolution of an Industry 11 Business Model Dynamics: A New Way of Doing Business 18 Business Drivers: Optimizing Performance for Success 39 Leading Practices: Critical Steps for Achieving Success 44 Appendix: Strategic Drivers: Formulae and Examples

Featured Industry Contributors

1 Mark Hawkins, CFO, Salesforce.com

2 Neil Williams, CFO, Intuit

2 Steve Cakebread, CFO, Yext

5 Mark Culhane, CFO, Lithium Technologies

5 Bob L. Corey, CFO, CallidusCloud

7 Ron Gill, CFO, NetSuite

8 Mark Garrett, CFO, Adobe

9 Kevin Bandy, Chief Digital Officer, Cisco

13 R. Scott Herren, CFO, Autodesk

15 Mike Kourey, CFO, Medallia

16 Matt Quinn, CTO and EVP Products & Technology, TIBCO

21 Clyde Hosein, CFO, RingCentral

© 2016 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Revolutionary changes in technologies have come in waves -- it brought us the mainframe, “the client-server and the cloud. From our experience, the cloud is exciting in that it enables us to help our customers connect with their customers in a whole new way. As the pioneer in Cloud SaaS offerings, we have witnessed disruption across industries and the globe as people embrace this dramatically improved technology. In 2015, the worldwide As a CFO, the big opportunity is how best to market for SaaS software support our respective companies in these application sales will be times of innovation and disruption, pivoting to new technology models and business models $33.4 billion in order to meet the modern day expectations with projections to grow and demands of customers and investors. more than double that, to This publication, Transforming your SaaS $67.2 billion, business, A strategic guide for optimizing business performance, serves as a useful by 2019. guide to gain a deeper understanding of the Source: Gartner, “Market Trends: Future Look at SaaS in the drivers and metrics across the balancing acts Application Markets”, November 25, 2015 of growth, margin expansion and long-term sustainability and competitiveness. Using this knowledge, SaaS and software companies have a greater opportunity to accelerate their business transformations, improve their competitiveness and amplify their future financial success.” – Mark Hawkins, CFO of Salesforce.com

The Cloud Service Providers (CSPs) solutions, either as an additional offering “Transforming your SaaS market, and more specifically or as a replacement of their on-premise business” is thorough and portfolio. Companies that enjoy a large the Software-as-a-Service (SaaS) comprehensive. It’s always good maintenance revenue stream have market, has evolved considerably adopted a hybrid strategy where the on- to step back and remember the since its inception in the 1990s. premise and SaaS offerings coexist, while strategic rationale for some of Whereas it began as a niche some are pursuing a complete business the choices we work with day offering, primarily used by start- model transition to SaaS offering. Some by day. As the article describes, providers have also started adopting a ups that recognized the benefits of "freemium" licensing model, providing the I believe the SaaS model is a computing in the cloud, it has since software code for free and charging for better way for customers to use gained strong adoption among services and support. software and for companies to enterprises around the globe. 3. Integrated Technology and Product build and deliver it, as it actually With lower operational costs than on- companies: These include integrated enables faster development, premise software, quick deployments, technology companies (IBM, HP and delivery and adoption.” rapid product upgrades, flexible Cisco) and product companies (GE and —Neil Williams, CFO of Intuit configurations, seamless integration, Siemens) that have integrated SaaS scalability, high availability and inherent offerings into their core businesses. security, there are tangible, competitive With their subscription-based model, advantages for adopting a SaaS solution. the SaaS offering allows them to earn recurring revenue streams. As enterprise adoption has increased, the “Transforming your SaaS number of SaaS solution providers has A new way of doing business business" is a complete tutorial The SaaS business model differs grown commensurately. With varying and describes the proper metrics markedly from that of traditional software operational models and capabilities, and measures needed to have these providers can be grouped into the businesses, with unique challenges following categories: for product and pricing, research and successful SaaS business. development, sales and marketing, service All the metrics described are 1. Pure-SaaS solution providers: and support and finance. As a result of important to have a successful These companies were designed these differences, SaaS companies must from the outset with a cloud/SaaS- be managed differently than traditional on- SaaS company. The key based product offering. This category premise software companies. metrics I focus on are Growth includes pioneering, cloud companies in Customers, Growth in ACV, SaaS business drivers (Salesforce, NetSuite), as well as a Growth in Deferred Revenue and number of startups and emerging high As a result of this distinct management growth companies. approach, the SaaS business requires Growth in Cash Operating Cash a different set of drivers and metrics Flow. These metrics help the 2. On-premise software providers: to measure business performance and company focus on improving the Responding to the increasing demand efficiency, for each type of SaaS company for cloud-based solutions, and to provide — pure-SaaS, on-premise software value of the business.” more predictability, some on-premise company, integrated technology/ product —Steve Cakebread, CFO of Yext software vendors (Oracle, Adobe, Intuit) company—weighing the significance of have transitioned to providing SaaS these metrics differently.

This paper highlights the transformational priorities and critical challenges for the SaaS business, with an underlying goal of providing a framework for achieving long-term success. For more information about this publication, or to learn how KPMG can help your Cloud (SaaS) business, please Prasadh Cadambi Satya Easwaran contact us: Partner, Technology Industry Partner, Advisory +1 650-793-4129 +1 650-391-5365 [email protected] [email protected]

This publication provides a strategic Because of their inherent complexity, methodology for each metric in the framework for increasing growth, these drivers and metrics must be appendix. profitability and sustainability for the SaaS measured and interpreted correctly The road to success business. We present strategic drivers in order to be applied effectively — Successful implementation of the metrics along with key metrics used to assess whether internally, externally or both. blueprint is a top-down challenge for performance at each stage in the business Throughout this publication, we describe SaaS companies, which must review lifecycle — launch, scale/optimization and these metrics in detail and explain how and transform their existing enterprise stabilization (see illustration immediately to incorporate them into a successful performance management frameworks below; highlighted metrics are “must business strategy, providing calculation haves” for success). and operating models.

Key stages of growth Launch > Scale and Optimize > Stabilize >

Strategic Drivers Customer Growth Customer Growth Customer Growth – Customer Lifetime Value – Customer Lifetime Value – Customer Lifetime Value – Number of customers – Subscriptions/customer – Billings/customers – Billings Customers Revenue Growth Revenue Growth – Total Contract Value Revenue Growth – ACV – Backlog – Total Contract Value – Bookings – Annual Contract Value (ACV) and Average – Backlog – Calculated Billings ACV – ACV and Average ACV – Recurring revenue – Bookings – Bookings Growth – ACV to Billings ratio – Calculated Billings – Recurring Revenue (ARR/MRR/QRR) – ACV to Billings ratio – Average Revenue per User or per Account – Recurring revenue – Deferred Revenue – Average Revenue per user or per account – Time to recognize deferred revenue – Deferred revenue – Time to recognize deferred revenue Costs Costs Costs – Customer Acquisition Costs – Cost to Serve – Cost to Serve – Research & Development Costs/Sales – Research & Development Costs/Sales Margins – Sales costs/Sales – Sales costs/Sales – Recurring Margins – Marketing costs/Sales Margins – Gross Margins Margins – Recurring Margins Cash flow – Recurring Margins – Gross Margins – Gross Margins – Service Margins Mix – Cash flow from operations – Service Margins Mix – Operating cash flow margins Cash flow – Net cash per share Cash flow – Cash flow from operations Profitability – Free Cash Flow – Cash flow from operations – Operating cash flow margins – Operating cash flow margins – Net cash per share – Net cash per share – Free Cash Flow – Free Cash Flow – Months up-front Sales Effectiveness Sales Effectiveness Retention – Growth Efficiency Index – Growth Efficiency Index – Gross revenue churn – Sales and marketing efficiency – FTE's drivers (i.e. ARR/Sales FTEs) – Net revenue churn – Lead Velocity Rate – Sales and marketing efficiency – Dollar-based Net Expansion Rate – Sales cycle length – Lead Velocity Rate User adoption – Average Contract Length – Sales cycle length – Volume and type of Support Tickets Raised – Renewal Rate – Average Contract Length – Net Promoter Score – Customer Acquistion by Channel – Renewal Rate – Typical acquisiton path – Leads-to-trial conversion rate – Leads-to-trial conversion rate – Trial-to-paying-account conversion rate – Trial-to-paying-account conversion rate Retention Retention – Customer churn Sustainability – Customer churn – Gross revenue churn – Gross revenue churn – Dollar-based Net Expansion Rate – Quick Ratio User adoption User adoption – Products per customer – Products per customer – Number of features accessed per customers – Number of features accessed per customer – Volume and type of SupportTickets Raised – Net Promoter Score – Net Promoter Score – Altitude metric – Altitude metric

SaaS installed workloads

therepresent total cloud workload 50% ofand are growing at a compound annual growth rate (2014-2019) ofSource: Cisco 34% Global Cloud Index: Forecast and Methodology, 2014-2019

IDC predicts the share of SaaS globally will grow from 20% in 2015 to 30% by 2019 Source: IDC, Worldwide SaaS and Cloud Software 2015–2019 Forecast and 2014 Vendor Shares, Doc #257397, August 5, 2015

The Software-as-a-Service (SaaS) While the SaaS market keeps growing, “Transforming your SaaS business’ market has grown considerably a number of new considerations are provides a fantastic framework while undergoing significant shaping the industry, given the key for management teams and role scalability, high availability, security change since the late 1990s, when and data residency play in the decision investors on how to measure and it began as an alternative way of criteria for adopting SaaS in an enterprise evaluate a SaaS business through delivering software. environment. Data residency, for instance, the key stages of growth. SaaS can have a significant impact on global businesses are fundamentally While the earliest SaaS offerings SaaS operations, as illustrated by the included a handful of major recent decision by the European Court different than traditional software players such as Salesforce and of Justice (October 2015) to overturn the companies given customers NetSuite, the market is now very Safe Harbor agreement between the EU don’t own or have the burden and US, requiring additional measures competitive, with a wide variety of operating the software. As a to transfer EU cloud data to the United result, how you build and operate of business models. States. As SaaS providers become more the software, support it, sell it, The adoption of SaaS is in large part mature, enterprise SaaS implementation attributable to the number of competitive projects are also becoming larger and bill for it requires alignment advantages that it offers compared to a in terms of scale and scope. Some across the entire organization. traditional software licensing model, such providers have begun integrating social This guide concisely lays out the as more flexible configurations, reduced media components into their offerings, key considerations and metrics to costs that are more predictable, and faster a differentiating element in what is measure each step of the way.” deployments. increasingly a highly competitive SaaS market. As the corporate adoption rate of SaaS — Mark Culhane, CFO of grew, the industry moved from edge With global corporate demand for SaaS applications to core, with a proliferation of solutions growing steadily, a growing Lithium Technologies providers which developed SaaS offerings number of solution providers (on-premise for an expanded field of domains, software providers and integrated including HR, talent management, technology and products companies), have entered the SaaS marketplace, each finance and accounting. Today, Customer The evolution to the digital Relationship Management (CRM), with a goal of delivering greater value, Enterprise Content Management (ECM), increased revenue and the ability to marketplace has set the stage Customer Experience Management monetize intellectual property. for a Buyer-led economy. (CEM) and Enterprise Resource Planning Transforming your business to (ERP) are the most profitable SaaS the Cloud is essential to compete offerings. As per Gartner’s estimates, Business Intelligence (BI), digital content in this new digital marketplace. creation, office suites and CRM comprise The Cloud completely disrupts high-growth areas (year-on-year growth the old market methods for between 25-45 percent in 2015).* competing and communicating.”

* Source: Gartner, “Market Trends: Future Look at SaaS in the — Bob L. Corey, CFO of Application Markets”, November 25, 2015 CallidusCloud

The primary categories of SaaS as well as the fact that their solutions were – Vendor solvency is a vulnerability that providers include the following: built with a cloud native delivery model. impacts both the customer and provider. As a result, they have enjoyed higher SaaS providers must therefore track cash 1. Pure-SaaS solution valuations, a reflection of their primary flow metrics closely, particularly during providers business model attributes: the launch phase. This becomes less A. Exponential growth, particularly in of an issue as they scale and become Pure-SaaS providers are “born in the established market players. cloud”, which means that their product the early years, partly due to the offering was designed to be cloud/ SaaS– compounding impact of renewals – Contract and Service Level Agreements based from the outset. and add-on sales requirements are likely to require a robust contract management cadence Most pure SaaS providers began as B. Predictable revenue streams, including annuities for both customer and provider. For SaaS technology start-ups, and many of them providers, this may also include requests went public after recording rapid growth C. Long-term profitability (margins for periodic data backup. and maturity. The 2015 estimated in the short terms are invested in median sales growth for U.S-based public growth), supported by economies With the above in mind, below are the emerging software companies was 47 of scale within the SaaS business key transformational priorities and “must percent, according to Goldman Sachs. model have” metrics that pure SaaS solution providers should consider: Pure SaaS solution providers are often Pure SaaS providers may face critical rewarded for their first-mover advantage operational challenges, including:

Types of offerings Key transformational priorities Horizontal offering: specific product aimed at a broad number of 1. Developing a modular service-oriented architecture to customers in multiple industries support new technologies and features and allow scalability Vertical offering: complete solutions tailored for customers in a 2. Adopting cloud-based subscription platforms and billing specific industry & pricing systems 3. Elaborating cloud specific sales compensation plans, Competitive edge carefully set goals and index on relevant SaaS metrics Cloud experience, no on-prem legacy issues, cost benefits, 4. Building and nurturing a robust partner ecosystem flexibility and scalability 5. Adopting an integrated approach in operating the product, sales and marketing functions throughout the Providers Examples product release cycle, to iterate faster – Salesforce – Medallia – Adobe – Yext “Must Have” Metrics – Netsuite – Lithium Technologies – ACV/ ARR on a disaggregated basis – RingCentral – Recurring gross margins – ARR/Sales FTEs – Growth Efficiency Index – Customer Lifetime Value – Gross churn – Customer Acquisition Cost – Cash Flow from operations

Note: highlighted metrics are the new SaaS specific metrics to be considered

“The thing that surprises many 2. On-Premise Software As a result of their original business investors and boards of directors providers model dynamics, on-premise software about the SaaS model is that, companies have a challenging, strategic A key consideration for on-premise course-correction to execute. However, even with perfect execution, an software providers is to respond to the companies that have successfully acceleration of growth will often increasing customer demand for cloud- navigated this transition have prospered, be accompanied by a squeeze on based software solutions. creating enormous shareholder value. profitability and cash flow. Companies that enjoy healthy Inherent in the amortized revenue maintenance revenue streams have begun Following a transition to adopting a hybrid strategy where the on- the cloud and an annuity model in SaaS is a longer delay premise and SaaS offerings coexist. between investments in capacity business model, Adobe Some companies that are primarily and the uptick in recognized software license-driven are transitioning experienced a 3.5-fold revenue driven by that capacity. to a business model that includes cloud/ increase in shareholder To oversimplify a bit, a new SaaS SaaS. Others are still evaluating their value. Meanwhile, blue chip sales rep will simply cash more options to determine the most favorable software giants including business model moving forward. paychecks before he/she delivers Microsoft, Oracle and SAP revenue than the same rep in a Some providers have started adopting have all begun a similar a "freemium" licensing for open source transition to the cloud with a perpetual model. Investors need intellectual property model, as a variant of to be prepared to see some P&L the on-premise model. They in essence SaaS-based model for their and cash flow metrics turn down provide the software code for free but core product offerings. when things are going really well. charge for services and support, in what The counterintuitive corollary, can best be described as a services model. of course, is that when growth levels off or slows, margins and cash flows tend to improve.” Types of offerings — Ron Gill, CFO of NetSuite Offerings can combine on-premise and SaaS delivery. Cloud-based versions of flagship on-premise software suites, mostly horizontal offerings

Competitive edge Software market experience, installed base, know-how and brand equity, flexibility in offerings depending on the customer’s needs

Providers Examples – Microsoft – Intuit – Oracle – Autodesk – SAP – TIBCO – Adobe – CallidusCloud

Over the past five years, we have With the above in mind, below are the key transformational successfully transformed our priorities and “must have” metrics that on-premise software Creative product business from providers should consider: a shrink-wrapped CD software offering to a cloud-based Key transformational priorities subscription model. During the 1. Adopting a cloud first strategy in developing and business model transition, our deploying products which look and feel like a web- profit and loss statement was not browser customer experience and that can be used the best measure of the health across multiple devices of our business. The faster we 2. Managing and reporting both product offerings (on transitioned our customers to a premise and pure SaaS), taking necessary steps to mitigate offer cannibalization subscription model, the faster our revenue fell in the short-term. 3. Operating the product, sales and marketing functions closely throughout the product release cycle: integrated We shared new metrics to approach rather than a functional/ decoupled approach help analysts better measure 4. Transforming the finance organization, attracting better the health of the business as FP&A talent, acquiring the right technology (i.e. subscription we went through this transition. based billing engine), communicating the right metrics We shifted their focus toward internally and externally the building blocks of our new 5. Building the right sales team to sell annuity based Creative Cloud business— product offering and retooling the existing sales compensation plans accordingly number of subscriptions, average revenue per user (ARPU), “Must Have” Metrics annualized recurring revenues – Number of subscriptions (ARR), and revenue that was – Average revenue per account contracted and either deferred or – Revenue (License vs Maintenance) in backlog (off-balance sheet). – Maintenance renewal base and changes in maintenance We were transparent and renewal base over-communicated with Wall – ARR Street. We provided both – Deferred revenue short- and long-term metrics, including three-year compound – Backlog annual growth rates for revenue – Net Dollar Based Churn and earnings per share to give Metrics that need to be considered and that are perhaps not being tracked, are in bold font investors a way to measure our progress and to have a view of what the business would look like after the transition.

— Mark Garrett, CFO of Adobe

3. Integrated Technology and Products companies “Cisco and our partners have been working with industries Integrated technology and product deep expertise and intellectual property companies are also including SaaS with in turn delivering stable recurring revenue from retail to manufacturing their core business offerings. Historically, streams that include a high margin and to government to help them these companies would embed or build higher market valuations. The digitize, disrupt and unlock perpetually license their software as part strategy has strengthened their customer business value. At Cisco, we of a solution bundle. They are now offering relationships by shifting the narrative from software as a separate service that spend/cost to business outcomes. are transitioning our business includes multiple licensing options. SaaS model from a hardware focused offerings allow them to monetize their model to one focused more on software, services and new Types of offerings consumption models to meet Software (including VoIP, operating systems, and analytics), the needs of our customers. hardware (laptops, chipsets, switches, routers, etc.),licensing of This transition involves a delicate intellectual property balancing act to ensure our existing revenue streams co- Competitive edge exist with and support SaaS Integrated Highly technical specialization in their field, size and reputation and new business model Technology of offerings companies revenue growth. A successful Providers Examples transformation would need to span the spectrum from – IBM offerings, to routes to market, – HP to business and support – Cisco Systems functions - all these need to align – Qualcomm to execute on our digitization strategy and better support client organizations. We have Types of offerings focused on increasing internal Highly niche software offerings, typically IP-based solutions collaboration across functions to ensure sales, product, services Competitive edge and support organizations are working in concert to ensure we Product High degree of specialization and domain knowledge. companies Investment in technology aligned to core business create a unified portfolio that our partners can digest and drive Providers Examples digitization opportunities across – GE companies, industries, cities and – Siemens countries”

— Kevin Bandy, Chief Digital Officer of Cisco

With the above in mind, below are the key transformational priorities and “must have” metrics that integrated high technology companies and product companies should consider:

Key transformational priorities 1. Adopting cloud-based subscription platforms and billing & pricing systems 2. Leveraging the partner ecosystem to enable cross-sell/ up-sell to the existing install base 3. Retooling sales compensation plans to include a cloud/ SaaS component 4. Managing and reporting product lines and offerings, including SaaS 5. Investing in enhanced customer on-boarding and servicing

“Must Have” Metrics – Gross Margin/ Net Margins – Revenue Growth – Research & Development as a % of revenue – Sales & Marketing expenses as a % of revenue – Deferred Revenue growth – ARR and ARR Growth – Backlog – Subscription per customer

Metrics that need to be considered and that are perhaps not being tracked, are in bold font

Solution providers offer distinct The offering differentiation impacts a finance function operations. As a result, business models that reflect their number of factors, including product and SaaS companies need to be managed pricing, sales and marketing, the way differently than traditional on-premise offering (SaaS vs. traditional on- service and support is provided and the companies. premise software delivery)

Product and pricing

Traditional On-premise Offering Saas offering – Single-tenant – Multi-tenant Architecture – Software installed directly on customer’s IT – Direct access to cloud-based application infrastructure

Release Cycle Generally up to twice a year Typically 6 to 8 weeks

Pricing Upfront license fee as well as ongoing support fees Recurring subscription fees

Speed of Weeks or days - can be longer depending on Several months deployment complexity of integration with other systems Scheduled, large-scale, typically once a year, time Ongoing, more frequent upgrades throughout the Upgrades consuming and can cause significant disruption year

Customer Traditional software user interface and experience, Browser-based user interface and experience, Experience desktop based, single location access accessibility across multiple devices

Security and Baseline cost for product security, access control Higher cyber security and compliance costs to ensure Compliance and compliance with applicable regulations data privacy and residency

Prior to a product release, SaaS solution customer demand for accessibility across them more agile to accommodate pricing providers seek to enhance key capabilities, multiple devices and platforms. models changes (such as per seat vs. such as hosting and system management, Additionally, SaaS solution providers are usage based billing) while also providing commerce platforms and business support transforming their design to a modular, real-time reporting that creates visibility systems. They also look to enhance the service-oriented architecture, one that into usage patterns. Some SaaS providers customer experience, investing in the supports new technologies and features are actively looking for billing engines product architecture, design and user and is readily scalable. They are also designed to support the subscriptions interface. Mobile first design has become transforming their billing systems, making model. the norm, a response to the increasing

“I believe all enterprise software Key Success Factors for pure SaaS offerings will move to (or be born in) the cloud for a few reasons. First, – Modular architecture and scalability as a design principle at the outset, to manage the cloud provides limitless Cost to Serve (CTS) and achieve benchmark gross margins at maturity compute and storage elasticity, – Invest in user interface and user experience, mobility (access across multiple which is not only a superior cost devices) model, it also enables work – Spend continuously on innovation and security that was previously prohibitive to complete. Second, the – Invest to ensure uptime and availability and plan sufficiently for business continuity and performance explosion of mobile devices – Invest in proper billing systems customized for metered usage over the last 10 years has fundamentally and permanently – Invest in application performance monitoring changed the way companies – Adjust for variability between product pricing and volume get work done at all levels. And third, the cloud is an inherently collaborative platform, which is increasingly important for all businesses. These are business driven imperatives, which is why I believe all enterprise software moves to cloud/mobile. It is important to recognize that the business metrics that companies (and investors) need to focus on are dramatically different for cloud/mobile businesses” — R. Scott Herren, CFO of Autodesk

Sales and marketing

Traditional On-premise Offering Saas offering Marketing Tradeshows, conferences, print, outdoor, Significant events and tradeshows, website, Webinars, and lead social marketing, content marketing, referrals, Search Engine e-mail generation Optimization (SEO) Small to Midmarket Customers – High Small to Midmarket Customers - Low touch, land and touch, partner/ reseller based sales, shorter expand, short sales cycle sales cycle Sales Model Enterprise Customers - High touch, direct Enterprise Customers - High touch, direct sales force, lengthy sales force, lengthy sales cycle sales cycle

Sales Traditional sales incentives and Elaborate compensation plans, with significant focus on ACV Compensation compensation plans structured towards and multipliers/ decelerators based on service mix, billing, Plans bookings and revenue recognition contract length and renewal

Sales Cycle within the customer’s IT environment. significantly more complex IT and This has enabled business teams within operational environments (multiple Typically, the sales cycle for traditional an organization, rather than centralized geographies, large data/ record software providers is a lengthy one that IT, to directly buy SaaS solutions. SaaS volumes, preferred vendor criteria, incorporates a high-touch, direct sales companies also have a strong support SLAs). Additionally, their higher license process. base for retention, due to multiple touch requirements and integration costs result The cycle is considerably shorter for points within the organization that create in longer decision timelines that involve SaaS providers, due to lower upfront cross-sell and up-sell opportunities. multiple stakeholders. costs (operational effort, financial For enterprise customers, the sales commitment, and switching cost), quicker cycle may not vary between on-premise deployments, and seamless integration and SaaS. Enterprise customers have

Marketing Campaigns Providers that have a hybrid on-premise Sales and marketing expenses and SaaS offering are faced with the for traditional Software vendors SaaS providers often employ a “land additional challenge of creating different and expand” business strategy, applying marketing tactics to support each business marketing strategies that focus on model. Some SaaS providers combine 20-30% customer acquisition. Those strategies both traditional, on-premise and SaaS include combining digital marketing incentives, both for the internal sales force of revenue (websites, social media, search, e-mail) as well as for prospective clients. SaaS with integrated campaigns (events, providers directly appeal to customers Sales and marketing expenses sponsorships, media and analyst relations) of on-premise solutions with aggressive for pure SaaS vendors Common practices for increasing pricing comparisons that focus on the customer acquisition and referrals include Total Cost of Ownership (TCO) benefits of engaging prospects in free trial programs, working with a SaaS provider. 40% of providing them with on-boarding and assistance trials, and inviting them to revenue participate in online user communities. KPMG Research"

Partnership support “Customer acquisition and Both on-premise as well as SaaS providers balancing growth and sales capacity, while retention is critical to the leverage partnerships to support their considering all compensation mechanisms, SaaS business model. market growth. The partner ecosystem including equity and options, to retain sales for on-premise providers is mature with team talent. These programs should focus Sales teams have a crucial attractive market opportunities across on ACV, rather than bookings, as the key role to play and must be the customer lifecycle that address metric that drives compensation. incentivized accordingly, system implementation, maintenance and Additional factors that impact sales with tailored compensation upgrades. compensation include new customer Building and nurturing a robust partner bookings, contract length, upsell and plans. The objective is to not ecosystem is critical for SaaS providers renewal. Finally, in light of its subscription only generate the best and looking to expand internationally, and scale business model and associated payment most profitable customer their operations more rapidly. Partners earn models (advance vs. arrears, annual vs. SaaS-related compensation in a number quarterly), SaaS solution providers are relationships, but also to retain of ways, including incentive-based referral increasingly aligning commission payouts and grow these customer fees, revenue sharing of implementation to customer billing. This alleviates the cash and professional services, and joint go-to- flow strains that SaaS providers face in the relationships over time. Sales market initiatives. early years of operation when the costs of compensation plans therefore acquiring customers are higher. need to be indexed on ACV, Sales incentives On-premise and SaaS providers offer the key metric for SaaS, with distinct commission structures and costs. Sales compensation programs are As a result, sales commissions must be multipliers or decelerators to designed to align with the SaaS sales life managed effectively to enhance market cycle. To maximize sales performance, align behaviors around other penetration while limiting cannibalization. SaaS providers must set the right goals, metrics such as Average Contract Length, Billing terms and Up-sell. The sales Key Success Factors for pure SaaS offerings effectiveness drivers detailed in this paper are thorough and – Understand and identify customer core versus edge buyers provide a good guide to the – Attract sales talent to sell an annuity-based product offering, need for robust lead management tracking metrics relevant to – Develop the right sales compensation plans to incentivize and retain sales talent SaaS businesses.” – Leverage non-traditional marketing channels — Mike Kourey, CFO of – Build and grow partner ecosystem with a viable incentive mechanism Medallia – Invest heavily on customer acquisition and retention (most start-ups do not have the kind of reputation and brand value that on-premise providers enjoy, making customer acquisition a key priority) – Maintain high engagement across multiple customer touch points and incentivize S&M for higher engagement – Optimize costs while maintaining high customer base growth and strong renewal rates

“Good product development Service and support and support processes always involve metrics, but in the Traditional Saas offering world of cloud solutions, On-premise offering metrics are often one of the keys to success. Cloud Delivery On-premise Cloud-based support architectures can provide Installation Core customization Configurations/extensions the most direct, unfiltered, actionable insight into how Professional Training, integration, customized Maintenance, training your product is used. In a cloud Services onboarding context, you also have a level of control over the DevOps Support Phone Multi-channel, self-service, phone environment that doesn't apply to deployed software The SaaS service delivery model impacts The SaaS delivery model typically requires (at least not for the provider), data management, privacy and residency, the availability of 24/7 support, as the which means you can put and data security, both for core business service is provided remotely. The nature those metrics to good use and support functions. As mentioned of service and support for SaaS can in constantly optimizing your previously, data privacy and residency include a range of proactive tools (such as offerings. On the flip side, you laws and their associated requirements application performance monitoring and can significantly impact global SaaS usage monitoring) and self-service tools also take on the operations businesses. Keeping abreast of public (such as chat applications, Wikis, user responsibilities for scalability sentiment1 and understanding developing communities, and e-mail). SaaS providers and performance, adding legislation is critical to leverage potential use value-added, professional services a new dimension and new benefits while mitigating adverse impacts. beyond implementation as a key element Furthermore, the current compliance of differentiation. The speed and ease of challenges to the solutions landscape in which SaaS solution providers implementation are important customer you provide.” operate is broad, with a number of selling points. — Matt Quinn, CTO and EVP reporting standards. SaaS solution providers are focused on creating an agile service and support Products & Technology at Compliance includes TIBCO infrastructure, which enables business SOC 1 & 2, ISAE 3402, growth expansion while providing differentiated and tailored services to and SOX 404 customers.

Key Success Factors for pure SaaS offerings

– Invest in ensuring application security – Understand compliance requirements in market of operation and incorporate into product features – Invest significantly in hardware (data centers) to support hosted applications delivery – Invest in 365/24/7 support – Invest in self-service tools and channels – Build value-added professional services layer (especially true for start-ups)

1. See for example the EU-US Safe Harbor agreement that has been overturned. The EU data can still be transferred and stored in the US, with appropriate model clauses formalized between providers.

Finance Organization

Traditional Saas offering Traditional On-premise offering Saas offering On-premise offering Meeting short-term revenue and earnings targets Delivery On-premise Cloud-based support are significantly dependent on FP&A team execution Short-term Meeting short-term and long-term revenue targets (i.e., quality of financial modeling and forecasts) Installation Core customization Configurations/extensions revenue and are significantly dependent on the sales management – as revenue predominantly comes from existing earnings team execution – as a significant proportion of bookings (including Churn) and change in deferred Professional Training, integration, customized bookings translates to revenue upfront relating to Maintenance, training guidance revenue. Services onboarding license revenue Sales management team should continue to focus on Net ACV to accelerate growth Support Phone Multi-channel, self-service, phone

The Finance organization and CFO play as well as pricing and profitability Quote to Cash (Q2C) infrastructure in significant roles in SaaS businesses, as analyses. order to support rapidly growing business they are the principal drivers for evolving The Finance function must also develop and customer expectations. Integrating internal behavior and communicating and adopt relevant tools and systems sales and business operations can support externally. As a result, the finance to support the SaaS business model. growth in sales, order accuracy, and function should actively support business Several companies have invested in ultimately customer satisfaction. strategy execution. Identifying, tracking systems and infrastructure geared to Finally, the finance function has a role to and communicating (both internally and support this model, such as new billing play in supporting the sales teams and externally) the most relevant metrics is engines, revenue recognition systems and helping align their sales compensation paramount to achieving this objective; revamped ERP suites. programs to the SaaS business the finance function needs to adapt and The ability to support and interface with imperatives. As a business partner with structure itself accordingly, attracting the the right tools and analytics, the finance appropriate talent, with seasoned FP&A core business activities is essential. To this end, SaaS solution providers depend on function is uniquely positioned to support team members capable of execution and drive changes in the business model. (quality of financial modeling and forecasts) their finance function to transform their

Key Success Factors for pure SaaS offerings

– Adopt tailored billing (i.e. subscription based billing), invoicing, revenue recognition processes and systems (billing engines, revenue recognition systems, etc.) Key Success Factors for pure SaaS offerings – Identify and attract seasoned finance profiles – Identify, define, develop and track the right SaaS business metrics – Invest in ensuring application security – Invest in flexible and dynamic analytics and automation tools – Understand compliance requirements in market of operation and incorporate into – Communicate around the right metrics internally, to change and drive new behaviors product features – Communicate the right metrics externally, for analysts to understand and value the – Invest significantly in hardware (data centers) to support hosted applications delivery SaaS business performance – Invest in 365/24/7 support – Invest in self-service tools and channels – Build value-added professional services layer (especially true for start-ups)

With their unique business SaaS businesses face significant financial the pace of growth and gradually, with model, SaaS companies cannot losses in their early years, as they must sufficient scale, the business begins an be evaluated by traditional invest heavily in sales and marketing to optimization process. Eventually, the acquire new customers. Due to their business generates sufficient profit/cash performance metrics. Accurate revenue model, they derive returns to cover its costs and provide cash for assessments of financial and from those investments over a longer additional investment. At that point (all operational health require an period of time compared to traditional other costs remaining equal), the business understanding of the drivers software companies, who employ a more stabilizes and becomes profitable. predictable maintenance model. relevant to the SaaS business, along with the meaning that As the SaaS business scales up, customer acquisition costs (CAC) cause it to burn they convey and their relative cash rapidly. The recovery is slow, which significance as the business may in turn lead to a cash flow problem. evolves from launch to a stage of Losses typically grow proportionally to stability.

Stages of growth of a SaaS business

Key Stages of Scale & Launch Stabilize Growth Optimize

For a SaaS business, the choice between providers to select the right growth opportunities. To preempt this challenge, growth and profitability is critical, yet investments and communicate to the it is essential to assess the performance delicate. Balancing longer-term economics market about the profitability impact for of the SaaS business using metrics that with short-term profitability is key for each as well as the outlook during each are relevant to each stage in the SaaS success. stage of growth (through to maturity). business lifecycle. The choice between As SaaS is typically a winner-take-all Many SaaS stakeholders, especially those growth and profitability, for instance, is market, growth becomes a priority. that are unfamiliar with the SaaS business addressed for key drivers in the following However, investments made for growth model, do not understand this growth sections, as well as within the summary, can decrease profitability in the short- vision. As a result, they decrease market which covers combined metrics analysis term. In order to be valued and rewarded growth initiatives in the early, loss-making (Unit Economics Framework). accurately, it is important for SaaS solution years, thereby impeding future growth Growth Profitability Sustainability

The following three dimensions provide a lens through which these drivers can be categorized: Each of these broad indicators comprises several components. For example, customer growth and revenue growth Growth Profitability Sustainability are sub categories of growth, and each requires its own set of metrics.

Growth Profitability Sustainability

The three categories are broken down into sub categories as follows:

Subscriptions per CLTV Billings per Customer Customer Customer Growth Drivers Number of Customers

Accelerating Average Revenue per Growth TCV (Total Contract Value) Bookings User or per Account

Backlog Revenue Calculated Billings Deferred Revenue ACV (Annual Contract Time to Recognize Growth Drivers ACV to Billings Ratio Value) Deferred Revenue

Average ACV ARR/ MRR/ QRR

CAC (Customer Acquisition R&D Spend as a % of Marketing Costs as a % Costs) sales of ARR

Cost Drivers Sales Cost as a % of CTS (Cost To Serve) ARR

Optimizing Margin Drivers Gross Margins Recurring Margins Service Margins Mix Profitability

Cash Flow from Operating Cash Flow Months Up-front Cash Flow Operations Margins Drivers Free Cash Flow Net Cash per Share

Growth Efficiency Index ARR quota per FTE Renewal Rate

Sales & Marketing Customer Acquisition by Quota FTE by Channel Efficiency Channel Sales & Marketing Typical Acquisition Path Sales Effectiveness Expense/$ bookings LVR (Lead Velocity Rate) Drivers Sales FTEs for Acct. Avg. time for new sales Leads-to-trial Growth/BD Sales FTEs recruit to book a deal conversion rate Trial-to-paying-account ARR/Sales FTEs Sales Cycle Length conversion rate Average Length of Bookings/Sales FTEs Contract Securing Sustainability Retention Customer Churn Net Revenue Churn Quick Ratio Dollar-based Net Drivers Gross Revenue Churn Expansion Rate Customer Experience Volume and Types of Products per Customer Altitude Metric User Adoption Support Tickets Drivers Number of Features Accessed per Customer NPS (Net Promoter Score)

One must evaluate and apply these 1. Growth “Software as a Service (SaaS) metrics across the SaaS business life cycle is an industry still in its Growth, as measured by customer in a weighted fashion, as their relevance relative infancy. However, count and revenue, is the most critical and significance vary depending on the the inflection point for cloud stage of growth. performance indicator for SaaS companies, especially in their early years of operation. has been crossed, and the First, one must define each category and The rate of growth is linked to financial adoption of SaaS solutions is its associated drivers, charting their relative success and used to measure competitive set to increase significantly. importance along the SaaS business life positioning in the market, first-mover cycle. Refer to the appendix for details on advantage, and the capacity to capitalize Successfully balancing rapid how these drivers are calculated. on the network effect and move rapidly up growth and longer-term For the essential drivers to track – CLTV, the SaaS business model life cycle. economics with short-term Churn and User Adoption - we have profitability is critical for included proposed levers to guide success for public SaaS actionable strategies. 1.1 Customer Growth There are three ways to achieve customer companies. The key concepts Although these drivers can be tracked growth: outlined in this publication internally, some are tracked by external stakeholders. A. Increase customer base (number of including unit economics and customers) the “Rule of 40” provide a As the external metrics are based on publicly available information, they may B. Maximize sales penetration with sound foundation to measure not provide sufficient insights to the each customer (subscriptions/ and manage this delicate management team to manage and drive customer) trade-off. At RingCentral, we growth effectively. However, they are C. Maximize Customer Lifetime Value have been unique in continuing critical to track, as the results are expected (CLTV) to meet or exceed guidance provided to to demonstrate high growth investors and stakeholders. Internal teams Initially, SaaS companies focus on and concurrent substantial should also track external metrics. increasing their customer base, tracking improvement in profitability.” drivers such as the number of customers The external or internal nature of each and subscriptions per customer. However, — Clyde Hosein, CFO of metric is identified, using the following these drivers do not accurately assess RingCentral legend: customer growth. Selling SaaS is a long- term proposition; therefore Customer Metrics Metrics Lifetime Value (CLTV) is a far more tracked tracked insightful metric to use. internally externally CLTV is a holistic metric that includes insights into other key drivers, such as Investors and analysts will examine Annual Recurring Revenue (ARR), Cost external metrics over time (annually, to Serve (CTS), and Churn (more details quarterly), tracking them for a group on cost and churn drivers in following or portfolio of companies. They typically sections 2 and 3). use trends, year on year growth and few CLTV can be difficult to calculate, investors use Trailing Twelve Months especially since it includes variable metrics (TTM) timeframe to effectively compare associated with the customer, such as companies performance, given fiscal year churn and gross margin. However, it is a calendars may differ among individual critical metric for a SaaS company because companies within a portfolio. it can help focus on customers that offer the highest average lifetime value (LTV). It is also a critical input on where to peg the Customer Acquisition Cost (CAC), as the CLTV represents the return on the investment (CAC).

Disaggregating and segmenting the customer base can provide powerful insights that can be leveraged to maximize growth. During the launch phase, SaaS providers Levers to Maximize CLTV are focused on customer acquisition (CAC) – Growth – achieved through cross sell and up- and increasing customer subscriptions. sell During this phase, it is equally important Increasing Annual Contract – Product discounts to close deals to focus on the projected lifetime value of Value (ACV) each customer by measuring CLTV. – Controlling discounting practices to eliminate perpetual discounts As a SaaS business matures, while it may need to focus less on customer acquisition – Monitoring Cost to Serve expenses and Cost to (and associated costs), it should continue Serve expenses as a percentage of Revenue to track the number of subscriptions per customer, at least through the scaling Lowering Costs – Controlling operational expenses by reducing customer/ account specific costs, and by and optimizing phase: through renewals, optimizing infrastructure (data centers and farming the installed base becomes key colocation) after the initial growth. – Proactively preventing and reducing customer As the business matures, providers should Increasing Customer churn – number of customers begin tracking billings per customer while continuing to track CLTV. The Retention – Reducing dollar amount of churn – dollar value latter, as well as CAC, become easier to of churn measure as more data points become available (it typically takes 6-12 months or more of operations for reliable data to Customer Growth DriversCustomer – Definitions Growth Drivers be generated). Mature companies and providers implementing hybrid scenarios Estimation of the projected total gross margin value of CLTV: Customer Lifetime Value may find it challenging to track the CLTV a customer over the lifetime and CAC, due to shared costs (both on- premise and SaaS costs), which require Number of customers who have given a financial Number of Customers commitment for usage of the service allocation. A SaaS business should ensure that Includes the sum of all products subscribed by a single Subscriptions per Customer customer account CLTV, in the steady phase, remains at least three times the value of CAC to ensure viability, especially since SaaS is a Billings per Customer Monthly or annually, sum of billing per customer high-risk business where the impact of a technology shift is significant.

© 2016 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 22 Transforming your SaaS business Business Drivers (continued) Investors in SaaS companies focus on calculated billings, Key stages Scale and Target range which is calculated by adding of growth Launch Stabilize Optimize quarterly revenue to the change in deferred revenue from the prior Measured across the SaaS business life cycle More than 3 CLTV times CAC quarter to the current quarter. If Measured essentially a SaaS company is growing its at launch # of customers bookings, either through new Measured essentially at launch and scale business or upsells/renewals to Subscription/cust. existing customers, billings will Measured essentially at scale and stabilize Billings/customer increase. Some investors believe that calculated billings, rather than revenue, is a better forward- looking indicator of the health of 1.2 Revenue Growth a SaaS company for two reasons: Revenue is a critical metric for a SaaS For a SaaS business, the timing of billing (1) Revenue understates the true business. However, since revenue for is important as it can alleviate the cash SaaS delivery accrues and is recognized flow constraints that SaaS companies value of the customer because over time, it is important to analyze face in their early years. Generally, SaaS it gets recognized ratably revenue by drivers or proxies, such as companies bill enterprise customers bookings, calculated billings, recurring annual-in-advance with 30-day payment (2) Due to the recurring nature revenues, deferred revenue, and terms, and 30 to 45 days prior for renewals. of revenue, a SaaS company backlog. Some companies offer recurring, auto could show stable revenue payment options tied to a customer’s bank Backlog is derived from Total Contract over a period of time (just by account or credit card. Value (TCV) and represents bookings that working off its billings backlog), have not yet been billed. As such, it is Total Contract Value (TCV) is the total which could make the value of the customer contract. TCV not yet included in deferred revenue (i.e., business seem healthier than it out periods of TCV not yet recognized in includes one-time and recurring revenue, deferred revenue). Additionally, one should but only the recurring revenue for the truly is. consider the time required to recognize period specified in the contract (generally Some investors also further deferred revenue and backlog as includes all years for which the substantive calculate New Billings, as the revenue. termination penalty is required to cancel the contract). SaaS companies bill customers difference between current year Since revenue is recognized based on annual-in-advance, which represents the accounting standards, one must examine billings and previous year billings Annual Order Value (AOV) and in some billing data. SaaS billings, can be paid multiplied by the renewal rate. cases Annual Contract Value (ACV). Backlog in advance for a year or periodically represents deferred revenue from bookings It can be challenging to use throughout the lifetime of the contract, that have not yet been recognized. Backlog such as quarterly or monthly. Calculated Billings as a metric, metrics include the percentage of annual if a company employs non- revenue recognized from contracts at standardized billings policies (i.e. the start of the year and the percentage of quarterly revenue recognized from when billing customers monthly, contracts at the start of the quarter. quarterly, annual-in-advance or Bookings and deferred revenue are further three years in advance) or when analyzed based on seasonality and in light they have time and material of seasonal cash flow. professional services revenue.

Annual Recurring Revenue (ARR), In cases where there is upfront billing revenue growth can provide a good Monthly Recurring Revenue (MRR) and without revenue recognition, solution picture of the company’s health but only Quarterly Recurring Revenue (QRR) are providers treat the unrecognized portion if it is considered alongside the average similar drivers that measure the amount of the billing as deferred revenue, which remaining life to recognize this revenue. of revenue to be collected by a company represents services booked and billed but Looking only at the increase in deferred over a stated period of time. They can be not yet rendered. revenue is an unreliable indicator because measured annually, monthly, or quarterly, This is a controllable factor for the it could reflect factors such as a change in and they are important for subscription- company and provides a steady revenue billing terms (from monthly to an annual based companies as they show the stream in the near term. It is treated as a billing cycle), a change in customer mix value of contracts and the business as liability item in the balance sheet, which (SMB to enterprise) or other factors. a whole. The Average Revenue per decreases over the life of the contract as Although the change in deferred revenue User or per Account (ARPU or ARPA) revenue is recognized. is also tracked, either per-month or and calculated billings do not provide per-year, as an additional measure of A SaaS company can show growth in the best insights into growth drivers, the amount of revenue generated per deferred revenue if the average dollar external stakeholders still watch them customer or customer account. Changes amount over the remaining life of deferred closely. These external metrics, along with to ARPU/ ARPA need to be analyzed for revenues increases without the actual internal metrics, are relevant data points to underlying drivers - customer size, product revenues increasing. Therefore, deferred accelerate growth. mix, pricing to understand impact of controllable factors vs. competitive factors.

Revenue Growth Drivers – DefinitionsRevenue Growth Drivers

TCV: Total Contract Value Total value of the customer contract

Out year bookings not yet recognized in Backlog deferred revenue

Annual Contract Value of a specific subscription ACV: Annual Contract Value agreement

Average Annual Contract Value of subscription Average ACV Metrics used to analyze agreements bookings on a monthly basis: A New ACV Sum of all closed deals in a particular year Bookings B Upsell ACV (usually an annualized number) C (A+B) Recurring ACV Sum of revenue during the period (i.e. a quarter) and D Churn Calculated Billings change in deferred revenue E Down sell/ Scope Reduction Ratio of how much has been billed to the annual value F (C-D-E) Net ACV ACV to Billings ratio of a particular contract – evaluation of billing patterns # new customers Periodical recurring revenue over a specific period that # lost customers ARR/ MRR/ QRR does not include one-off fees

Average Revenue per User or Average revenue per user or account, either per month per Account or per year

Deferred Revenue Portion of a billing, liability on the balance sheet, which represents services that have not yet been provided

Time to recognize deferred Period of time over which services will be provided and recorded as revenue. A typical measure tracked is the revenue % of contracts that are within 1 year

During the launch phase, the number of customers and deal sizes are relatively small. Therefore, Annual Contract Key stages Scale and Launch Stabilize Target range Value (ACV) and bookings can be a of growth Optimize helpful predictor of future revenue Measured across launch and scale TCV/ Backlog growth. Bookings are analyzed as an Measured across the SaaS business life cycle annualized number since they may be ACV / Bookings ACV: 100-200% tied to contracts with varying durations Measured across scale and stabilize growth Calculated Billings (month-to-month, annual, or multi- Measured across launch and scale year subscriptions). The following ACV to Billings Ratio 1:1 components should be considered . Measured across the SaaS business life cycle ARR/ MRR/ QRR Annual Growth of when performing an ACV analysis: revenue: 25-36% Average Revenue per Measured essentially at launch and scale (depending if provider A. New ACV: ACV from new customer User or Account public/ private) Measured across launch and scale contracts, which is further analyzed to Deferred Revenue see what the business is buying and Measured across launch and scale Time to recognize at what price deferred rev. B. Upsell ACV: additional sales to existing customers, which include subscription upgrades/ complements/ expansion, to evaluate what upgrades G. Number of new customers: Number agreement by looking at the annual value have been acquired and at what price of new customers acquired over the of a contract and calculating the amount by existing customers month, analyzed per channel/service that has been billed to date. C. Recurring ACV: ACV from existing offering/customer population Another indicator that one should monitor subscription contracts, which is further H. Number of lost customers: Number beginning with the launch phase is the analyzed to see which subscriptions of customers lost due to churn over the Average Revenue per User (also calculated programs customers engage in, and month, categorized by the reason for at Customer and Account level). As the subscription-based revenue trends renouncing the service offering SaaS business stabilizes into its maturity D. Churn: loss of customers and/or As the business enters the growth phase, it typically has implemented a revenue during the month, analyzed to phase and begins scaling and optimizing series of annual recurring contracts, along determine and ultimately alleviate churn operations, it begins collecting money with leads for new customers. To grow the factors from its customers, turning bookings existing customer base of annual recurring contracts, SaaS businesses focus on upsell E. Down sell/ scope reduction: the into billings. As a result, the metrics that assume greater relevance at this stage and cross-sell opportunities, an effort to portion of bookings attributable to limit churn and increase billings. As the offerings proposed to customers are revenue (recognized and deferred) and calculated billings. business stabilizes billings and revenue who renounce the initial purchase, or recognition stabilizes, and the rate of that reduce the scope of their current The ACV to billings ratio is also important deferred revenue eases (unless there are subscription/ service and provides relevant insights during changes to multi-year billings). F. Net ACV: ACV from new and existing the launch phase. This ratio evaluates customer contracts for a particular year, billing patterns and measures the billing adjusted for lost ACV attributable to efficiency for a particular subscription churn

2. Profitability Cost Drivers – Definitions Cost Drivers One should analyze the profitability of a CAC: Customer Acquisition Total cost of sales and marketing efforts to acquire a SaaS company in terms of costs, margins Cost (per Customer) new customer, including the cost of on-boarding and cash flow, along with the related drivers for each of these segments. This CTS: Cost to Serve Costs of initial investment, all running costs, ongoing customer service, upgrades, and client relationship section also covers the need to balance growth and profitability and introduces the Total amount spent on Research and Development R&D spend as a % of Sales “Rule of 40” concept. expressed as a percentage of total sales revenue

2.1 Costs Sales cost as a % of ARR Total cost of sales expressed as a percentage of annual recurring revenue One of the biggest determinants of SaaS Total cost of marketing expressed as a percentage of profitability is Customer Acquisition Marketing cost as a % of ARR Cost (CAC). CAC is generally not included annual recurring revenue in calculating CLTV, as CLTV equals the gross margin from the customer over the customer lifetime. However, CAC is compared with CLTV to determine and optimize the CAC payback period. CAC is akin to an investment cost to Key stages Scale and Target range of growth Launch Stabilize acquire a customer for a SaaS business, Optimize and estimating the CLTV enables Measured the business to assess payback and essentially at launch CAC 20-33% of CLTV appropriate ROI on this element. spent on CAC Measured across scale and stabilize Recovery Time Cost to Serve (CTS), generally expressed Cost to Serve 1-1.5 years as a percentage of revenue, is another R&D spend as a percentage of Sales important cost component that impacts R&D profitability. To effectively manage CTS, Sales cost as a percentage of ARR Sales Cost SaaS companies should have effective Marketing cost as a % of ARR product and database server architecture Marketing Cost (modular architecture). A complex and ineffective architecture could lead to an inability to achieve benchmark gross margins. Costs as a whole are often large In the initial stages of a SaaS venture, company should develop a more modular and staggered, while revenues are more CAC can be greater than projected CLTV. architecture from the outset, incorporating predictable. However, as the business grows, CLTV scalability as a design principle. increases, with profitable businesses R&D spend as a percentage of Sales In the early stages of the SaaS business capable of maintaining a CAC that is compares the strength of companies, as life cycle, in an effort to increase brand considerably less than CLTV. it reveals the effectiveness of research awareness and credibility, providers expenditure relative to overall sales Similarly, CTS can be significantly higher in will likely choose to service enterprise (capitalized and amortized R&D costs, the first two stages of growth. It typically customers, However, this approach carries form part of this analysis). stabilizes later in the business life cycle, its own risks, and one should undertake depending on the solution provider’s these large projects only if they do not Sales Cost and Marketing Cost as a ability to leverage economies of scale compromise profitability and resourcing. percentage of ARR show the relative and market maturity. However, in some In such cases, management may need amounts of sales and marketing situations, it might be difficult to stabilize to track these large projects separately, expenditure to a company’s annual CTS if a SaaS company has a complex depending on the maturity of the SaaS recurring revenue, or steady income product or database server architecture. company. stream. In order to ensure CTS stabilization, the

2.2 Margins Margins Drivers – Definitions Gross Margins costs include application Gross margins are calculated as the difference between hosting costs, customer on-boarding Gross Margins subscription revenue and costs (including application costs, customer service costs, R&D hosting costs, etc.) over subscription revenue amortized costs vs. capitalized costs and third-party fees (such as software license Recurring Margins Recurring profits generated from running the SaaS business and data fees). In-house team contribution to gross margins versus third-party Service Margins Mix While gross margins are important, SaaS service providers contribution to gross margins businesses should analyze recurring and non-recurring margins separately. Recurring Margins are the profits that are generated from running the SaaS Scale and Key stages Launch Stabilize Target range subscription business. As investors favor of growth Optimize companies with a strong cash flow, the recent trend for emerging software companies is to expand operating margins. Measured across the SaaS business life cycle Service Margins Mix can help ascertain Gross Margins Gross margins 30-40% the economic value of partnerships, as Measured across the SaaS business life cycle it measures the contribution to gross Recurring Gross Recurring Margins Margins 83-85% margins of third-party service providers and partners. At launch and scale, it is Measured at launch and scale crucial to monitor and evaluate the value Service Margins Mix proposition of partnering with third-party service providers.

2.3 Cash Flow As they expand, SaaS companies face billing terms when contracting with their spend. A strong cash flow appeals to increasing cash flow challenges. At the customers. Smaller providers looking to bill investors and demonstrates a healthy same time, investors now turn their in advance usually need to incentivize their financial picture. attention to a healthy cash flow that is customers through price discounts and However, investors also consider the linked to increased operating margins. promotions. impact of pre-paid multi-year deals while While it is critical for SaaS companies to Cash flow from Operations and calculating operating cash flow margins, know when they will generate positive Free Cash Flow need to be measured and adjust for cash from long term cash flow, the ideal timing of achieving a throughout the life cycle of a SaaS deferred revenues. break-even status is imprecise. The timing company, and is as important as analyzing Net Cash per Share is a measure of a of cash collection – such as upfront billing, revenue and profitability drivers. Heavy company’s cash divided by the number where the SaaS solution provider bills the investment in the early stages of a SaaS of shares outstanding. It represents the customer the entire value of the contract business results in lower operating cash percentage of a firm's share price available at the beginning of the subscription period flows. It is therefore important to track this for immediate spending on other business – can help in synchronizing receipts with driver so that the business can prepare for activities, such as research, marketing, expenses. However, only established future growth and profitability. or other financial activities. It is also an solution providers can command such Cash on hand provides opportunities to important liquidity measure that signals if expand and increase investment in other the company would need access to capital areas, such as expanding research and in the near term. development or increasing marketing

Foreign Exchange A global customer base can make SaaS businesses more denominated and foreign currency denominated customer vulnerable to FOREX risks and currency fluctuations, contracts, calculating growth rates using constant currency. which can in turn impact revenue and profitability. The Hedging strategies – Currency fluctuations can have impact becomes more pronounced with growth and scale, adverse impacts on the operating income and cash flow as companies expand their global reach and geographic of SaaS solution providers that operate internationally. diversification. Different hedging strategies, in terms of revenue and cash SaaS providers with large international operations may want flow, are available to mitigate such volatility. to report their financial performance on a constant currency Such an approach requires strategic planning, with basis, using constant exchange rates (market analysts and accurate currency exposure forecasting (which currencies, investors use constant currency basis for their analyses and what volumes and over what horizon) and cash flow at valuations). risk evaluation (which factors in correlations between Impact on deferred revenue – Deferred revenue is currencies). recognized based on the foreign exchange rate at the date Financial instruments, such as options and forwards, are it is recorded in the financial statements. Future revenue usually combined to hedge forecasted sales in the normal is correspondingly recognized at the same rate as when course of business and reduce the risk that earnings and deferred revenue was originally recognized in the financial cash flows will be adversely affected by exchange rate statements. For example, a strong U.S. dollar at the time fluctuations. Hedging programs must be reviewed on an deferred revenue is recorded in the financial statements, ongoing basis to ensure effective coverage of forecasted would result in relatively lower revenue recognized in future cash flows (and any changes to forecasts), and proper periods, even if the U.S. dollar subsequently weakens. As calibration that matches current foreign exchange market such, it may be important to disaggregate ACV, deferred conditions and outlook. revenue and revenue by U.S. dollar

Cash Flow Drivers – Definitions Cash Flow Drivers

Cash generated from ongoing business activities, that provides Cash flow from operations an indicator of the health and liquidity of the enterprise

Measures available cash flow minus all capital expenditures, Free Cash-Flow or cash flow required to maintain or acquire assets

Cash generated from core operations per dollar of sales. A high Operating cash flow margins margin can indicate efficiency at converting sales to cash

Net cash for a company, divided by its shares outstanding – Net cash per share only applicable for publically listed companies

Measure of the sales team performance in achieving more Months Up-front customers’ payment in advance

As mentioned previously, SaaS businesses upfront cash flows of the on-premise customer and the amount of time make significant upfront customer license business. This creates a cash flow required to cover this initial investment acquisition investments at launch to crunch for SaaS providers. (for illustration purposes, a Customer secure their customer base. Cash inflows The following chart shows the impact Acquisition Cost of $5000 is considered, from these investments are generated of customer acquisition cost for one with a $450 monthly subscription gross over time, which is different from the margin).

Cumulative cash flows for one customer $12,000

$10,000

$8,000

$6,000

$4,000

$2,000 Month 1 Month 3 Month 5 Month 7 Month 9 Month 11 $0

$(2,000) Month 13 Month 15 Month 17 Month 19 Month 21 Month 23 Month 25 Month 27 Month 29 Month 31 Month 33 Month 35 $(4,000)

$(6,000)

This example reveals negative cash flows positive cash flow occurring in January of The more customers that are acquired, for the first 11 months following customer the following year. This cash flow crunch the greater the rate of growth and positive acquisition for one customer, with the first is a necessary prerequisite for growth. cash inflows, as illustrated in the graph below: Cumulative cash flows for multiple customers $250,000

$200,000

$150,000

$100,000

$50,000

$(50,000) Month 1 Month 3 Month 5 Month 7 Month 9 Month 11 Month 13 Month 15 Month 17 Month 19 Month 21 Month 23 Month 25 Month 27 Month 29 Month 31 Month 33 Month 35 $(100,000)

$(150,000)

Cumulative cash flows for 1 customer Cumulative cash flows for 5 customers

Cumulative cash flows for 20 customers

One way to alleviate this cash flow crunch is to incentivize customers to pay Scale and in advance. This can be done through Key stages Launch Stabilize of growth Optimize financial incentives, such as discount programs. This is typically feasible only for existing customers, as new customers are less likely to accept advance payment terms. Measured across the SaaS business life cycle Cash Flow metrics Getting more customers to pay in advance can help to reduce churn. The switching costs for these customers are higher, Measured across which increases customer lock-in. Months Months Up-front launch Up Front is the metric used to monitor the sales team performance in achieving more customers paying in advance. It can be used to incentivize team members as they seek to sign customers to such a program. Once the installed customer base has generated sufficient cash to cover the 2.4 “Rule of 40” initial acquisition costs, profits and cash There is a trade-off between growth and desirable. This rule recognizes the short- flow will become positive, with the return profitability. One can target profitability term impact on profitability due to a focus on investment proportional to the initial (and reduce spend/ focus on growth) on growth. Based on this rule, a company buy-in. As customer acquisition growth or focus on growth (at the expense of in the growth phase with an 80% growth increases, profits and cash flow balance short term profitability). This is primarily increase commensurately. To further because of Customer Acquisition Costs Rule of 40% = accelerate growth, providers may pursue for customer growth, while the Customer another round of investment. Lifetime Value takes longer to realize and Year over year revenue As the prospect of additional losses and recoup the initial investments. growth + pre-tax operating cash flow shortfalls may make investors As the business matures and enters the margins or free-cash flow wary, it is vital for both start-ups and “scale & optimize” phase, a new set industry veterans to communicate in of rules can be introduced that gauge advance of a new round of growth performance and help navigate growth and rate that produces 40% negative margins acceleration, in order to secure sufficient profitability. is acceptable. Given the premium attached funding for the company’s future and to growth for a SaaS business, the inverse sustained growth. One such rule, which evaluates the relationship—80% margins and negative relationship and balance between growth growth— is viewed unfavorably by and profitability, is known as the “Rule of investors. 40”. This rule considers the sum of growth rate and profitability: While one can consider this ratio at launch, the optimum point at this stage Used by market analysts and investors, would need to be as high as possible and Rule of 40 proposes that a combination not benchmarked at 40% – which is the of growth and profitability yielding 40% is threshold when operating at scale.

3. Sustainability Sales Effectiveness DriversSales – Definitions Effectiveness Drivers Monitoring the long-term sustainability of a Sales FTEs for Account Growth Efficiency Index NumberMeasure of of sales revenue staff growth devoted efficiency to account - relationship growth divided between by SaaS business is critical for success, with Growth/Sales FTEs for BD thecosts number incurred of staffto increase tasked growth with new and business actual revenue development growth particular focus paid to sales effectiveness, MeasuresAnnual recurring the effectiveness revenue ofdivided Sales andby the Marketing number spend of in the retention and user adoption. Sales andARR/Sales Marketing FTEs Efficiency previoussales staff period to generate revenue growth in the current period

Measure of how much a company spends on Sales and Sales and Marketing Expense/ Average number of bookings per member of sales staff 3.1 Sales Effectiveness Bookings/Sales$ bookings FTEs Marketing (S&M) for $1 of booking Because the sales and marketing function Sales FTEs for Account NumberThe growth of sales in the staff number devoted of qualified to account leads growth divided by in a SaaS company works differently from Lead Velocity Rate (LVR) Growth/Sales FTEs for BD themonth-over-month. number of staff tasked with new business development that of traditional software providers, measuring sales effectiveness in a SaaS Average time for new sales ARR/Sales FTEs TimeAnnual taken recurring for a newrevenue member divided of bythe the sales number staff of to sales make staff a business is crucial for understanding its recruit to book a deal booking from the time starting at the firm performance metrics. As noted earlier, treat enterprise customers differently SalesBookings/Sales Cycle Length FTEs (Days) TimeAverage from number initial interactionof bookings to per the member completion of sales of the staff sale, when considering sales effectiveness. in days Undertaking large projects early in the Average duration in months or years of a typical AverageARR Lengthquota per of Contract FTE Annual Recurring Revenue quota, by the number of total staff SaaS business life cycle boosts brand subscription contract awareness, but one must weigh this Measure of achieved renewals for all contracts up for against execution risks, profitability, and QuotaRenewal FTE by RateChannel Sales quota for each member of staff, categorized by channel the diversion of resources away from renewal (in terms of customer or contract value) product development. AverageCustomer time Acquisition for new sales by TimeNew takencustomers for a andnew subscribers member of categorizedthe sales staff by theto make a recruitChannel to book a deal bookingmethod fromor channel the time of bookingstarting at the firm

Typical Acquisition Path The growth in the number of qualified leads month-over- Lead Velocity Rate (LVR) Grouping and categorization of sales to subscribers by their (% of cohort) monthtype and method of becoming a subscriber

SalesARR Cycle quota Length per FTE (Days) TimeAnnual from Recurring initial interaction Revenue quota, to the bycompletion the number of theof total sale, staff

Average duration in months or years of a typical AverageQuota LengthFTE by ofChannel Contract Sales quota for each member of staff, categorized by channel subscription contract

Sales and Marketing Expense/ Measure of how much a company spends on S&M per $1 increase Renewal Rate inMeasure revenue of–actual achieved revenue renewals for look for back, all futurecontracts revenue up for for Actual or Future Revenue Growth forwardrenewal looking (in terms outlook of customer or contract value)

SalesCustomer and Marketing Acquisition Expense/ MeasureNew customers of how and much subscribers a company categorized spends on by Sales the method and or by$ bookingsChannel Marketingchannel of (S&M)booking for $1 of booking

Leads-to-trialTypical Acquisition conversion Path rate GroupingMeasures and the categorizationsuccess ratio inof persuading sales to subscribers leads to by their (%(funnel of cohort) metric) typetry out and the method product of becoming a subscriber

Leads-to-trialTrial-to-paying-account conversion rate Measures the success ratio in convertingpersuading trialleads subscribers to conversion(funnel rate metric) (funnel metric) intotry out customers the product

Trial-to-paying-account Measures the success ratio in converting trial subscribers conversion rate (funnel metric) into customers

The Growth Efficiency Index (GEI) is a measure of revenue growth efficiency across launch and scale, a composite Key stages Scale and metric that combines cost and revenue. of growth Launch Optimize Stabilize Target range This index looks specifically at the Measured at launch and scale relationship between costs incurred to Growth Efficiency Index Measured at launch and scale grow the company and actual revenue Sales and Marketing GEI < 1 efficiency increase (if any). Identifying these costs Measured at scale means differentiating between the FTE’s drivers Measured at launch and scale contract length recurring spend used to support day-to-day LVR LVR 10-20% higher than MRR operations (Cost of Goods and Services, Measured at launch and scale Sales cycle/ Average General and Administrative Expenses) and contract length Measured at launch and scale growth spend (namely sales and marketing Renewal Rates expenses, as well as customer success Measured at launch expenses – which consists of a dedicated Customer Acquisition Measured at launch and scale team for on-boarding new customers, Funnel Metrics managing customer references and so on). Achieving a GEI less than 1 is desirable, as this indicates that revenue growth exceeds costs incurred. A GEI greater than 1 is an indication to recalibrate S&M providers begin mapping FTEs (Full Time Lead Velocity Rate (LVR), or Lead spending. Employees) dedicated to new customer Momentum, measures the growth in the Tracking and benchmarking the GEI growth (hunting) and FTEs servicing number of qualified sales leads month- is particularly useful to more precisely existing client accounts (farming), along over-month, on a monthly basis. This calibrate growth efforts and goals. It with linking investment in sales force real-time metric is a revenue and growth reflects, at a high level, the sales and optimization to financial success via drivers trend indicator, which needs to be tracked marketing team’s effectiveness at such as ARR/ Sales FTEs. alongside other forward-looking metrics. generating revenue growth. As the business stabilizes into a phase of LVR is helpful when measured against Sales and marketing spend efficiency maturity, the focus shifts to exploring up- sales growth. Assessing the relationship is also measured across launch and scale, selling and cross-selling opportunities with between the two can detect underlying like the GEI. This metric investigates existing customers. At this point, metrics and structural problems. As sales leads the relationship between sales and such as FTEs dedicated to up-selling (with are generated, sales growth should marketing spend and revenue growth a view on increasing subscription revenue) proportionally increase. If sales leads are across different periods. Typically, this ratio and FTEs dedicated to cross-selling (with secured but sales growth does not follow examines spend incurred in the previous a view on increasing product revenue) proportionally, this may indicate that either period and the resulting revenue growth, gain significance – especially among the sales team quality is decreasing or a metric that reveals sales and marketing larger SaaS solution providers, who have the product is not keeping pace with efficiency. sufficient manpower to staff dedicated the competition. Either way, corrective teams. measures should be pursued. As the business graduates into a growth phase, optimizing the sales force remains In the launch phase, the focus is on Average Contract Length is a useful critically important. At this stage, solution hunting and acquiring target customers. In metric to track from launch through the this phase, it is more important for SaaS scaling phase. The SaaS business model solution providers to invest heavily in their favors a longer contract, as it secures sales force and marketing teams, making a more sustainable cash flow. As such, sure that a steady stream of qualified average contract length is a good indicator leads is generated and converted to paying of the contract portfolio’s health and customers in the least amount of time. can also serve as a metric on which to incentivize the sales teams.

Renewal Rates is used to assess 3.2 Retention the health and performance of a SaaS portfolio. Customer retention is as Churn, or the loss of customers and/or Additional tools and analyses are required important as customer acquisition. The revenue during a set period of time, can in order to fully understand and mitigate renewal rates, whether looking at number significantly impact the growth of a SaaS churn. One such tool is cohort (customer of customers or contract value, is the company. Although churn may not be as group) analysis, which regroups and flipside of customer churn. A higher meaningful during the launch phase, as a evaluates new customers for a given renewal rate indicates marketing and sales company grows, even a relatively low rate month. This analysis is performed month- effectiveness and is also an indicator of of churn can substantially impact revenue to-month and over the lifetime of the customer loyalty. and earnings. Because of its impact on relationship with the customer. It offers a growth, churn is a must-track metric comparative analysis between different As mentioned previously, customer across the SaaS business lifecycle. customer groups and provides insight acquisition is key during the launch phase. Customer Churn refers to the number into seasonality patterns, evaluating To maximize acquisitions, one must the effectiveness of measures aimed at understand the target audience behavior of customers that have discontinued their subscription during a given period of time. alleviating churn (such as new product and track the effectiveness of marketing features) and how different customer and sales campaigns. This allows the One must distinguish between revenue- or dollar-based churn and customer- groups react to such actions. Cohort enterprise to devise strategies and test analysis also provides insight into the customer-acquisition channels, directing based churn for an accurate analysis of performance. number of customers that are lost over customer acquisition costs and efforts a period of time while identifying when on the channels that yield the most Net Revenue Churn measure the churn stabilizes. customers and the steadiest stream of revenues lost during a given period due revenue. to the loss of customers or lower run rate Dollar-based Net Expansion Rate (DER) is another measure of customer Finally, from launch through scale, due to reduced features or users. A loss of non-subscription-based- or shorter-term retention, measured at one point in time. funnel metrics measure the sales team It presents a comparative analysis of effectiveness at converting a lead into products/services can lead to revenue churn. aggregate revenue for existing customers a paying customer across the sales (those in place for at least 12 months) for cycle. The leads-to- trial conversion rate Customer churn is dependent on the the current year against the prior year. It measures the success ratio in persuading size and total number of customers. As provides an image of revenue sustainability leads to try out the product (i.e. visitors-to- customers vary by size and value, there and is a marker of the quality of customer trial could be an appropriate replacement is an important distinction between losing relationship over time. DER can also be for a company where the strategy aims a top customer versus losing a bottom completed by a measure of how much at maximizing visitors). The trial-to-paying customer. For a company with varying support subscription revenue is added account measures the conversion product pricing, dollar-based churn is a over time. rate to the next stage, or how a lead more relevant indicator of performance. becomes a paying customer with a signed Dollar-based churn is also a key metric The “Quick Ratio” provides a view of subscription contract. for larger companies, as the focus is to a SaaS business’s growth efficiency. It accelerate growth, which can be achieved combines two SaaS metrics (revenue through negative revenue churn (which and churn in this case), and is used by occurs when the expansions/up-sells/ investors and internal management to cross-sells to existing customer base quickly benchmark growth performance. exceeds the loss of revenue from churn).

Customer churn is measured in terms Retention Drivers – DefinitionsRetention Drivers of net subscriber additions (net increase in the number of subscribers) and Customer Churn Net Subscriber additions and net subscriber churn net subscriber churn (change in the number of subscribers), and it reveals Revenue churn without upsells of existing Gross Revenue Churn the number of customers that were customers lost or did not renew against the total Dollar Retention Rate (DRR) percentage of revenue number of subscribers for a given period. Net Revenue Churn renewed from the previous year SaaS businesses tend to focus more on customer churn in their early years, Dollar-based Net Expansion Measure of customer retention and support as their objective is to acquire as many Rate subscription revenue expansion over time customers as possible to gain economies Measure of growth efficiency, which combines of scale. Churn Prevention is the success Quick Ratio revenue and churn. rate in reducing churn over a period of time. Revenue Churn and dollar expansion rates become important in the later Scale and years as the company becomes mature Key stages Launch Stabilize Target range enough to up-sell, cross-sell and drive of growth Optimize deeper engagement within each customer account. For measuring revenue churn, a Net Revenue Churn or Dollar Retention Measured across launch and scale Customer Churn <10% Customer Churn Rate (DRR) metric is sometimes used. for enterprise segment DRR includes the benefit of up-sells, Measured across the SaaS business life cycle Gross Revenue Churn cross-sells and price increases based on GAAP subscription revenue recognition. Measured at stabilize Net Revenue Churn If the DRR is 100 percent, it means the Measured at scale and stabilize company has renewed 100 percent of its Dollar-based Net DRR ~110% revenue from the previous year. DRR has Expansion Rate significant flaws because it considers both Measured at launch Quick Ratio Quick Ratio = 4 lost revenue from customer cancellation (i.e., lost customers due to unhappy customers) as well as down-sell and up-sell to existing customer (satisfied customers). As such, it would be better a negative value. This metric should be is 4, which means that for every $1 of to disaggregate the data and analyze analyzed across the entire SaaS business revenue lost during a specific month, Gross Revenue Churn to determine how lifecycle. $4 should have been added. As the much revenue is lost without considering Finally, the “Quick Ratio” provides a business scales, it becomes more difficult up-sells, and understand the causes of snapshot of a SaaS business’s growth to achieve the target of 4. This ratio is customer cancellations and down sells. efficiency, particularly during its launch therefore primarily to be used at launch as Gross revenue churn will always be higher phase. The commonly accepted target an additional metric for revenue growth. than net churn because it cannot have

Levers to Minimize Churn – Increase the revenue from a client by exploring additional opportunities once a Up-Sells and Cross-Sells relationship has been established – Demonstrate additional value to current offerings used by customers

– Optimal charging and pricing set for usage-based billing models Usage/overage-based Billing – Incorporate levels of price sensitivity

– Continue to grow the overall customer and revenue base organically to reduce New Customer Acquisitions the impact of any customers that are lost

– Reduces the turnover and risk of losing customers on a frequent basis with greater lock in for contract duration Longer-term contracts – Establishes longer relationships for guaranteed business

– Staff top talent to customers with low NPS scores to increase retention Focus on Risk Segments

– More accurately segment customers to assess churn risks while highlighting Channel/Product Segmentation strategies for retaining business

– Customer interaction and engagement on customer product needs and the ways to retain their business Customer Engagement – Feature sets that are sticky – determine what parts of the product are beneficial for retaining customers and reducing churn

– Constantly track customer satisfaction and analyze reasons for contract cancellation and customer churn Customer Retention – Track user adoption, a leading indicator of customer satisfaction > for specific metrics, please refer to section 3.3

3.3 User adoption To sustain its business, a SaaS company is being used after the subscription begins. the point of view of sustainability, any needs to closely monitor account health During the launch phase, drivers such as metric around user adoption should only and user engagement. Lack of user number of sign-ups, number of log-ins, and consider the base of monetized usage or adoption can lead to churn, and SaaS users on free trial are important to monitor users who drive revenue. solution providers need to watch several and analyze, as they reveal customer drivers that reflect how well the software acquisition and adoption. However, from

Levers to Maximize User Adoption – Analyzing product usage to improve usability – Increased trial conversion to full subscription, and encouraging Product Usage full and early use of the product during a trial

– Identify up-sell opportunities at early opportunities based on Feature Usage usage patterns and customer feedback

– Analysis of issues experienced by users to help on product support and to determine fixes/patches that may be required Volume and type of support tickets – Develop products based on the needs and perceived limitations of current offerings

– NPS is a customer loyalty metric. This metric can provide insights into Leading practices and drive focus to issues revealed by lower scoring customers Net promoter score (NPS) – A best practice guide can document learnings from successful strategies and be used as a reference for customer/account management

In the initial phases of a SaaS business, User Adoption Drivers – DefinitionsUser Adoption Drivers tracking product subscription data Number of products that each individual subscriber purchases. and feature usage data are critical. This Products per customer An attach rate is sometimes disclosed, which also measures can be either at an individual customer success in increasing products per customer account level or for the business overall. Number of features accessed As the business graduates into the growth per Customer Proportion of total features that are used by subscribers phase and then into maturity, it becomes important to look at the volume and type Volume and type of Support Total number of instances raised to support, the types of issues encountered and study on timings and variety of problems of deployment and delivery support that Tickets Raised existing customers seek. Net Promoter Score (NPS) Customer loyalty metric that is scored between -100 This is a critical input for product to +100, with positive scores considered good customization, product R&D investment Usage of service (data volume, number of users, decisions, troubleshooting and upgrades. Altitude metric computing cycles) / entitlements (monthly revenue) Across all stages, SaaS companies should track Net Promoter Score to gauge overall customer satisfaction. Altitude is another metric to be tracked Scale and across launch and scale. The Altitude Key stages Launch Stabilize Target range metric is particularly useful as a measure of growth Optimize of service usage with regards to customer Measured across launch and scale entitlements, and it can help calibrate Products and Features offers as well as pricing. Any measure of usage can be employed, whether it is data # of features accessed Measured across launch and scale per customer volume (i.e. GB/ months) or computing Measured across scale and stabilize cycles (i.e. monthly SQL cycles). In terms Volume and type of support of entitlements, revenue can be put into Measured across the SaaS business life cycle perspective with the measure of usage NPS selected. For example, some companies Measured across launch and scale define and track altitude as “Monthly SQL Altitude metric cycles / monthly revenue”. This defines upper and lower thresholds to determine the levels at which usage customers receive value for the money paid (whether they are paying too much or not using the service enough).

The previous sections defined For instance, an investment to accelerate Lifetime unit margin considers essential SaaS business and growth in the SaaS business would impact the following key metrics: near-and medium-term profitability (higher financial drivers, how to CAC), but would support longer-term interpret them and when to - CLTV sustainability, given the winner-takes-all track them across the SaaS Customer Lifetime Value, which is nature of the market. Similarly, investing business lifecycle. Tracking a key Growth metric, in higher-touch customer support might and analyzing these metrics penalize profitability in the near term (higher CTS), but increase lifetime unit individually is essential for - CAC Customer Acquisition Costs, margin and customer revenue as it assessing performance across which is a key Profitability metric, reduces churn. specific dimensions— growth, Unit economics can also provide broader profitability and sustainability. - CTS insights in terms of strategy. Consider There are several areas of Cost to Serve, which is a key a SaaS provider looking to make an inter-linkage between these profitability metric, acquisition. Target companies can either be acquired to support growth or increase dimensions. This dynamic - Churn profitability, depending on the strategy requires a holistic analysis or attrition, key sustainability pursued. Unit economics can help to identify trade-offs and metric. determine the lifetime unit margin of the consequences of strategic acquiring company in either scenario (all decisions and thus support other factors remaining unchanged). business strategy execution. Lifetime unit margin can also help The key to success in the SaaS business is assess short- and medium-term impacts to grow volume while leveraging scale to One such holistic framework approach of a strategy or acquisition on growth, optimize costs, thereby ensuring healthy is known as customer or contract unit profitability and sustainability. These cash flow streams and minimizing churn. economics, which supports decision key business decisions come with Tracking and analyzing individual metrics is making in the early stages, particularly consequences, and companies need to key for tracking success across individual at launch. This framework highlights understand the trade-off and opportunity dimensions. However, unit economics key relationships between metrics and costs of selecting one strategy over provides a holistic framework for analyzing the impact of investment opportunities another. business performance and supporting on growth, profitability and sustainability. strategy execution. Customer or contract unit economics uses lifetime unit margin as a marker to measure customer profitability in terms of the costs incurred in acquiring, servicing and retaining the customer.

For all SaaS companies—from Strategic Planning startup to global market leader, Using traditional software business drivers like Salesforce—the journey on a SaaS business can lead to unwise Leading practices needs to be navigated carefully. business decisions. Understanding the Get leadership buy-in for a long- The latest financial results of specifics of the cloud model, and more term cloud vision traditional software stalwarts specifically the SaaS model, is paramount to identifying and setting up the right – Decide on the right performance such as Oracle and SAP indicate business drivers. For example, under metrics that despite a rocky SaaS start, the cloud model, valuation is driven by - Assign ownership of these with numerous challenges, these subscriptions and bookings, rather than metrics total revenue. Anticipating this can alleviate companies can achieve success. - Fix goals and targets (markers) Tremendous opportunities operational challenges and enable setting the right controls and governance around against these metrics and chart exist for companies that can the new focus drivers. an implementation roadmap integrate relevant business Not only does the right set of drivers - Plan for continuous and model benchmarks to gain a need to be identified, but ownership for seamless monitoring of competitive advantage. each set also needs to be assigned to the metrics as well as user different business units. Communication feedback SaaS providers can expect myriad of these drivers is also key. Traditional challenges at nearly every stage of - Communicate around the software providers that decide to transition growth, including planning, budgeting metrics (also externally in the to a SaaS business model will need to for resources and forecasting, and when case of public companies communicate their new SaaS drivers and measuring the overall performance of the forecast markers internally and externally – Plan for revamping existing business against its forecasts. Companies to secure key stakeholder buy-in. business processes – particularly that have successfully navigated the the sales and marketing SaaS life cycle offer a number of Leading The sales, marketing and the finance organization and the finance practices to avoid these pitfalls. While the organizations need to be designed to organization transformation experience and success support a SaaS business. mantra is unique to every business and SaaS providers often neglect the – Set up supporting systems that depends largely on seamless execution, importance of user adoption and feedback. enhance customer experience these Leading practices can provide As a result, despite offering a compelling – Build sophisticated usage directional guidance to both existing product, many SaaS providers lose analytics in subsequent upgrades SaaS companies and those considering a enterprise customers because of low and releases transition to SaaS. adoption. SaaS delivery allows tracking usage closely to draw meaningful insights on usage behavior patterns. Neglecting this opportunity and overlooking user feedback can be detrimental to success. On the other hand, by exclusively emphasizing the core product offering, the SaaS provider loses focus on supporting systems, such as on-boarding, billing and provisioning, all critical for sustained adoption.

Budgeting and forecasting Forecasting success for a SaaS business The market distinguishes short-term SaaS players across size is limited by the amount of visibility guidance misses for on-premise providers management has on recurring revenues, versus those for pure SaaS solution and stage of growth may churn, renewals, and new subscription providers. An on-premise solution not be fully utilizing growth. Precision in churn prediction provider typically misses its short-term should be a high-priority area, as guidance because it lacks sufficient new internal and unforeseen churn impacts growth and bookings (the result of market softening, adds to costs, thereby impacting both changing customer preferences, increased external data margin and cash flow. By closely watching competition or sales force effectiveness). usage patterns, providers can better For a SaaS solution provider, short- to draw actionable insights predict (and prevent) churn. term revenues and earnings are driven on churn management. Cost calculations typically draw the predominantly by existing bookings. Missing the revenue and earnings attention of solution providers. However, Leading practices these may underestimate less obvious guidance by a SaaS solution provider cost elements, which can result in is viewed as a finance/FP&A issue and – Look out for all hidden costs and may create market credibility challenges significant repercussions. Cost of cash burn rate compliance is one such element. In some that impact longer-term forecasts. It is – Keep a strong eye on CAC and highly regulated industries (healthcare, for therefore essential to invest in FP&A skills CLTV, as well as churn instance), misunderstanding compliance and capabilities to develop robust financial requirements (HIPAA, for instance) may forecasting models. – Develop visibility on recurring lead providers to understate cost. Similarly, revenue rhythm underestimating CAC or CTS could derail – Maintain visibility on new the budgeting exercise. subscription growth

Reporting and governance SaaS businesses need to monitor dashboards should be designed to provide performance against relevant KPIs on a timely performance reporting to different Leading practices continual basis. Two factors can impede business groups. – Inculcate a culture of this process: Granularity of reporting is another measurement – Not inculcating a culture of measurement important requirement many SaaS providers tend to overlook. SaaS – Develop disciplined financial – Failing to implement disciplined financial processes processes businesses are comprised of many interrelated parts; tracking each can be – Consistently prepare and The lack of a measurement culture can daunting. For instance, although business distribute different dashboards lead to inaccurate data and metrics while & investment costs are integrated in tailored to the different parts of placing increased administrative burdens traditional cost reporting, the two should the business on employees. The lack of a robust be separately measured to drive more financial process–one that enables end- informed decision-making. – Ensure timely performance to-end control on invoicing, collections reporting and renewals and that closely tracks If SaaS solution providers fail to invest in revenues and expenses – will lead to proper reporting tools that measure and operational hardships when the need for manage the relevant drivers at the required measurement arises. level of granularity, it will face sustainability challenges. It is critical to evaluate the SaaS solution providers require sufficiently trade-off between the effort required to mature frameworks, tools and systems gather detailed information and the value that can handle standard reporting tasks that such insights provide. This balancing while being flexible enough to extract approach helps prioritize metrics and data for customized insights. Customized reports to grow and sustain the business.

Operational transformation priorities

The unique nature of the SaaS business – Sales force management: Sales force necessitates a focus on key operational management is a critical requirement for Leading practices areas. This is especially true for existing SaaS companies. This includes funnel – For “pure-SaaS” solution product/ software companies that are metrics, growth/velocity metrics, sales providers, define and align entering the SaaS market, as they must force productivity metrics, cost, churn around “must-get-right” factors contend with business models and and cash flow. A key success factor is during the launch phase go-to-market models specific to the designing the right metrics that align existing business as well as the new SaaS the incentives of the sales force with – Existing companies launching a business. the value drivers for SaaS, such as ACV, SaaS offering need to evaluate the strategy for the SaaS Priority areas include: bookings growth, up-sell and wallet- share growth, advance payment and division upfront – whether it will – Billing models: SaaS offerings typically churn management. be standalone/ separate at the include monetization models such outset, completely integrated as subscription, utility and Enterprise – Finance operations & processes: The unique needs of the SaaS model have a or incubated at launch but Licensing Agreements (ELAs). There separated based on scale are variants including Freemium as well broad impact on finance beyond planning as Try and Buy designed to attract new and touch on budgeting, forecasting – The fast-changing nature of the customers. The variety of billing models and reporting. Key impact areas industry necessitates periodic, coupled with payment options warrants include billing and invoicing, revenue strategic reviews to ensure careful consideration. recognition, revenue assurance, external rapid course correction reporting, investor relations, taxation and – Pricing and profitability: The pricing compliance. Several companies have models for SaaS offerings are complex invested in systems and infrastructure, and include volume, bundle, renewal and such as new billing engines, revenue customer-based discounting. Analysis recognition systems and revamped ERP service velocity, and customer retention. of profitability at a gross and net margin suites to support this model level is challenging, especially with SaaS company leaders need to drive a the addition of ELA variants for large – Product architecture: As a core design “Customer-first” culture and invest in customers. An effective deal review principle, it is critical for the SaaS product talent management. Customer service and margin analysis process including to be both modular and scalable. This and operations for SaaS companies the deal desk composition is a key optimizes Cost to Serve (CTS) during the require a different structure, processes, requirement for the SaaS model growth phase. Also key is to ensure an metrics, and governance, open architecture, which ensures high – Regulatory compliance: The complex – Customer segmentation: Customer system availability and interoperability segmentation in the SaaS market nature of the SaaS business presents with leading technology solutions, multiple compliance challenges, uses usage and behavioral elements thereby enhancing adoption. extensively. An added layer of complexity including data privacy, security & risk is the choice of go-to-market channels, – Customer service and operations: management, licensing, transfer pricing including direct, partner, reseller and Customer satisfaction is a critical and taxation (including cross border). distributor. It is important to design success factor. The SaaS business Additional requirements are involved a customer definition, hierarchy and model success is driven by rapid growth, when working with government entities. segment definitionthat closely mirror the Complying with applicable requirements solution provider’s business strategy. is essential for sustainability.

Strategic drivers: formulae and examples

Growth

Estimation of the projected total gross margin value CLTV of a customer over the lifetime

Number of customers who have given a financial Number of Customers commitment for usage of the service

Customer Subscriptions per Includes the sum of all products subscribed by a Growth Drivers Customer single customer account

Billings per Customer Monthly or annually, sum of billing per customer

TCV Total value of the customer contract

Out year bookings not yet recognized in deferred Backlog revenue Accelerating Annual Contract Value of a specific subscription Growth ACV agreement

Average Annual Contract Value of subscription Average ACV agreements

Sum of all closed deals in a particular year (usually Bookings an annualized number)

Revenue Sum of revenue during the period (i.e. a quarter) and Calculated Billings Growth Drivers change in deferred revenue

Ratio of how much has been billed to the annual ACV to Billings ratio value of a particular contract

Periodical recurring revenue over a specific period ARR/ MRR/ QRR that does not include one off fees

Average revenue per Average revenue per user, either per month or per user/per Account year

Portion of a billing, liability on the balance sheet, Deferred Revenue which represents services that not yet provided

Time to Recognize Period of time over which services will be provided Deferred Revenue and recorded as revenue

Customer Growth Customer Lifetime Value (CLTV)

CLTV CLTV is the ratio of recurring revenue to churn percentage that is = (Average revenue per account the average gross margin (i.e., gross revenue less cost to serve) * Gross Margin) that all customers will generate before they churn or cancel the * (1/Churn %) subscription.

CLTV Projected Projected CLTV: The true reflection of CLTV is estimating the = NPV {[ ]T [(ARR-CTS X (Churn + projected total gross margin of a customer over their lifetime. It Capital interest rate)) / considers the NPV of the annually recurring revenue (net of cost to (Churn + Capital interest rate – serve) spread across the life of the contract and discounted by the Growth rate)]} churn rate, capital interest rate and the growth rate of the business.

Number of Customers

Number of customers represents those who have given a financial #Customers = commitment for usage. This excludes users on free trial, number of Total sign-ups – Free Trials log-ins, etc. The user base should only include monetized usage or users that drive revenue.

Subscriptions per Customer

Subscriptions-per-customer includes the sum of all products Subscriptions per customer = subscribed to by a single customer account. This does not measure =(Products subscribed by different instances of access by a single customer account/ customer account) subscriber.

Billings per Customer

Billings per customer = (amount invoiced per customer)/ Sum of billing for a specific customer, measured yearly or monthly. month

Revenue Growth The various components of revenue for a SaaS company are best explained through the simple illustration below: ABC Inc., a SaaS solution provider has the following set of customer subscriptions:

Customer Lead converted Contract commitment Upfront commitment Contract Value

A Jan’15 Yearly US$200 US$2,400

B Jan’15 Monthly US$120 US$120

C Feb’15 Yearly US$120 US$1,440

D Feb’15 Yearly US$120 US$1,440

E Mar’15 Yearly US$200 US$2,400

F Mar’15 Monthly US$200 US$200

G Apr’15 Yearly US$120 US$1,440

Assumption: Customers with yearly plans pay upfront for the whole year; customers with monthly plans pay on a per-month basis.

Total Contract Value (TCV)

TCV = Total value of the customer contract, including one time and recurring (Upfront and recurring payments revenue, over the entire period specified in the contract. over life of subscription)

Backlog

Backlog results from the out year bookings not yet recognized in Backlog = deferred revenue. Backlog metrics include the percentage of annual (out year bookings not yet revenue recognized from contracts at the start of the year and the included in deferred revenue)/ percentage of quarterly revenue recognized from contracts at the revenue at start of period start of the quarter.

Number of Customers

ACV = Annual value of the customer contract, including one time and (Upfront and recurring payments recurring revenue, over the first year of the agreement. ACV can also over first year of subscription) be viewed in concert with Customer Acquisition Costs.

Bookings

Month Monthly Bookings

Jan’15 US$200 Yearly + US$120 monthly = US$2,520 Bookings = (Closed deals, with different Feb’15 US$120 Yearly + US$120 Yearly = US$2,880 prices and durations) Mar’15 US$200 Yearly + US$200 monthly = US$2,600

Apr’15 $120 Yearly = US$1,440

Bookings is a contracted value. Each month, bookings only. Annual contract bookings represents the sum of all represent the sum of all closed deals for that particular month closed deals in a particular year

Calculated Billings

Month Monthly Bookings

Jan’15 US$200 Yearly + US$120 Monthly = US$2,520 Monthly billing = (Billing per Feb’15 US$120 Yearly + US$120 Yearly+US$120 Monthly = US$3,000  month per customer) Mar’15 US$200 Yearly + US$200 monthly+US$120 Monthly = US$2,720

Apr’15 US$120 Yearly+US$120 Monthly = US$1,560

– For contracts with yearly plans, billing has been considered – For contracts with monthly plans, billing has been considered for 12 months upfront. on a per-month basis.

ACV to Billings ratio

Ratio of how much has been billed (yearly contract) to the annual value Ratio = of a particular contract. This typically evaluates billing patterns. The ratio ACV/ Calculated Billings becomes more favorable as more payments are made up-front.

Revenue

MRR = Month Monthly Monthly Recurring Revenue (MRR) = (Revenue per month  per customer) Jan’15 US$200 + US$120 = US$320 QRR = 3 X MRR ARR = 4XQRR

Month Monthly Bookings

Feb’15 US$200 + US$120 + US$120 +US$120 = US$560 Total Revenue US$200 + US$120 + US$120 +US$120 +US$200 + US$200 = = ARR +Non-Recurring Revenue Mar’15 US$960 US$200 + US$120 + US$120 +US$120 +US$200 + US$200 + Apr’15 US$120 = US$1,080

– The monthly recurring revenue (MRR) for each month – Quarterly recurring revenue (QRR)/Annual recurring revenue comprises the monthly revenue recognized for each contract, (ARR) can be either a sum of individual MRRs or an average of irrespective of the yearly/quarterly/monthly plan subscribed as particular months. part of the contract. – ARR is an annualized amount that can be added to annual, non-recurring revenues in arriving at total revenue.

Average Revenue per User or per Account

Average Revenue The average revenue per-user or per-account metric measures the average revenue per per Account = customer account over a given time period (typically average recurring revenue per account ARR / Number of Customers over a year).

Deferred revenue Monthly Deferred Month Monthly Billings Monthly Revenue Revenue

Jan’15 US$2,520 US$320 US$2,200 Monthly deferred revenue Feb’15 US$3,000 US$560 US$2,440 = Billings – Revenue Mar’15 US$2,720 US$960 US$1,760

Apr’15 US$1,560 US$1,080 US$680

Time to recognize deferred revenue

Time to recognize deferred revenue = Period of time over which services will be provided and recorded as revenue for a particular average remaining life to contract. This metric is typically reviewed in context of the change in deferred revenue. recognize revenue

Profitability Customer Acquisition Cost. Total cost of sales and CAC marketing efforts to acquire a new customer

Costs of initial investment, all running costs, ongoing CTS customer service, upgrades, and client relationship

R&D Spend as a % of Total amount spent on Research and Development Cost Drivers sales expressed as a percentage of total sales revenue

Sales Cost as a % of Total cost of sales expressed as a percentage of annual ARR recurring revenue

Marketing Costs as a Total cost of marketing expressed as a percentage of annual % of ARR recurring revenue

Gross margins are calculated as the difference between Gross Margins subscription revenue and costs (including application hosting costs, etc.) over subscription revenue Optimizing Margin Drivers Recurring Margins Recurring profits generated from running the SaaS business Profitability In-house team contribution to gross margins versus third- Service Margins Mix party service providers contribution to gross margins

Cash Flow from Cash generated from ongoing business activities; indicator Operations of the health and liquidity of the enterprise

Free Cash Flow Measures available cash flow minus all capital expenditures

Cash Flow Operating Cash Flow Cash generated from core operations per dollar of sales. A Drivers Margins high margin can indicate efficiency at converting sales to $

Net cash for a company, divided by its shares outstanding – Net Cash per Share only applicable for publically listed companies

Measure of the sales team performance in achieving more Months Up-front customers payment in advance

Costs Customer Acquisition Cost (CAC)

CAC per customer CAC represents the sum of all one-time costs of all marketing and sales activities and the = (Sales, Marketing costs physical infrastructure and systems required to motivate a customer to purchase. This  incurred during the period) / includes fully loaded labor costs, which are typically quoted as an average unit Total number of customers added cost per new customer (generally it is the total department costs/ total sales and marketing in the period costs)

Cost To Serve (CTS)

CTS CTS as a percentage of revenue is typically used. CTS includes engineering, support, = (Recurring Service Expenses)/ account management, customer service, billing activities, physical infrastructure, systems  and fully loaded labor costs. revenue

Spend as a % of revenue or sales R&D spend as a % of Sales

– R&D spend as a % of Sales = [ ] (Research & Development costs)/ Sales Ratios evaluating spend – Sales cost as a % of ARR = [ ] (Sales team costs)/ ARR vs revenue – Marketing cost as a % of ARR = [ ] (Marketing spend)/ ARR

Margins Gross Margins

Gross Margin = Gross margin includes elements such as application hosting costs, customer on-boarding (Subscription revenue – costs, customer service costs, and any third-party fees such as software licenses or data subscription COGS) / Subscription fees. revenue

Recurring Margins

Recurring Margin = Annualized Recurring Expense Recurring profits include sales and marketing costs of replacing churn, but exclude any (COGS + G&A + R&D) / Entering other costs of growing the business beyond churn replacement. ARR

Service Margins Mix

Service Margins Mix In-house contribution = In-house teams service margins/ gross margins The Service Margins Mix identifies the contribution to gross margins from in-house teams Third-party contribution = Third- versus those made from third party providers and partners, thus evaluating the economic party service provider value of these partnerships. service margins/ gross margins – To be repeated for all partners/ third party providers

Cash Flows Cash flow from Operations

– Cash burn rate = Cash spent per month, quarter, or year Relevant cash flow from operations ratios – Cash in cash out = Cash flow at the end of the month, quarter, year; revenue at the end of the month, quarter, year

Free Cash Flow

Free Cash Flow = Measures available cash flow minus all capital expenditures, or cash flow required to Operating cash flow – capital maintain or acquire assets. expenditures

Operating cash flow margins

Ratio Cash generated from core operations per dollar of sales. A high margin can indicate = cash flow from operations)/  efficiency at converting sales to cash. $ 1 sales

Net cash per share

Net cash/share = Net cash for a company divided by its shares outstanding (applicable only for publically net cash/ #shares listed companies).

Months Up-front

Measure of payment received in advance, which is critical for SaaS businesses. More Months Up-front = payments upfront can alleviate the cash crunch felt by SaaS businesses in their early Avg. number of months payment years. This metric can be used as an incentive for sales teams to persuade clients to pay received up-front/ New bookings in advance.

Sustainability Growth Efficiency Relationship between costs incurred to increase growth Index and actual growth

Sales and Marketing Measure of sales and marketing spend vs revenue growth, Efficiency future revenue growth and $ bookings

Sales, bookings, ARR, number of staff devoted to sales, FTE’s based drivers average time for new sales recruit to book a deal

The growth in the number of qualified leads month-over- LVR month. Sales Effectiveness

Drivers Time from initial interaction to the completion of the sale, in Sales Cycle Length days

Average Length of Average duration in months or years of a typical Contract subscription contract

Customer Acquisition Customer acquisition by channel, typical acquisition path

Measure of achieved renewals for all contracts up for Renewal Rate renewal (in terms of customer or contract value)

Measure of leads to trial and trial to paying account Funnel metrics conversion, across sales cycles

Customer Churn Net Subscriber additions and net subscriber churn Securing Gross Revenue Churn Revenue churn without upsells of existing customers Sustainability Dollar Retention Rate (DRR) percentage of revenue renewed Retention Drivers Net Revenue Churn from the previous year

Dollar-based Net Measure of customer retention and support subscription Expansion Rate revenue expansion over time

Measure of growth, efficiency, which combines revenue and Quick Ratio churn

Products per Number of products that each individual subscriber Customer purchases

Number of Features Proportion of total features that are used by subscribers Accessed per Customer

User Adoption Volume and Types of Total number of instances raised to support, the types of Drivers Support Tickets issues encountered and variety of problems

Customer loyalty metric that is scored between -100 to Net Promoter Score +100, with positive scores considered good

Usage of service (data volume, number of users, computing Altitude metric cycles) / entitlements (monthly revenue)

Sales Effectiveness Growth Efficiency Index (GEI)

GEI is a measure of revenue growth efficiency, which looks at the relationship between costs incurred to increase growth and the actual revenue increase. Growth expenses include sales and marketing expenses, as well as customer success expenses. The GEI can also be measured on ACV. GEI = Growth Expense / ARR Growth Additionally: – ARR Growth = Growth Expense / GEI - Illustration: consider a growth expense of 0.6 and a GEI of 1.4, with a churn rate of 25%, this would give a net ARR growth of approximately 18%

Customer Acquisition

– Number of FTEs dedicated to new customer acquisition – Bookings per sales FTE = ACV/total number of sales FTEs – Average time for new sales recruit to book a deal Ratios looking at monetization – Leads-to-trial conversion rate = Trial subscribers/Leads of customer acquisition efforts – Trial-to-paying-account conversion rate = Booked customers/Trial subscribers – Customer acquisition by channel – Sales cycle length – Average length of contract = average duration (in months or years)

Lead Velocity Rate (LVR)

LVR = Avg. [(Qualified leads for current – Represents qualified sales lead growth. month – Qualified leads for last month) / – Helps define long-term marketing and product strategies

Qualified leads for last month]*100

Renewal Rates

– Customer renewal rate equals the number of customers who renewed their contracts / Renewal rates in terms of number of contracts up for renewal. customers and $ – $ Renewal rate equals the value of contracts renewed / value of contracts up for renewal.

Customer Maintenance

– FTEs dedicated to new customer growth/ FTEs servicing existing client accounts = (FTEs that acquire new customers/ %sales FTEs that maintain existing customers)*100 Ratios looking at monetization of – ARR/Sales FTEs customer maintenance efforts – FTEs for cross-selling = (FTEs dedicated to selling more products/total FTEs)*100 – FTEs for up-selling = (FTEs dedicated to subscription revenue growth/total FTEs)*100

Sales and Marketing Efficiency

Sales and Marketing Efficiency = – Measures Sales and Marketing efficiency in generating revenue growth. This metric Last period sales & marketing evaluates the relationship between S&M spend in the previous period versus attributable expense/ (Current period revenue – revenue growth. Last period revenue) – Another variant of this is known as the “Magic Number.”

Other ratios looking at sales and – Sales & Marketing Expense/$ bookings marketing effectiveness

Retention Customer Churn

Customer churn = #Customers cancelling contracts Represents percentage rate of customer cancellations over time, usually on an annual basis. Total Customers*Elapsed time Can also be calculated as a ratio between renewing customers and expiring customers. (annually)

Gross Revenue Churn

Gross Revenue Churn = Revenue churn rate without effect from upsells or upgrades from existing customers. (Churn and contracted revenue)/ Typically, revenue used in calculating Gross revenue churn is MRR or ARR. revenue at beginning of period

Net Revenue Churn

DRR = Dollar-based retention rate (DRR) includes the benefit of upsells, cross-sell and price (ARR at the start of the year) / increases based on GAAP subscription revenue recognition. If DRR is 100 percent, that (ARR at the end of the year) simply means the company renewed 100 percent of the revenue from last year.

Dollar-based Net Expansion Rate

– Dollar-based Net Expansion Rate (DER) is a measure of customer retention at one point in DER = time. aggregate ACV at t for customers – An extension of this rate consists in evaluating how much support subscription revenue already customers 12 months prior/ has been added over time, as a further indicator of revenue sustainability. This rate is aggregate ACV at t-1 for customers calculated on an individual support subscription contract basis and is equal to the total 12 months prior subscription contract value at one point in time divided by the number of years remaining on the contract at that point in time.

Quick Ratio

Quick Ratio = The “Quick Ratio” provides a snapshot of a SaaS business’s growth efficiency, particularly (New MRR + Expansion MRR) / during the launch phase. It is used by investors and internal management to rapidly (Cancelled MRR + Contraction benchmark growth performance and is constructed by combining two iconic SaaS MRR) metrics, namely revenue (Monthly Recurring Revenue in this case) and churn.

User Adoption Product and feature subscription

– Product purchase = Volume of products sold in a year/total number of customers.

Product and feature subscription – Feature usage = (Number of features purchased + number of annual upgrades)/total number of customers. metrics – Volume and type of support tickets = Volume of support tickets/total number of customers.

Net promoter score

– Promoters are loyal enthusiasts who will keep buying and referring services to others, NPS thereby fuelling growth. Significant up-selling and cross-selling opportunities exist. = (Promoters – Passives are satisfied but unenthusiastic customers who are vulnerable to competitive + Passive customers offerings. + Detractors) – Detractors are unhappy customers who can impede growth.

Altitude metric

Altitude = Measure of usage – Usage of service (data volume, number of users, computing cycles) / entitlements (i.e. Monthly SQL cycles) / (monthly revenue). entitlements (i.e. monthly revenue)

KPMG: An experienced team, a global network KPMG’s professionals combine industry knowledge with technical experience Prasadh Cadambi to provide insights that help Partner, Technology Industry technology industry leaders Prasadh has over 20 years of experience and serves as a lead partner overseeing and take advantage of emerging managing global audit teams. Additionally, he advises some of the world’s leading business opportunities and software and SaaS companies to help them implement new business models and proactively manage business transformation programs, complex transactions, M&A and capital raising transactions. He advices software and SaaS sell-side equity analysts on emerging accounting issues challenges. and financial statement analysis. He has also authored numerous publications, including Our network of professionals KPMG’s publication on building a successful cloud provider service. He is KPMG’s in 155 countries, have representative on AICPA Software Revenue Recognition Task Force. extensive experience working with global technology companies ranging from the Fortune 500 to pre-IPO startups. We aim to anticipate the short-and long-term opportunities of shifting business, technology and financial strategies. Satya Easwaran KPMG operates as a global Partner, Advisory network of independent Satya has over 20 years of experience working with leading global companies across member firms offering audit, USA, Asia, Africa, Australia and Europe. He serves as a Management Consulting tax and advisory services. partner assisting CxOs in the areas of strategy, business and finance transformation as companies continue to embrace new business models and digital innovation. He has established deep C-suite relationships with leading global companies in the high- tech and other sectors and helped them in conceptualizing and executing transformational initiatives. He is a frequent speaker at industry forums and has also authored multiple publications on leading practices in finance and transformation priorities.

Co-authors KPMG would like to thank the following tech industry Chaitanya Gogineni leaders for their valuable insights: Director, Management Consulting Mark Hawkins, CFO, Salesforce.com James P. Murphy Neil Williams, CFO, Intuit Director, Management Consulting Steve Cakebread, CFO, Yext Mark Culhane, CFO, Lithium Technologies Lead contributor: Mark Pele Bob L. Corey, CFO, CallidusCloud Ron Gill, CFO, NetSuite Additional contributors: Mark Garrett, CFO, Adobe Sutithi Chakraborty Kevin Bandy, Chief Digital Officer, Cisco Jonathan T. Hsiung R. Scott Herren, CFO, Autodesk Anuj Mathur Mike Kourey, CFO, Medallia Michael D. McCormick Matt Quinn, CTO and EVP Products & Technology, TIBCO Christopher Padden Clyde Hosein, CFO, RingCentral Patricia Rios Parikshit Sinha Siddharth Sureka Adrien Vion

© 2016 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. For more information about this publication, or to learn how KPMG can help your Cloud (SaaS) business, please contact us:

Prasadh Cadambi Chaitanya Gogineni Partner, Technology Industry Director, Management Consulting +1 650-793-4129 +1 408-306-0480 [email protected] [email protected] Satya Easwaran James P. Murphy Partner, Advisory Director, Management Consulting +1 650-391-5365 +1 650-796-4163 [email protected] [email protected]

For more information about the Technology Industry practice, please contact: Gary Matuszak Richard Hanley Global and U.S. Chair Technology, U.S. National Advisory Leader, Media & Telecommunications Technology, Media & Telecommunications 408-367-4757 408-367-7600 [email protected] [email protected] Jana Barsten Rusty Thomas Global and U.S. Audit Sector Leader, Global and U.S. Tax Sector Leader, Technology Technology 408-367-4913 408-666-4067 [email protected] [email protected]

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