June 27, 2012

Can a Growing Company Grow Faster While Spending Less? (Part 2)

In Part 1 of this post,
I laid out a portfolio company case study that lays out the
considerations a CEO should take into account when deciding between
capital efficiency and revenue growth.  In that post, I focused on the
economics of acquiring new customers and suggestions on how to optimize

One reader commented that the scenario I laid out was unrealistic
because the cost of acquiring a new customer is higher than the revenue
derived from that customer in the first year. That dynamic is actually
not unusual in a SaaS, recurring subscription company.  In SaaS, a
really good benchmark is when a dollar in CAC results in a dollar in
first year revenue. Yet many SaaS companies operate on a 12-24 month
break-even point for CAC. That doesn’t mean they are not good
businesses. It just means that they will likely consume a lot of capital
before they can get to a more scalable model.

A more holistic way to think about customer acquisition economics is
by looking at the cost of acquiring a new customer against the lifetime
value of that customer. David Skok wrote a great post on the topic here.

In this post, I will focus on the economics of maximizing revenue from existing customers. The metrics to focus on are:

  1. Dollar Renewal: For every dollar available for
    renewal in a given period, how much actually renewed? Note that what’s
    available for renewal is not always equal to the first year bookings.
    You need to remove any non-recurring bookings such as one-time setup
    fees and professional services to onboard a customer. Getting a monthly
    forecast for renewals is a critical addition to your forward budget
    plan, and tracking execution against that number is a key indicator to
    your customers’ user experience, the value they derive from your
    solution, and the effectiveness of your internal process for renewing
    customer accounts.
  2. Churn: What revenue did not renew could be
    attributable to a reduced level of usage, or to complete
    customer abandonment. Either of those is considered churn, and should be
    calculated in terms of monthly churn.
  3. Upsell: This is additional revenue derived over and
    above the amount available from that customer in renewal. So, if you
    originally sold a customer 10 annual licenses, and in month 13 you
    renewed the 10 licenses and sold 3 more, you would recognize that
    account as a 130% renewal/upsell. Tracking upsell separately is just as
    important as tracking churn. There will always be some level of churn in
    a customer base, and in some cases welcome churn (e.g. customers that
    generate low revenue and high support costs). The ability to sell more
    to existing customers can dramatically improve the overall customer
    acquisition costs.
  4. Customer onboarding success: How long does it take
    to onboard users within a customer account? Have they signed off on the
    onboarding, and are they happily up and running using your solution?
    Churn can invariably be associated to user experience, onboarding, or
    both. If either of those elements are bad, the customer will likely
    churn sooner or later.
  5. Usage: Do you have the means to track customer
    usage by user over time? Is there a negative usage level that will
    trigger your customer support to proactively work with the customer to
    diagnose and correct an issue? Does your product management team
    understand the usage issues, and is it proactively making design changes
    to improve it? Does your account renewal team check on that usage
    before trying to call for a renewal?

To calculate the customer lifetime value, start by determining the
life of the customer in months (1/(monthly churn) and multiply it by the
average revenue per month per customer.

Now, look at your CAC and compare it to the LTV and the break-even
point. If you have a BE of more than 12 months and a LTV that’s less
than 2xCAC, you’re in trouble. If your BE is 12 months or less and your
LTV over 3xCAC, you’re golden. Anything in between is ok, but has lots
of room for improvement.

Here’s another post that offers advice on where to focus your sales efforts as a growing software company: “Sell More to Your Existing Customers Before You Sell to New Ones”

Firas Raouf is a Venture Partner with OpenView Venture Partners.  You may find this post, as well as additional content on OpenView's blog located here.  You can also follow Firas on Twitter (@fraouf) by clicking here