In this episode, we start our Primer on SaaS – Software-as-a-Service – a trilogy on everything you need to know about SaaS. We will give an Overview of SaaS, as well as discuss the intrinsic Business Models. Please look out for our next episodes that will deep-dive into Sales, Pricing, Financing, Benchmarking/KPIs, Lessons Learnt and Predictions.

Navigation:

  • Introduction (01:24)
  • Section 1 – Overview (04:39)
  • Section 2 – Business Model (17:59)
  • Conclusion (45:19)
Resources
  • Please check below to download our SaaS Primer PDF deck, serving as reference for our episodes 15-16-17
Our co-hosts:
  • Bertrand Schmitt, Tech Entrepreneur, co-founder and Chairman at App Annie, @bschmitt
  • Nuno Goncalves Pedro, Investor, co-Founder and Managing Partner of Strive Capital, @ngpedro
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Full transcription: may contain unintentionally confusing, inaccurate and/or amusing transcription errors

Intro (01:24)

Bertrand: Welcome to episode 15. In today’s episode, we will talk about SaaS. 

What is SaaS?

What does SaaS mean? SaaS means Software-as-a-Service. This is, and we will talk more about that later on, but this has become over the past decade, one of the most successful way to distribute and monetize software. Why is that? We’ll talk more    about that, but in a nutshell, SaaS is really a new philosophy and approach to software, that emerged around 20 years ago, as a way to deliver, a centrally-hosted application over the internet, as a service.

In the past, you had to have your own server. You have to install your server. You have to upgrade and maintain your server, and you have to install software on every user laptop or desktop. It was very complex to maintain, to manage, but also on the pricing side, in the past, you would pay a very big license fee for your server, for your desktop license, and you would keep paying, a smaller amount, a maintenance fee, every year, usually for technical improvement. But you will have to keep managing your software server and clients side, for years. And it will become very difficult and complex, and you would have to keep up with improvements in the software. And it was difficult to keep up.

What SaaS enabled, software-as-a-service, was, you don’t have to manage the server side anymore. It was pioneered by companies like Salesforce, like Netsuite. So no more central IT costs to manage all of this, and the software would be distributed on the internet through your browser, so no need to install a specific software. And pricing was also changed as a result, no need for a big upfront license cost. You would pay every month, every quarter, every year. You could stop any time, or once a year, using the service, suddenly become much easier to consider trying a new service. It would become much easier to distribute that new service, and more important, much more alignment, between customers and supplier.

Why? Because suddenly, the customer can leave anytime. Or at least once a year in most cases. And what this means is that it pushed suppliers to make sure their software was of really good quality. And on top of it, usually, much more focused on satisfying end user and consumers, not just making sure they check boxes with central IT.

So it has been an evolution. It started 20 years ago. It started to ramp up with the last financial crisis in 2008, when companies decided it’s time to give it a try. There was at the time, still some worries around storing your data somewhere else, not controlling your server equipment, infrastructure, and while there is still that worries, there is probably an acknowledgement today that these guys, the SaaS providers, are more certainly doing a better job than your own IT to manage this type of service at scale, and safely. That’s in a nutshell what is software as a service.

Section 1 – Overview

Nuno: Today’s primer, we’re going to go through a variety of slides, which we will publish. These slides are coming from a variety of sources. So we’re acknowledging all the sources we’re taking this from, well known venture capital firms that have been looking at this space for quite a long time and a few other sources.

So please do take attention to our resources where we will find some of the background around our discussion. 

Around software as a service actually, my time and in development as a computer engineer in developing systems and as an engineering manager was in the early days of what we then called application service providers, wireless application service providers, and some of these actions mutated into what we know as software as a service today.

And it’s funny cause some of the systems I developed are still in production today two our products and one was a custom made system. And if we were to really deep dive, around some of the pain points, Bertrand as you mentioned, actually even installing something like this was a pain in the neck, sometimes the drivers are missing in the computer, et cetera.

So the world of the internet, and the sandbox of the browser has really brought us, a very appealing, unified way to deploy software, which is very powerful. So maybe moving agenda a little bit to the overview of software as a service in the space and what we’re seeing happening, today.

Bertrand, do you want talk to us a little bit about, and this is based on Battery slide on the five forces of software’s accelerating role.

Bertrand: Yes, let’s start with a big overview about what’s happening, why is it happening, let’s focus first on the big picture of SaaS. And why is SaaS accelerating in term of growth?

One first point, that’s true that over time software markets are growing. There was this famous saying from Marc Andreessen, that software is eating the world, and that’s true, software is eating the world, everywhere for the past, few decades.

Two, when you keep growing so fast, and going everywhere, at some point you start also getting into every niche market possible. Every niche market is having more software involved.

Three , software is actually displacing hardware, we used to have to run internet services for instance in the past, very complex advance servers, but this has changed. Now, the approach pioneered by Google, has been actually to put very basic hardware, and put all the smartness in the software, because your software is much easier to change over time.

So we have a situation where software has also been displacing hardware.

Fourth point, software is also displacing services and labor, software is replacing human work, usually it also creates new opportunities for human work, but definitely the most basic part of what was human work, is now being replaced by software.

And maybe one last point, every company is becoming a software company, even very traditional businesses, are moving on the software side of things to improve their business.

Nuno: If I were to move around, Software as a service and cloud, and what’s happening in this space over the last two decades. one really powerful slide is a slide that shows us we had really one private cloud unicorn around 2010 and hundreds of private cloud company.

Whereas around 2020, we now have by any accounts, close to a hundred private cloud unicorns and thousands of private cloud companies. And if we look at this movement, it’s really coming from two angles, we’ll discuss them a little bit later. 

We’ll talk about horizontal  versus vertical SaaS, whereas horizontal in many cases is more functionally driven “software as a service” companies. So companies that are trying to serve a specific need across industries or sub industries. So for example, a company like Gusto and a disclaimer, I’m an investor in Gusto, is a company that focuses on HR management, payroll, et cetera, and does so across industries. 

Whereas vertical companies normally are very focused on a specific industry that they’re serving. Either with a specific functional focus or, normally more broad appeal to that industry. And we see, for example, companies that have done really well in software as a service in very old industries, like oil and gas, healthcare, I call it an old industry, certainly in certain parts of the world seems like an old industry energy and others.

Bertrand: Yes, it has been a fantastic rise of  what could be considered the successful cloud companies over the past 20 years. So one reason we have seen an acceleration is, actually, the time it takes to go from one to a $100 million in ARR, has actually been shortening. We have these interesting slide that shows that it used to take 10 more years, 15 more years, to go, from one to $100 million ARR, while some of the most recent companies, like Twilio, took only five years, Slack took only three years, to go from that one million to $100 million ARR.

There is an acceleration, and this acceleration is due to a few things. So first, every professional has access to a desktop or a laptop with a powerful web browser, there is wide acceptance in term of business model to use a software as a service provider, there is no more question about, “Does it make sense? Is it safe enough?” And so that means that, basically, there has been an opportunity to accelerate. 

And the last point, around that, has also been the financing. In the past, it used to be difficult to get financing for a SaaS business, either a private SaaS business, or even to be understood by the public market. Acceleration of financing has helped a lot to move faster  and to achieve these growth rates. So that’s the combination of all these points that make it that we are moving from what used to take 15 years, to now it can take just a few years, to go from one to $100 million, in ARR. 

Nuno: And I would highlight as well, the acquisition piece, because from a customer acquisition perspective, and we’ll talk about it later at length around consumerized enterprise and some of the dynamics of what some people call consumerized enterprise, I prefer that term, others would call it bottom up software as a service, where you’re effectively bringing users to your platform, as you would bring consumers into your platform.

Slack is a great example of that. Companies like Twilio, I’d say probably Twilio is one of the few really successful companies in attracting, what I’d call micro-type companies and developers, to the table, the business to developer space as I call it, has not had a lot of successes too, it’s probably one of the few there. 

But moving maybe directionally, to talk about what’s happened from the perspective of just value creation in this industry. What we can see is a phenomenal growth in terms of public market cap, and public market capitalizations are a great proxy to what’s happened to the overall industry and from 2008 to 2020, the value of the top five public cloud companies has increased by 44 X. That’s just mind-blowing 44 X from 13.89 billion to $616 billion at the time that this slide and chart was created. I’m sure the numbers today even look better. 

But it’s also interesting to me to look at some  the grand-daddy of software as a service, which we need to highlight like Salesforce, obviously being one of the anchor companies that a lot of software as a service has been based on. The guys who wrote the playbook around: we are on the internet, we are not going to do installs on prem, et cetera.

But also the turnaround of companies that were very much focused on selling installs, on selling software packages like Adobe, where we’d buy these beautiful packages of things that we would install on our computers and the turnaround that a company like Adobe has had is just, again, out of the swirl, the company that was literally the epitome of installs on prem, on your clients, for designers, for people that work with photos, et cetera, to totally turn around and become a cloud company. And one of the most valuable cloud companies in the world is incredible. So again, the trend is definitely there, but also the turnaround, the change in how you deliver your products can lead to significant value creation, Adobe, again, being a great example of that.

Bertrand: Yes, it’s a model that was actually quite mis-understood for a long time by analysts on Wall Street, and at the time it was probably brave to do that transformation because, for a while, when you move from traditional software to SaaS, you are actually decreasing your revenues, because suddenly, what you used to book in a year, will take you three years  to be booked. If you don’t manage to convince,  the analyst on Wall Street that, yes, there is light at the end of the tunnel in three, four, five years, you will truly get the benefits, it will be a very painful transition.

And the other piece that can be painful, is how do you convince your clients? Because a lot of clients that were used to the old model, really don’t like it, and can be pretty vocal about that change. Especially the smaller businesses, and if you think about the Adobe,  they definitely have a big focus on smaller businesses.

There was a lot of very vocal opponents to that switch. But ultimately, I think many saw the value : suddenly it’s cheaper to get access for just a year to the Adobe products and two, obviously, that’s also, let’s not forget the big benefit of SaaS, you get automatically the upgrades, no need to be on an older version, but you are working with somebody else on a newer version, and they are not compatible, that sort of stuff.

So suddenly, you can also create a better end user experience, but it takes a lot of convincing. So, pretty amazing ride and transformation for Adobe. And I want to add, that when we talk about that $600 billion market cap, Microsoft is excluded of it, because it’s not just a pure SaaS company. Oracle that acquired Netsuite is also excluded of it, because it’s not a pure SaaS company. So we are really truly talking about the pure SaaS companies at least as of today. So it’s even more amazing when you think about it.

And you talk about valuation, what has been pretty insane, has been the growth of cloud-based companies in terms of valuation, since the beginning of the year. We are talking about, and I’m talking about metrics from end of July, if I’m comparing start of the year to end of July for that selection of cloud-based companies, it’s what is called the EMCLOUD, the Bessemer Cloud Index, we talk about a growth rate of 69%,  since the beginning of the year. While the NASDAQ at the same time, has grown 22%, while the S&P 500 grew 2%, while the Dow Jones is down 6%. So it has been an amazing, insane ride for cloud-based companies for the past, six / seven months.

Nuno:  It’s also important to say at this stage that maybe there’s too much value, attributed to some of these companies. We are now at a point where the EV to revenue multiple, so the enterprise value to revenue multiples, for this index companies is 18.4 X, 18.4 X. So their enterprise value is 18.4 times their revenue multiples.

And so it’s at this stage, in my opinion, again, I’m not a public markets investor, I’m a private markets investor, but in my opinion, it’s maybe a bubble creating around some of the software as a service plays. Maybe because the allocation of assets around technology is so limited at this stage that people just feel they need to bump it into high growth assets that are clearly benefiting for example, from COVID at this stage. But I can’t see how certainly, some of leading companies in the world can continue commanding such high multiples. So at some point, probably these multiples, will need to rebalance and come down, even with high growth rates, in any way phenomenal, but I would be a little bit more modest and conservative going forward on what the revenue multiples will look like.

Bertrand:  We could definitely be in a bubble, that’s for sure. As you say it is a question of assets allocation. If you don’t trust the traditional economy, how companies will fare during this difficult time of COVID-19. Then you go more to the tech side, if you go more to the tech side, SaaS, we are talking about recurring revenues. In most cases, contracts that are for a year, so you are not fighting every week, every month, to sell more devices for instance, Apple does, and every quarter you start from zero.

Here, every month,  you already have a huge base of existing clients, that cannot get out of their contract, if they are on yearly contract, they could even be on two year contract, so there is definitely a level of safety in SaaS that is very rare, and probably very valuable in time of economic crisis. But at some point of a fair question around when the rest of the industries, outside tech, start to get better, and, we get beyond that, COVID epidemic, will valuation in SaaS go back closer down to earth or not, that’s probably the big question.

Section 2 – Business models

Nuno: Very good, and switching gears to business model and having, quite a bit of discussion around business model, we would start with Battery’s T2D3 framework, it’s a bit of a mouthful T2D3 framework, and this is effectively a [product market fit framework. And what Battery’s saying, when you achieve product market fit, in some ways your numbers might look something like this.

And these are, annual recurring revenue. So ARR end of year numbers and millions of dollars. So at some point you achieve a million dollars. They actually are very specific in saying it doesn’t need necessarily to happen in year one. At some point you achieve 1 million in ARR and then you would triple into your second year.

So second year chief $3 million. Then you triple again, in 2 year, year three, so 9 million, and during year four, you double, to 18, and then double again in year five to 36. And finally, by year six, you’d be at 72. Again, this is just a framework to put into perspective that we’re talking about extremely high growth rates.

I don’t think Battery or anyone else is saying, this is the numbers you need to achieve to show us product market fit. I think they are just saying, this is what  product marked could look like. But again, very high growth rates, and the reason why I emphasize that certainly early on, we’re talking about tripling, in some cases we even seen companies quadrupling or more, I’ve had one or two investments for companies move faster than this, the dimensions of your growth are extremely high when you start and they should be. So if they’re not happening at that stage, it might mean a variety of things that really there’s very little stickiness in your product or that you’re having really the pains of customer acquisition or that people don’t really understand your product, or that maybe you’re in too small of a market or too niche.

But there was a variety of thing that might be happening. So when I see a startup coming to me saying,  it’s taken me three years to get to a million I’m doing really well, and I’m anticipating that this year I’m going to do $2 million, that’s not very exciting. So that’s element number one of the discussion, which is your early growth is expected to be quite high once you’ve untapped a little bit, your ability to get customers onto your platform, acquire them in a sustainable manner or relatively sustainable manner. 

The second part that I find really interesting around this framework is, there is still an assumption of very high growth. I think the impressive thing, if you achieve something like this, if you achieve the T2D3,  the impressive thing is not the first few years, because honestly I’ve seen companies in year two and year three, do a lot better than this. The impressive thing would be that you’re still sustaining and doubling year on year when your basis 18 or 36 – $36 million in ARR.

That is incredibly impressive, and that’s where a lot of the elements that we’ll talk about later in today’s podcast will come in, which is the elements around, how do you operate? How do you sell? How do you fundamentally scale quickly to go to market at a point where you’re selling really fast your customers and going to the next level?

Bertrand: One point I want to add is that, usually the first few years, until you get to a million in ARR, are really considered, a time to discover what is your business, what is your business model, and so some companies might go pretty fast to a $1 million in ARR, some companies might get slower, but that might not be a bad omen for the future of the business.

Even if you take Slack, for instance, we talk about how fast you go from one to 100, and they moved very fast, but before that, actually, they changed business model. They started as a game company, they decided to move to B2B, and then they tweaked their product. And my point is, that it might take you some time to get that first million, but after that, once you reach $1 million in  ARR every investor’s going to look at you with a very strong expectation in term of further growth of the business, how fast you can go.

But obviously, there is also a constraint based on financing,  to achieve such a pace of growth, depends on the financing, and therefore dilution you are willing to get as an entrepreneur, and that’s always a question, depending on how big is your opportunity, you probably want to get some important financing, to make sure you grow faster than your competition. If you are more in a niche market, that’s really a fair question, do you really need to grow that fast? And let’s say in year four or five, you suddenly stop growing. 

Nuno: One point that I would add. And we discussed it in some of our previous episodes is this notion of product market fit, being dynamic. Product market fit is not a static thing. I think this framework shows it perfectly. You keep achieving product market fit at different levels. There’s almost like an entry product market fit and adequacy of a product to a certain market.

And then there’s a scaleup product market fit, which actually has a lot to do with operations and go to market and marketing and sales, as we’ll discuss later on, and how you scale those teams, how you scale those processes, so that you achieve that. To Bertrand’s point, in many cases needs to come with financing and we’ve seen some really significant wins.

We have also seen some significant losses as well. Some companies that went into this mode that didn’t do very well, a mode that I would call land grabbing. You raise a lot of money. You put it to play into “go to market” strategies with marketing and with sales aggressively almost too you know what Reed Hoffman would call blitz scale?

I figured out the process. I can scale it very quickly and I’ll just inject the capital I’ve been financed with to take it to the next level.

Bertrand: As you discussed previously before Nuno, there are really two types usually of enterprise software. Horizontal software that any company might end up using, from small to big. We are talking about security, we are talking about sharing documents, we are talking about Salesforce management, and you have the vertically specific type of SaaS, and here we are talking about companies that are focused on very specific verticals. Either answering the needs of the health care industry, a company like Viva, for instance, or a company like a Mindbody that is focused on managing the sales process  for health, studios and gyms.

So very different companies have different approaches, and one thing that is clear, is that if you are a more horizontal type of companies, you usually end up spending more in sales and marketing as a percentage of revenues, because you are touching very different type of businesses and industries, and you have to, industry by industry, make proof again, and again, of the value of your software.

Where, if you are in a more vertically specific software, you probably end up with lower cost of sales and marketing, because you are a better fit for this vertical, you have been very focused on that one vertical, everyone ends up knowing who you are. So you don’t have to spend as much. That’s probably the big difference between horizontal software, more aggressive spend in S&M is necessary, less in vertically orientated software. But at the same time, usually the opportunity might end up being bigger in horizontal software, because again, it can touch any company, not just some specific verticals.

Nuno: If we go a little bit into growth rates and what they mean, depending on your target customers, we see an interesting trend, but maybe not surprising, which is obviously growth is driven by small, businesses or very small businesses and not so much driven by mid market or enterprise, or enterprise and mid market type hybrids.

The interesting piece for me is I would expect actually this difference to be even more significant. I don’t know Bertrand if you agree with me or not, but I’d certainly expect the Delta of contribution to growth, to be much higher on SMBs versus for example, in particular enterprise. And in this case, it doesn’t seem to actually be that high, certainly from this analysis from KeyBank.

Bertrand: First, let’s talk about numbers. We are talking about 34% growth rates for SaaS companies targeting enterprise, or mid-market clients. 39% if you are targeting mid-market SMB clients, 43% growth rate if you are talking about SMB and very small businesses. There is a difference, but not more than 10% in terms of growth rates between the two sides.

One thing that is clear,  we have some slides, actually, about this, is that you have way more churn in the SMB market, or the very small business market. We can be talking about, in some cases, 50% yearly churn. To keep managing your growth, yes, it’s easier to sell, there is less decision making involved, it can be more self-service, there’s a lot of stuff that make it easier. But if you are fighting a 50% churn year after year, you have to fill up definitely way faster to keep your growth rate.

So I think that’s probably why you don’t see such a significant difference between the two, because obviously, on the enterprise side, actually there is much less churn, because, ripping off a solution that people have been used to, trained to, connected to your IT system, obviously takes more time, is more pain, and usually, you don’t end up doing that every year.

Nuno: Exactly. This is not a profitability analysis, of course. And it’s not an analysis that encompasses all the economics of serving a specific market. We know for a fact that sometimes serving very small businesses is not worthwhile, but it is really a notion of ARR growth. And how much can you derive it from these targets?

Bertrand:  And for sure, on the small business side, you need to have a very efficient onboarding process, self-service process, self-support process. So it’s a very different game and approach, and one thing I’ve seen is that it’s easier overall for companies starting in the mid-market  to go higher up to the food chain, than to go to the other way around. Very few enterprise companies that started enterprise, end up being successful, on the SMB side.

Let’s remember that for instance, Salesforce started SMB in term of target. No one was ready on the enterprise to take a bet on Salesforce. So they started from the SMB up, and not the other way round. In term of learning for me, I don’t think you make a decision on your business model based on these growth rates. But I believe that there is value to start smaller in term of clients, so that you have more opportunities to go up in the food chain, than the other way around.

So in terms of how do you create faster growth, or more efficient growth, in SaaS, you have probably four different angles  you could look at; one is, customer acquisition, obviously, how do you efficiently add more customers, and there is way more to talk about, and we will talk later about product led growth, customer acquisition, how efficient are you?

Second one is pricing, how do you optimize pricing? And pricing is not just a question of taking the most value where you can, it’s also facilitating the sales process. If it’s cumbersome to explain, if it’s cumbersome to manage, if it doesn’t feel fair, that’s trouble and that will not get to the best result.

Three is about the margins, obviously. If you can improve your margins, your software will be more valuable, and let’s not forget that in SaaS your growth margin is something that is carefully looked at. The reference in traditional software growth margin, were actually not always  that great, because it was often caused by a very big percentage of professional services.

But now with SaaS, there is an expectation that is simple to use, simple to integrate, so very few PS, professional services, needed. So an expectation that your growth margin is actually in the 70 to 80% range.

And finally, customer success. Because that team is critical in SaaS. It’s an invention of the SaaS ecosystem, customer success management. These guys are here to help you increase ACV over the life of an account, and ACV is the annual contract value. And this team also helps you decrease churn, they make sure that customers stay satisfied, keep using your product, and will renew year after year. 

So these four angles; customer acquisition, pricing, recurring margin, customer success, are really key to help create a more efficient growth.

Nuno: And it’s fascinating to me because, if I had to choose, obviously all of these items are super important, and they all almost would deserve their own episode first, just to talk about how to do efficient customer acquisition, how do you think through customer success? how do you think through margins, et cetera.

But for me, the exciting piece is pricing certainly from the companies that are often look at, which are very early stage companies to Series Seed, Series A. It’s always the neglected piece of the puzzle. And a lot of money is left at the table on something as simple as I could charge a lot more for this. People have to know no clue of  how elastic or inelastic their prices.

So obviously if their price is very elastic, they can drive a lot more demand from lower prices. While if it’s inelastic, obviously there’s no difference for me charging maybe a 100 to $200 per seat per month for a user, and actually there is a huge difference for me as a company because I am taking two times more revenue.

It’s fascinating to me how a little companies spend in terms of their time, just looking at pricing very early on, and how many of these times this leads to significant mis-pricings that actually are difficult to realign later down the road, that creates significant imbalances and issues in the company going forward.

And sometimes even a total lack of understanding about the market. I recently saw a company I won’t say in which industry and the name of the company, but I recently saw a company that was charging the classic software as a service per seat per month play, and they were very happy about it, and I was like, cool.

And then they were like, and by the way, we’re helping our clients generate significant deltas of revenues for themselves, and that took me aback. So okay, so you’re charging, I don’t know, a couple of hundred per shares or per month, and your clients are generating a couple of tens of millions per user per month. Because of what they’re using. Yes. 

And then the next question is what about so the industry, so the way they do it today through software systems, other agents in that industry, how do they charge for it? And shockingly enough, the agents that are present in that market that use their own software charge a cut of how much they generate in revenue to their customers.

So all of a sudden I’m like, why are you not charging a percentage of their incremental revenue ? Because that seems to be wildly accepted by the companies. And this company was so focused on having a pure SaaS model with incremental revenue per seat, that they forgot that their industry actually charges a ridiculous amount of money to generate this added value back to your customers.

So again, to the point. Pricing is not just cost plus and pricing is not just undercutting. Your competitors. Pricing is about also understanding the value add you give back to your customers. And over time that’s what generates the biggest bang for the buck is, sometimes slight tweaks on your pricing, adding pricing arrangements, and pricing tier-age.

And all of that kind of tap a lot of value for companies. Again, if you get it wrong very early on, sometimes it’s actually very difficult to change it around and it takes years, in some cases, companies die because of that.

Bertrand: We’ll have way more to say on the pricing side in the pricing section. So thanks, for giving us a taste of excitement about what pricing can bring. To keep moving up, and also a good slide from McKinsey, that we were looking at, they were trying to break down a typical SaaS business in pieces. And what they found is that, you can end up with two main pieces to look at, and understand your business.

One is a cash engine, and here what you are trying to understand is, how much free cash can you generate from one dollar of ARR on your platform? And what do they call free cash?  Basically it’s your gross margin minus your R&D, minus your G&A. So basically it means, whatever is left, can be used either to generate profit for the business, or to be reinvested in sales and marketing. 

And that second part, the sales and marketing equation is what they call the growth engine. And here it’s about, for $1 of spend of sales and marketing, how much net new ARR, annual recurring revenues, do you add. And so basically, if you combine the two, the cash engine, how much cash you generate, that could be used for sales and marketing activities, and two, how much from your sales and and marketing activities, can you generate in net new ARR, you can create an equation that can make a lot of sense of, how do you optimize the  two engines of your business.

Nuno: It’s an interesting slide. It’s very funny, because it represents two sub quadrants of the BCG matrix, right? It’s the cash cow logic on the left. And then obviously there’s the growth piece on the right. moving maybe to something a little bit more exciting,  not that the McKinsey slides are not exciting, right?

I’m an ex-McKinsey, So we could do very exciting slides once in a while. But talking a little bit about product led growth. And this is a really interesting phenomenon that we’ve seen over the last few years, which is companies that really articulate their growth around the usage of their product per se.

And what we mean by that, and this is very similar actually to what’s done in consumer in some cases, I want you to use my product and therefore, once you use my product, there’s all these types of facilities that I generate so that’s stickiness of using my product actually translates into revenues.

It translates into, potentially cross selling, upselling the product and doing a variety of other things. Later around some of the things that are most used around product led growth, but things like referrals. If I’m referring my product to someone else, because I really liked the product. It’s a very powerful way to getting a product across. 

Free trials, actually having no bar for me and the freemium model in general, which again,  I would allege certainly that the gaming industry created in the first place works really well for some of these software as service products. In particular for their low bar use, very simple UX, these products, if you get to actually use them for a period of time and you become a highly retained and engaged user, at some point I might actually pay for it or at some point I might actually bring it back into my organization and convince others to use it, then also pay for it.

So again, product led growth has really led to a fundamental shift on how people think customer acquisition, on how they move from a very classic model of just acquiring through paid acquisition, events, all sorts of PR plays and many other things to a world that is actually very contained around the product itself.  

Bertrand: When I co-founded App Annie in 2010, there was no such word as, product led growth, but ultimately that’s what we did, we were one of the first B2B software business to have this approach to let the growth be driven through the  product, and that’s a big difference.

I’ve been a big believer of this business model, because it felt that before the software as a service industry,  was mostly averaging the same go to market approach and mindset as the old software industry, the traditional software license, capex type of business model. Where product led growth is really, taking truly advantage for distribution, and go to market, of the fact that, you can offer the service in a very low friction, and potentially, even free way.

So at that time in 2010, there were very few SaaS companies doing what we did at App Annie, there were a few, like Dropbox also having a freemium offering, and definitely we took some inspiration, all of us, at least us at App Annie, to leverage what we saw was happening, at least in Asia, in B2C gaming, where the B2C freemium business model was taking over Asia by storm in the 2000s, across Korea at least and China.

And thinking that, “Hey, you could actually have a similar approach with a SaaS business, where some users get the service for free, and always keep using it for free.” But some are going to transition from a free service, to a paid service. And they transition easily because, they have the trust that the service is working, it’s solving their problem, there is no more test to do, and everything in the sales motion is easier. 

And what defines product led growth companies vs some other companies? What really, truly defines them is, that they think first in terms of product, as a mechanic of growing your business, it’s not two clear separation between sales and marketing activities on one side, and building a product on the other side. And that’s really the innovation.

And by the way, going back to the McKinsey slide, it’s probably in some way, an old school type of business model to think that way, to separate clearly the growth from the company, from the product. Best in class SaaS company, I believe, these days, has to be product led.

And  what do you put into that? It’s a free trial offering, it’s a self-service buying experience, it’s a bottom up sales process, it’s product qualified leads, it’s a freemium offering, it’s SEO optimization ASO optimization . So it’s all of this combined at the product level, that usually make a product led company, versus a non product led company in term of growth. 

Nuno: And there’s often in particular with very  early stage SaaS companies, this discussion around: how soon should I do self service? How soon should I, you know, get a machine working on qualifying leads from people that are using my product to also bring it into their organizations are doing bottom up sales, as some people would call it.

And I always say you can always try things. Without necessarily doing product, which is the shocking piece. And I was literally yesterday having a conversation with a company that, what they did was they put something forward on their websites that looks like self service, right?

People go there, they put in a form, they get then an email with some information. Then they go back to the website and they finish the play and they get to see some of the early results of using that service. Just with a trial run, with a smaller batch of data, and the funny thing is there’s no tech behind it.

They are only truly just getting forms and there’s someone looking at their computer and sending an email back and then they’re processing the data live. And so again, sometimes you can start testing some of the mechanics, even if you don’t have the tech ready and even not spending a ton of money in creating that self-service play, you can test a lot of things without necessarily actually spending a ton of money and in development. 

And in many cases I believe, small companies forget about this. Again, this is a really good way to see what works and what doesn’t. It might be that’s maybe your client base or the clients you want to go after actually are not really that savvy and maybe it is difficult to do a self service play for some of these clients, or it might be that your UX is just not very good.

And so if you simplify it, it might work out, but again, there’s a lot of little elements that you can actually start testing much earlier than you would think with much less financing than you think. 

Bertrand: And, if we move from  financial metrics, to product related metrics, there has been a name that has been used, North Star metrics, to talk about your product metrics and what is the focus? The idea is that, if you measure ARR, MRR, that’s good and important, but it’s really the price  that customer paid, and obviously your revenues. The North Star is more focused on the values that customer get, so the value you truly deliver . Of course, you will still look at your MRR, ARR, that’s useful information, key to run your business carefully, but if you want to focus on what truly customers get in terms of value, you want to have also some North Stars metrics.

These metrics will be more focused on, again, the value you deliver. So for example, instead of using MRR, paid seats, as product metrics, you would use some traditional metrics in bulk, like an MAU, a DAU, a number of message sent. But actually even better would be to use some very precise KPIs that show that there has been a true, deep, product market fit, and you have a true good usage of your product.

For instance, it could be a number of users who have spent more than 16 days in the last month in their product. You can have a number of messages that were sent within the first 30 days of signup. So that will be more precise metrics that are more fine tuned to your product.

If I take some companies, Box for instance, some of their North Stars metrics have been DAU over MAU, so how many daily active users you have versus your monthly active users, combined with the number of file actions. Box is a way to store files, manage your files, so having a metric that is very focused to the core of your business model, I believe, is critical. 

And we could go on and on . If I take a company like Greenhouse, one of their key North Star metric is, how many hires are made through their platform. Greenhouse is a product that is used to hire people. 

Nuno: In this horses for courses. So metrics think about it in a more holistic way. On the one hand you have exactly custom metrics, North Star type metrics that are a little bit more aligned with your business and the nature of it. These metrics might or might not actually match, standard metrics in the market, but you should still have standard metrics in the market.

I’ve always had this debate where people show me, for example, monthly active users numbers. And then it’s actually not monthly active user numbers. It’s an engaged monthly active user number. So the bar on that number is higher than the market of just one session per user and that month. So again, horses for courses, you should have metrics that are custom metrics and you should have standard metrics in the market. 

The other pieces, there are internal metrics and external metrics, there are metrics that you want to convey to your investors, if you’re then a public company you want to convey to the market and there’s metrics that you use really internally that are really trying to align engineering, trying to align product, trying to align your marketing, trying to align your sales. So again, internal and external metrics. 

And then the last piece is, again, these metrics normally fit in. I’m probably simplifying here, but they normally fit into one of four buckets.

They are potentially traction metrics. They are retention metrics, so active users and a number of other metrics around that. There are engagement metrics, so metrics about, for example, the number of file actions that you refer to Bertrand at Box is more of an engagement metric. 

And finally, there are what I would call monetization metrics. So metrics around, which revenue per user or per seat. Some cross selling numbers that might actually happen, basically upselling numbers and other numbers that are at the table, which are more related to that. Again, these metrics are metrics that evolve over time. So you might start with really simple standard metrics and then over time really develop your own custom set.

You might start just with external metrics and then over time, basically develop a lot of internal metrics that help you with your own processes. You might start very focused on traction and not focus so much on some of the engagement or monetization metrics, but certainly, having a view of the overall architecture of your metrics, and how you analyze the market, is very powerful.

Bertrand: Yes, absolutely. 

Conclusion

Nuno: So this concludes our episode 15, which starts our software as a service primer, and next time we’ll have episode 16 where we will continue it. And some of our topics for next time will include sales, pricing, and a few other deep down discussion points around software as a service.

 

So please join us next time, on our second episode on our software as a service primer.