Category Archives: Analytics

The Myth of “SaaS”

Software-as-a-Service (SaaS) has taken the technology world by storm. These days, all new software companies are SaaS which simply means they are based in the cloud and have subscription pricing. With the exception of mobile applications and e-commerce, almost all new companies are following this model.

It’s not surprising. The benefits of SaaS over older models of software delivery are clear. Cloud based software can be updated and improved much more rapidly than on-premise software, with a fraction of the cost of maintenance. Subscription pricing means that revenue continues to roll in month after month for the entire life of a customer. What is not to like?

However, many founders of SaaS companies have unusual levels of stress, even more so than typical founders. Your typical SaaS startup founder will:

  • Spend a few days every month trying to follow the latest SaaS metrics fad, based on blog posts like this*. They are searching for the perfect metric to compare themselves against other SaaS businesses.
  • Try desperately to reach a mythical MRR milestone that will magically open the door to raise their Series A.
  • They spend time meeting the best “SaaS” investors, even if those investors are completely unfamiliar with their space.

The ironic reality is that there is no such thing as SaaS anymore. SaaS has become so pervasive that the term is the equivalent of “Internet” or “Web” or “Software”. There are SaaS companies across every vertical, every market. Some charge millions of dollars a year and others charge $5 per month. Some are profitable with only 5 customers, others have 500,000 customers and still are in the red.

SaaS no longer means anything because the world of SaaS has become too large.

Those SaaS founders I mentioned earlier are under abnormal stress because they are chasing the myth of a “typical” SaaS business. There is no such thing as a “typical” SaaS business and all of the fancy metrics and analytics you hear about are attempts to normalize and compare SaaS businesses that are completely different. The only ones who benefit from such normalization are investors, who want help in picking and choosing which companies to support. As a founder, you only care about one business: yours.

The good news is that the world is much simpler when you abandon this myth of the “SaaS Business”. Your business, while it might be SaaS, is not governed by complex new metrics but by the The Most Important Equation for Your Business. Your MRR does not matter, there are businesses raising Series A rounds with $0 MRR everyday. What matters most is The Only Thing That Matters, just like with any other business. Investors will look at your rate of growth first and your MRR second.

In short, you are building a business. Just because it is SaaS does not mean the rules are different, only that there might be more distractions. Do whatever is right for your business.

Then, when you are successful, don’t be surprised when another founder tries to model themselves after you. It is SaaS, after all.

* This blog post is actually very good. I only point it out since every founder I meet that reads it finds it more confusing and intimidating than helpful. 

Efficient Analytics for Start Ups

Years ago, being data driven in your decision making gave you a competitive advantage. These days, being data driven has become table stakes to compete in the hyper-competitive business world.

But, what does it mean to be data driven? How do you even get started?

Last week, I gave a talk to help answer those questions at the Alchemist Accelerator and I was told it was very helpful. You will find a video of the talk embedded below, optimized for your web viewing pleasure. I hope you find it useful.

If there are other topics you would like to see me publish talks about, please let me know.

Closing the Loop

Today, I am currently an advisor/mentor/investor in 10 early stage start up companies, 3 accelerators and 1 venture fund. I pride myself on spending a lot of time with each company and getting as involved as possible, in many cases having projects assigned to me. Regardless, I am regularly shocked by a simple fact:

Only one of these companies sends me a regular update.

I know I shouldn’t be shocked, as the early days of building a company are hectic and busy so updating advisors and investors is never a high priority. There is also a natural fear of bad news, so if things are not going extremely well it is easier to say nothing than admit things are hard.

Unfortunately, the side effect of a lack of updates is that I’m not as engaged as I could be. As a founder you live through a hundred battles everyday, but if I never see them then I can’t understand. For all the time I spend with a company, not knowing about the struggles, the victories and the defeats means that when I do help it is with only a limited perspective. Even worse, I have no idea if the advice that I provided proved useful as I rarely get told the end results of any given decision.

But it’s not the fault of these companies. Almost all entrepreneurs are really bad at closing the loop.

Closing the Loop

One of the fundamental components of Corkscrew_(Cedar_Point)_01continuous improvement is feedback. If you don’t know how you are doing today, you can’t get better tomorrow. Modern engineering processes such as Scrum or Kanban encompass feedback as a core part of the process through the use of retrospectives. This is why the engineering teams at many startups are the best run teams, since they have a clear and well understood process to follow. So what of the rest of the company?

The best way to make sure your company is focused on continuous improvement is to make sure you always close the loop. For every decision that’s made, for every goal that is set you check back on it in the future to see whether it worked. Did that strategic partnership pay off? Did you meet your goal of 10% weekly growth? Make it part of your company culture to always review decisions and goals in the future, and learn from them.

All companies make decisions and set goals, but surprisingly few will review them on a regular basis. Many start up board meetings involve a review of key metrics, but not a review of key decisions and how they worked out. If you don’t review the decisions you made and the results of those decisions, what do the key metrics matter?

It can be scary to review past decisions since many of them will not work out well. However, fear of bad news will slowly paralyze your decision making because it will evolve into fear of failure. If you develop a habit of sharing news, both good and bad, you will feel a weight lifted from your shoulders – the weight of that fear.

Communication as a Core Competency

Making sure your team closes the loop is easy if you’ve set communication as a core competency of your team. If you have done that, then you already have plenty of tools and structures for communicating, you just have to make sure you communicate retrospectively.

Some examples of how you can close the loop:

  • Regular Updates. Send regular updates to your team, investors and advisors on your progress that review the results of key decisions (Leo has a great template for these kinds of updates that is short and easy). These serve not only to update the team around you but force you to put in writing what has worked and not worked on a regular basis.
  • OKR Reviews. Many companies use OKRs, but not many have regular public OKR reviews. Such a public review of individual OKRs should not serve as a punishment or a reward, but instead a chance for everyone to learn from what worked and what did not.
  • Waterfall Financials. When projecting your company’s financials, the only guarantee is that those projections will change (a lot). Keeping track of changes in your projections will help you understand the flaws in your forecasting models and waterfall financial reporting is a great way to do that.

The best way to make sure you are closing the loop is to make it part of your corporate culture. Any decision that gets made comes with a report on how it faired later. Remember, the goal of closing the loop is not to punish failure but to learn from your mistakes.

We all make plenty of mistakes, why not turn them into assets?

Image made available via Creative Commons by Coasterman1234.

You Need 10 Times More Customers

As an engineer, one of the first things you are taught is how to break down a problem into smaller and more manageable problems. Want to build a bridge? First, you’ll need to design the supports and the connections with existing roads, then the external structure. Building a house? You start with the foundation, then the frame, then the plumbing.

Building a company is no different. Billion dollar companies are not built overnight, they are built through a progressive series of steps. If you attempted to envision a billion dollar company from day zero, you would be overwhelmed by the challenge.

Take the following example of a high growth company’s life cycle:

Growth Stage Company

This is an intimidating chart. The number of customers grows slowly at first and then hits an inflection point where it begins to grow exponentially. How in the world do you design a company that can grow this way? How can you plan for that kind of growth?

The short answer is that you can’t. You can get lucky and have it just happen, but that is so unlikely that you would be better off playing the lottery.

What you can do, is break down the problem into manageable phases:

Growth Stage Company - Milestones

Here the growth path is broken into four stages: Series A, B, C and D. These might correspond to your funding rounds or they might just be milestones that you set for your company. At each stage, you have acquired 10 times the customers that you had at the previous stage. While these are still aggressive goals, they are goals that you can achieve.

The key lesson here is not that you should plan out the entire lifetime of your company on day one. The lesson is that, whatever stage you might be at now, your next goal should be 10 times the customers you have today. Setting such a goal will force you to take a hard look at your company and think about what will need to change to achieve that next level. When passing from one level the next, the following are typically true:

  • You will need to start doing things you have not done before.
  • You will need to stop doing some things that helped get you this far, as they will start to become liabilities.
  • You will need to continue doing what makes your company unique, the core of your identity.

What those things are will depend on the business and the level you are at today, but asking the questions will help you position the company for success. Even if you fail to achieve 10 times customer growth, you will have positioned the company well for growth and increased the overall value of your company.

Why should you aspire to being a high growth company and plan this way? It is true that slow growth companies can be very successful and often feel much more comfortable. However, the vast majority of wealth created in entrepreneurship comes from the high growth stages of business. It is during that high growth stage that your capital efficiency will be at its highest and hence the value of your company appreciate the most for the shareholders. For publicly traded companies, this is why high growth companies command a premium on their share price.

So, even if you are just starting your company today, think about how you will reach the next level of growth. Before you know it, you might have achieve that milestone and be thinking about how you grow by another 10 times.

The Most Important Equation For Your Business

Business is a very human activity. Despite the existence of high frequency trading, supply chain optimization and manufacturing automation all business boils down to one person selling something to another person. A product is worth what someone else is willing to pay for it, and business is the act of making that transaction happen. So, you would assume that you cannot describe business using mathematics.

But you can, and the formula that does is as follows:

LTV – CAC > 0

This equation describes the viability of your business. LTV (Lifetime Value) is the total amount of money you can expect to make from a customer over the entire period of time they are your customer. CAC (Customer acquisition cost) is how much it costs to acquire the customers that will then make you money. If the lifetime value of your customers is higher than your customer acquisition cost, then you have a profitable business because you make more from customers than it costs you to find them. If not, then it costs more to operate your company than it makes and the business will fail.

This equation maps into every kind of business precisely because all business is the act of one party selling something to another party. Below are some examples of how this equation applies to various types of business:

1. Physical Product

When you build and sell a physical product, both your LTV and CAC have many factors. Your LTV is not just the sale price of the product, as you have to remove the cost of producing the product in the first place. The CAC is a combination of both your marketing spend as well as the sales commissions you pay to either your sales people or the retail stores that sell your product. Hence, your equation looks like the following:

(Sales price - Cost of good) - (Marketing Spend + Sales Commissions) / Units sold > 0

As you can see, you calculate the net profit for the sale of a given item (Sales price – Cost of producing it) and remove the amount of marketing and sales commission that went into that item. In some cases, simply dividing the overall marketing and sales commissions by the unit price is misleading since different distribution channels have different costs. In those cases you would measure the viability of each channel independently and use the actual per item marketing and sales commission numbers.

2. Software as a Service

Most software as a service businesses are based on monthly subscriptions. Here, the LTV is the amount of the monthly subscription (often called the Monthly Recurring Revenue or MRR) times the average number of months a customer is active (paying for your service). The CAC depends a lot on your user acquisition strategy but is typically either sales commission based or performance marketing.

(MRR * Avg Months  Active) - (Marketing + Sales) / Number of customers > 0

The most challenging factor here is estimating the average active months for a customer, especially for new services which might not have a long history of data to use. Because of that difficulty, it is often easier to measure monthly churn rates which are simply the percentage of customers you lose every month. You can then use the MRR and monthly churn to estimate the LTV and use the following equation:

(MRR / Monthly Churn Rate) - (Marketing + Sales) / Number of customers > 0

By dividing the MRR by the monthly churn rate you are calculating retained revenue (the value of customers that stuck around). By subtracting out the cost of marketing and sales you are measuring how much it costs you to retain that revenue. You can see that if your churn rate is high (and hence your average active months per customer is low) then your business is not viable unless your marketing and sales costs are extremely low.

If you measure your MRR in aggregate instead of per customer, you do not need to divide the cost by the number of customers as you are calculating everything in aggregate.

3. Consulting 

In consulting, both your revenue and costs are measured in time. Every hour you spend working for a customer is revenue and every hour you spend recruiting new customers is the cost of acquiring those users. Assuming your hourly rate is fairly consistent then you can measure your viability the following way:

Average # hours per contract - Average # hours recruiting contract > 0

The great thing here is that you don’t need to estimate your CAC cost per unit since you are measuring your business in a universal unit of time (instead of money). This works even for large consulting firms who have many employees, assuming a fairly even hourly billing rate. If it is difficult to track the recruiting hours specific to each contract, you can generalize this and just use the total billable hours and the total recruiting hours across all contracts.

Note that this requires you to track your business development time in the same way you track your customer billable time, which I always recommend anyway. It is common for consultants to consider only the time that they bill in determining their cost structure, which is a mistake.

Viability vs Profitability

Most companies have a goal of being profitable, not just being viable. In those cases, the fact that your LTV is greater than your CAC is not as important as how much greater. One rule of thumb for high growth companies is for your LTV to be 3 times your CAC because that gives you room to make mistakes and still be profitable. Keep in mind that the cost of your operations is likely not zero so your ratio needs to cover that cost as well. The best person to judge the right ratio for your business will always be you.

If you don’t already watch this viability equation as one of the key metrics of your business, you should start. It will provide a simple way to understand the fundamentals of your business.

How To Measure Customer Happiness

Are your customers happy?

Such a simple question is remarkably difficult to answer. You could ask them, but rarely will someone tell you their honest opinion of you. You could wait and see if they remain customers (unhappy customers will leave) but by then it’s too late to change their mind. You could have someone else ask them, but in the end most people have difficulty explaining their own feelings.

Ideally, you would have a way to measure customer satisfaction that:

  • Is a simple metric (a single number).
  • Fast enough that you can measure it on a regular basis.
  • Does not require a lot of analysis.

The great news is that this simple measurement exists and it is called the Net Promoter Score. It allows you to ask your customers a single question to tell you everything you need to know. That question is:

How likely are you to recommend our company/product/service to your friends and colleagues?

The answer takes the form of a score, from 0 to 10, with 0 being not at all and 10 being extremely likely. To see how this works, please take the Sean on Startups net promoter survey here. I appreciate the feedback!

You then group your customers into three groups based on their response:

  • Promoters (9-10): Customers who love your product and will recommend it to others.
  • Passives (7-8): Customers who are ambivalent.
  • Detractors (0-6): Customers who are unhappy and may advise against working with you.

At first, this seems rather aggressive since you need to score a nine or higher to be considered a promoter. However, most people have an inherent ratings bias where they avoid giving very low ratings. Setting the thresholds at these levels adjusts for that bias.

To calculate your Net Promoter Score (NPS) you simply subtract the percentage of customers who are Detractors from the percentage of customers who are Promoters:

Net Promoter Score = % who are Promoters – % who are Detractors

Your NPS can be anywhere in the range of -100 (very bad) to 100 (very good). In most cases it will be in between, with a positive value better than a negative value. For example, in 2013 the Apple iPhone had an NPS of 70, Costco had an NPS of 78 and Southwest Airlines had 66 (source).

What then do you do with this number?

The most common use is to compare your NPS to average NPS scores for your industry. There are many resources available to do this and the more narrow your industry the more useful the benchmark. You can also easily find NPS scores for companies and products online.

This should also become a core metric for your business that you track on a regular basis. It is fast enough that you can survey your customers on a regular basis and track your NPS over time. In fact, Survey Monkey even has a pre-built template (which I used to create the survey for this blog). If you want to measure NPS on a very frequent basis (say monthly) it is a good idea to randomly sample customers for each survey as even this short question can lead to fatigue if you ask it too often.

The NPS is not a replacement for talking to your customers, which you should still do on a regular basis. However, it does provide an objective and quantitative measurement for customer satisfaction that you can use to measure your progress over time.

So, are your customers happy? Ask them one question and find out.

5 Metrics to Run Your Business

Whether you are running a company, driving a car or flying a jet you need a dashboard to tell you how you are doing. One of the most common mistakes is to fill up your dashboard with dozens of metrics covering every aspect of your business. The problem with this “kitchen sink” approach is that it is actually harder to understand how your business is doing. With a dozen different metrics, most days half of them will be up and half will be down – so how are you doing?

Focus on the fewest number of metrics that will allow you to understand how your business is doing. For example, I typically suggest companies use the following five metrics as their dashboard:

  1. Customer Acquisition. How many new customers are you adding every day (or week or month)? This is an important measure of how healthy your marketing efforts are working since this is the top of your conversion funnel. Depending on your business this may be new registrations, first time purchasers or application installs.
  2. Customer Engagement. How active are your customers? Just because you acquired them does not mean your customers are active and using your service. Do they use the product every week? day? hour? If your customers aren’t using your service then it’s only a matter of time before they churn out and are no longer a customer so this is your most important metric.
  3. Customer Retention. How long does someone stay a customer? This is critical to understanding your business model because this allows you to model customer churn. If it costs you $5 to acquire a user but they only stick around long enough to make you $2, then your business is upside down. The higher your customer retention, the easier it will be to grow your business.
  4. Revenue. How much money do you make every month? Focusing on daily or weekly revenue can be very noisy so for running your business focus on monthly revenue. In some cases, it might be more useful to measure revenue per customer in order to calculate a customer lifetime value.
  5. Cost. There are two kinds of cost  you might want to measure, depending on your type of business. Burn rate is how much money you spend every month on everything including salaries, rent and services. Customer acquisition cost (CAC) is how much you are spending to acquire every new user. If CAC dominates your costs then you should measure that, otherwise use the overall burn rate.

You will find that you cannot improve what you do not measure, but you will focus on improving whatever you do measure. If you can maximize acquisition, engagement, retention, revenue and cost you will have a very healthy business on your hands.

These five example metrics might not work for your company, but I bet there are five that do. Think about it and choose them carefully, they will be your guide through rough seas.