Oct 5, 2008

SaaS: Why The Second “S” Comes First

With the help of Stanford GSB student and IBM sales veteran Alex Salazar, we recently conducted a study on SaaS company metrics. The conclusion – that SaaS companies are service companies first and software companies second – may seem obvious now that you’ve read it. But read on to find out how the best startups deliver on customer happiness.

At MDV we have a large portfolio of SaaS companies, from those like Infusion Software targeting the small business market to Proofpoint, which delivers one of the leading anti-spam solutions to large enterprises. Spread across a variety of areas, Fliqz, Genius, PBWiki, Rally Software, Sabrix, and Visible Measures are just a few of the others.

Although many investors agree that bookings, MRR, and churn are important metrics, the numbers presented by different companies for these metrics often don’t match up. Bookings numbers are reported according to contract length, annualized, or sometimes whatever is easiest. Churn measures often lack context – customer churn, seat churn, and percent of revenue churn are all referred to as churn.

Here are the metrics.

Churn. Churn describes what’s leaking out of the bucket each term. It measures the health and satisfaction of customers, and forecasts the reliability of revenues.

On the negative side, churn numbers are confusing because there are an overwhelming number of churn calculations. They often lack context and of course, they’re only a trailing indicator. If churn suddenly increases, you’re already months late on a problem in your market or product. That’s why it’s not sufficient to measure churn.

Customer satisfaction. To determine (and predict) true customer satisfaction and the health of the recurring revenue base, you have to directly survey your customers as well and measure customer satisfaction. Customer satisfaction means surveying customers after support calls, and on a random basis across the entire customer basis, on a regular basis. Although it can help, it’s not sufficient to popup a web-based survey or send an email, because you don’t end up with a random and reflective sample of your customer base.

Bookings. The common wisdom is that bookings numbers are mis-leading (typically because they are annualized). Customers may churn out resulting in lower revenue than expected, or expansion may occur, resulting in numbers that are better than forecast. However, bookings are one leading indicator of MRR and reflect the performance of the sales team in the current month. Bookings can be an early indicator of something going wrong in the business. Ideally bookings should reflect contract length and provide breakouts for new sales, upsells, renewals, and non-recurring revenue.

MRR. Finally MRR, simply put is “how much we did this month.” MRR tells no lies. Unlike Contracted Monthly Recurring Revenue (CMRR), which describes the revenue expected next month, MRR is simple and actual. It reflects new accounts and pricing changes.

What These Metrics Mean To You
What does all this mean for management teams and investors? For investors, it means that it’s critical to ask qualifying questions when presented with bookings, revenue, churn, and customer sat numbers.

Granted, in the early stages of a company’s life it’s all about getting product up and running and customers using beta software. But once past that point, it’s keeping customers happy and healthy that matters. The flip side about SaaS is that while it’s easier for companies to deliver product to market and for potential customers to try out the offerings, it’s also easier for them to switch. Companies should actively think about ways to maintain high switching costs: the more customer data that can be imported into the system faster and that builds up over time, obviously the harder it is for customers to switch. Make your SaaS company a life-long relationship rather than a transaction; great service is critical to maintaining that relationship.

Service Is Today’s Critical IP
For years, software was the core intellectual property (IP) of tech companies. But delivering a best of breed, whole product experience over the Internet is hard. Customers expect 100% up-time and company and product responsiveness on part with consumer Internet offerings. The era of the 18 month release cycle is ancient history. Agile is the name of the game.

In fact, it’s a lot harder to exceed customer expectations with a service than it was with installed software. That’s why today, while the first “S” in SaaS remains an important part of a company’s IP, the second “S” comes first.

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