SmoothSpan Blog

For Executives, Entrepreneurs, and other Digerati who need to know about SaaS and Web 2.0.

SaaS Companies that Don’t Grow Pretty Quickly Have Something Bad Going On

Posted by Bob Warfield on October 11, 2012

Just read Jason Lemkin’s post on SaaS company growth.  He talks about two examples:

-  Workday, a $250M SaaS company growing at 90% a year

-  An unnamed smaller $40M SaaS company growing at 33% a year because, “growth is slowing, but we’re still doing great, because it’s all recurring revenue, and growing recurring revenue takes time.”

That bit about growing recurring revenue taking time, as if it is harder to grow recurring than big one-time license sales, is bunk.

Let’s do the math on two examples.  In the first, let’s assume a big one-time license sale company.  For the sake of simplicity, let’s say their average sale is (best Dr Evil impression):  ONE MILLION DOLLARS!

Further, let’s assume their marketing produces enough leads that they close 10 of these deals a year, and therefore have $10M a year in revenue.  Now they have to go on closing 10 deals a year, every year, just to stay flat.  No growth at all is implied in that scenario and that would be a very unhappy software company indeed.

Okay, now let’s consider the SaaS company, and let’s assume they’re in the same market.  So, they charge some fraction of the license company’s one million dollars.  Industry averages are anywhere from 2 1/2 to 4 years until the two breakeven.  Heck, let’s be bullish on things and make it 2 1/2 years.  Therefore they charge an annual subscription fee of $400K.

Now that’s less money, so presumably it’s an easier sale.  It certainly ought not be a harder sale.  And there should be all the normal advantages associated with SaaS.  Namely, it requires way less professional services to install it, the buyer doesn’t have a TCO that includes buying servers and paying more IT people to run them, yada, yada.

Let’s also stipulate our little SaaS company is running pretty near $10M a year in recurring revenue by selling 25 licenses a year.  Now here is where it gets interesting.  If we assume no churn, in other words, 100% renewals, we get the following over 5 years:

100%
Year New Licenses Sold Renewals Installed Base Revenue YOY Growth
1 25 0 25 10000000
2 25 25 50 20000000 100%
3 25 50 75 30000000 50%
4 25 75 100 40000000 33%
5 25 100 125 50000000 25%

Note that from the standpoint of conventional marketing and sales metrics, this company is flat.  If they didn’t have their renewals, they’d be in the same sad shape as our license company.  Instead, they are showing 100% growth after a year, and that declines slowly to 25% by the 5th year.

Folks, that is an amazing tail wind when you think about it.  If you’re going in front of a Board and shareholders to explain your numbers, wouldn’t you want to have a bunch of revenue from renewals automatically baked in every quarter?  I know I would.

So when I say, “SaaS companies that don’t grow pretty quickly have something bad going on,” we can now look at the definition of “bad”.

The first possibility, is that they haven’t seen any real growth in their lead funnel in a long time.  4 years to get to the 33% growth number Jason’s friend was quoting.  If you can’t figure out how to start growing again in 4 years, you’ll be just realizing the time to sell out was about 3 years back.  Bummer.

The next possibility is the lead funnel actual went away.  Here’s the same example where there are half as many new sales each year:

50% 100%
Year New Licenses Sold Renewals Installed Base Revenue YOY Growth
1 25 0 25 10000000
2 12.5 25 37.5 15000000 50%
3 6.25 37.5 43.75 17500000 17%
4 3.125 43.75 46.875 18750000 7%
5 1.5625 46.875 48.4375 19375000 3%

Interestingly, you still have time to react.  It isn’t until about year 3 that things turn really grim.  That’s a long time in the software business.  Did I mention I would rather face my Board and Shareholders as captain of a SaaS company than a perpetual license company?

Last possibility–there is something really wrong with your software, your customer experience, the competitive nature of your market, or even some paradigm shift that eliminates the need for your product that is causing renewal rates to tank.  If we cut that 100% pie-in-the-sky renewal rate to 50%, it turns out we get the same numbers we had when new leads got cut to 50%.  Again, you do have some time to react, but it is not a pretty thing.

Just for grins, let’s see what happens if you can grow your marketing lead funnel the way Old School Enterprise had to in order to get big.  Let’s say you double it every year:

200% 100%
Year New Licenses Sold Renewals Installed Base Revenue YOY Growth
1 25 0 25           10,000,000
2 50 25 75           30,000,000 200%
3 100 75 175           70,000,000 133%
4 200 175 375         150,000,000 114%
5 400 375 775         310,000,000 107%

Gee whiz, doesn’t that paint a nice picture?  And what did Jason start from?  Workday at $250M growing 90%?  Tracks the model pretty well.  I guess those Old School Enterprise guys running Workday know a thing or two about SaaS too, eh?

So keep an eye on your SaaS investments.  They have time to fix it if the growth rate slows–they’ll see it coming from the sales funnel.  And if they don’t manage to get it fixed before it manifests in the revenue, something very bad is probably happening there.

 

 

 

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