The SaaS market’s rapid growth shows no signs of slowing down. According to data from Statista, the industry is worth approximately $93 billion today and could be worth more than $150 billion by 2020. We’ve already seen huge changes in delivery, from all-inclusive platforms to more specialized tools and applications centered around specific processes like marketing automation and content marketing.

As the market continues to grow, we may also see changes to how SaaS companies measure growth and success, though efficiency and eliminating churn are likely to remain top priorities.

I recently talked with Byron Deeter, a partner with Bessemer Venture Partners, where he and his firm provide venture capital to cloud-based businesses in this market. We discussed which metrics are most important now, and Byron shared where he sees the focus shifting in a few years.

Sujan: What do you think is important for SaaS founders to measure right now?

Byron: We have this notion of the 5 C’s of cloud finance. Different weightings apply as you scale, but early on, there’s this notion of CMRR or CARR, which is Committed Monthly Recurring Revenue or Committed Annual Recurring Revenue.

This includes contracted revenue that may not go live, in addition to imminent customer churn. This figure is important because it’s a leading indicator of business. It answers the question, ‘What is the exact state of the business’s health today?’

Sujan: As a business grows past 10 million ARR, hitting that traction point, what metrics become important? Do they change?

Byron: Early on, it’s all about establishing market fit and growing revenue and figuring out the model. As you start to get to that 5,10,15 million ARR level, then you start needing to prove that the business can scale. That’s when we look at things such as Customer Acquisition Cost (CAC), payback, and churn rate. We look at the ratio of customer lifetime value to CAC and then free cash flow. Collectively, those are the top five metrics we look at in the growth stage.

Specifically what we’re looking at more these days is something we call the customer efficiency score, which is basically the interplay between the growth rate and capital efficiency. If you’re familiar with the rule of 40, which talks about revenue growth and profit, this is CARR growth and free cash flow. We’ve actually mapped out how efficient top companies are at each stage of growth and then benchmark new deals against that.

Sujan: When you’re evaluating a business, do you look at the channels a company uses to drive growth?

Byron: We definitely do. We particularly look for efficiency by channel, then marginal efficiency by channel and what is most scalable. A lot of our businesses benefit from organic traffic, but that’s not really scalable or sustainable. So the question becomes, ‘What’s the efficient rate of growth for this business and with additional investment, how can we grow it faster?’ It makes sense to raise venture capital when the business can access growth opportunities through marketing expansion and wants to use venture capital specifically for sales and marketing expansion.

At that point, we’ll look at which channels can be scaled up efficiently to have a sub two-year payback or, ideally, a sub one-year payback so we get quick returns on our collective dollars.

Sujan: How do you assess channel scalability?

Byron: There are different analyses for different types, and the simplest is search engine marketing. So we look at the volume of key terms available, the elasticity of supply, and the costs associated with ramping up your SEO. These make up the time-tested methodology of consumer internet companies.

At the other end, there are things like evangelism to scale your organic channel that you can estimate, but are harder to quantify. In between, there are more traditional direct sales methods, from looking at rep efficiency and productivity to channel partners and relationships.

I’ll note that channel relationships haven’t really been too successful in cloud from the reseller’s perspective, so they tend to be more oriented to direct channels that the companies can influence, where they can move the needle themselves.

Sujan: Anything else related to SaaS metrics that you think is relevant right now?

Byron: I think there’s this notion of efficiency by valuing public companies based on efficiency growth as opposed to ‘growth at all costs,’ and that’s trickling into the private markets as well. The tightest correlation of any metrics links to this efficiency rule. It trumps revenue growth and free cash flow, it trumps CAC to CLV, and it even outweighs other metrics we think are important. The efficiency rule is typically the purest way to determine the proper multiple to apply to a business.

Sujan: Efficiency has been commonly addressed, but is this something that has always been a priority and is just now being vocalized?

Byron: It has been valued, but it has ranked second or third to top-line growth and user acquisition. So when capital was cheap last year and before, the crude proxy for business value was revenue growth and as long as you weren’t burning massive sums of money to do it, you were given the benefit of the doubt.

And that applies to companies like Zenefits and Box in our portfolio, which grew very fast but spent a lot of money to do it. Box is actually turning free cash flow positive and growing much more efficiently now because of that. Just look at a business like Shopify, which is among the highest multiple businesses because of that interplay between growth and profitability.

And that’s what is different now. If you look back three years ago, the R-squared for revenue growth was about 70% in terms of what was the best predictor for the multiple in the business. Now, the revenue multiple is cut in half in terms of a predictor, and the efficiency score is now much more predictive than the revenue multiple.

Sujan: Do you think efficiency will still be a top metric five years from now?

Byron: I think efficiency is a good long-term metric. It reflects the maturation of the cloud space, because all businesses should be valued as a multiple of their free cash flows or the sum of their total free future cash flows, whether it’s Walmart, a high-tech company, or a McDonald’s franchise. We did find high predictability in long-term gross margins and renewal rates; free cash flow capabilities of these cloud businesses a few years ago led people to use revenue as a crude proxy for everything below it. Investors are more discerning now and we have large businesses at scale that are showing how the P&Ls are likely to unfold.

This leads to more educated investors, and we believe this is a good thing for the industry. Our CEOs are embracing it because then they can make trade-offs around the right rate and pace of investment for their business.

Are you involved in the SaaS market? What metrics do you focus on for your SaaS? Share your thoughts with me in the comments below:

Comments
  1. Great interview. Can you clarify this comment…The tightest correlation of any metrics links to this efficiency rule. It trumps revenue growth and free cash flow, it trumps CAC to CLV, and it even outweighs other metrics we think are important.

    What efficiency rule are you referring to? Efficient growth?

    Thanks. Ben.

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