Posts

We may have been talking about SaaS companies for more than a decade, but we’re still just at the beginning. The legacy software companies including Oracle, Microsoft, SAP and and IBM control 83% of the market cap of software businesses, representing $830B in market cap. The largest SaaS company, Salesforce, is just about half the size of SAP, and Microsoft is 8x bigger.

In revenue terms, the legacy vendors control an astounding 93% of revenue: $245B compared to $19B.

I’m thrilled to welcome Mina Radhakrishnan as an entrepreneur-in-residence (EIR) to Redpoint. Mina, my partner Jamie, and I got to know each other about 10 years ago at Google, where we were associate product managers all working in Marissa Mayer’s APM program.

Since Google, Mina has done some amazing things. In particular, Mina was Uber’s first PM. She joined when the company numbered about 20 people, and stayed through until the employee base reached many thousands. Mina introduced surge pricing, built the on-boarding software for new drivers, and managed the releases of the key products of the company including UberX.

In a recent podcast, Ron Gill, the CFO of Netsuite - a $7B+ market cap company with about $600M in 2014 revenue, which provides ERP software to mid-market companies - articulated the importance of the Lifetime Value / Cost of Customer Acquisition (LTV/CAC) ratio for his company. LTV/CAC is often used to justify marketing and sales investment to acquire customers. But there’s much more to it.

LTV/CAC is a powerful diagnostic tool for the performance of almost every team within the company: product, engineering, sales and marketing. Gross margin, which is an important factor in LTV, reflects the engineering architecture and the hosting costs required to support customers. Average revenue per customer is a function of the product and the sales efficiency (and arguably marketing/positioning.) The chart above isn’t meant to be comprehensive, but illustrate for a hypothetical company some of the constituent parts of the LTV/CAC. A real tree would be much more granular and could extend several layers deeper.

McKinsey developed the 9 Box Matrix in the 1970s to help GE prioritize investments across its 150 business units. Not all business units were equally attractive. Some should receive investments and others should be divested. The 9 Box Matrix evaluated business units on two dimensions: industry attractiveness and competitive strength of the business unit.

At some point in the last 40 years, Human Resources teams co-opted this model as a talent management tool, and replaced the two industry axes with people specific ones: performance and potential, as depicted above. Because the HR model has never been standardized, there are quite a few variations in circulation. But the usage patterns are consistent. The main goal of the 9 Box Matrix is to categorize employees, determine which to promote, retain and invest in, and which to reallocate.

As the next generation of SaaS companies achieve maturity, they have begun to serve larger and larger customers, who in addition to demanding a great product, often request services. Professional services, as they are often called, entail training and customization. For product driven startups, the decision to offer professional services is a tricky one. On one hand, the customer is always right and services often enable substantially larger contracts. On the other hand, selling hours to drive revenue decreases the efficiency of the business, by hiring more people in order to grow revenue linearly. In addition, many businesses operate their services divisions at a loss. But not all. The chart above compares the gross margins on professional services across the 13 publicly traded SaaS with the largest average revenue per customer, which ranges from $50-$800K for the 2015 fiscal year where available, and otherwise the last disclosed year before acquisition.

Of the 43 SaaS companies to have gone public in the time period between 2006 and 2014, 60% are trading above their IPO pop price – the price at the end of their first day of trading. The median company has appreciated 69% since its IPO. The chart above shows the trends for each of the companies in this data set. Xero tops the list that more than 17x appreciation. This is an anomaly; the company went public right as it was founded and has grown to be worth several billion dollars. It’s an amazing story. On the bottom end, Castlight has dropped by 80 percentage points in value since its IPO, to a market cap of about $850 million, and trades below the typical SaaS company at about 7x forward revenues. If you’re curious about the trends from IPO offer, you can find the chart here.

In 2000, the majority of tech acquisitions were primarily stock. One company would buy another using its own shares, instead of paying for the target business in cash. But since then, there’s been a secular trend to cash deals. In 2014, 90% of the tech M&A transactions consummated by companies, and excluding private equity firms, in the US with disclosed deal values were cash deals.

As the cash balances of large tech incumbents balloons (Apple is at greater than $30B, Google at more than $65B, Microsoft has $95B, etc), more and more M&A is primarily cash, because cash is cheap and interest rates are low. The best return on capital then is acquisition or stock buy backs which hit a record high earlier this year.

Creating a sense of urgency is one of the most powerful sales tools available to SaaS companies. There are many different ways of accomplishing this, but one of the most common ways is to offer discounts that expire. Discounts are powerful incentives to increase sales. But, they have to be crafted correctly, or they can have dramatic impact on a startup’s cash position. This is why sales incentives should be designed hand-in-hand with the company’s finance team. Imagine a hypothetical 20 person software company. Suppose this month is seasonally slow month, and the executive team decides to implement a 25% discount to accelerate sales. There are many ways of offering this discount to customers. Above, I have modeled three: a 25% reduction billed monthly, a 25% reduction billed upfront, and the first three months of the subscription are free.

Orbiting the Giant Hairball is one of the most unusual business books I’ve read. It’s irreverent, full of drawings, and completely chaotic in the most wonderful way. Gordon MacKenzie, the author of the book, worked at Hallmark cards for 30 years to the day. He started initially in the creative department imagining greeting cards and ultimately found himself with the title Creative Paradox. In his book, he described the way he injected creativity into his working life. I thought it was a great book with three salient themes.

In the late 1990s, two of the dominant talent management platforms were founded. Taleo and SuccessFactors grew very quickly after they entered the market, bringing novel delivery to the human capital market. Both companies eventually offered talent acquisition, performance management, and learning tools for human resources teams. But they started in different places. Taleo initially focused on recruiting tools and SuccessFactors on performance management.

As the chart above shows, both companies scaled revenue rapidly, reaching $100M in revenue 7 years after founding. SuccessFactors started out a bit slower, but eventually grew about twice as fast as Taleo.