Building Innovative Subscription-based Businesses: Lecture 2

Building Innovative Subscription-based Businesses: Lecture 2

• 1.
  Building Innovative Subscription-based Businesses BUS-185 Lecture 2: The Subscription Business Model Martin Westhead
• 2.
  Overview  No standard Concepts  Recurring Revenue  Lifetime Revenue  Acquisition, Boost, Churn (ABC)  Modeling Revenue (easier – so start there)  Leaky bucket  Subscription Plateau  Understanding Churn  Subscription Health checks  Magic numbers  The only three metrics that matter  Case Study: SendGrid
• 3.
  Optics check  WhichMonth is better?  Now which Month is better? (same data)
• 4.
  Always start with$  Two problems with subscription numbers  Apples and Oranges cannot be added  3 bronze + 2 gold is like 3 inches + 2 feet  But even without the sum confusing to see them together  Summaries should present either:  Dollars or  % change (in dollars)  Subscription/Customer numbers ARE useful  Just not recommended for summaries
• 5.
  Recurring Revenue  RecurringRevenue  Annual (ARR)  Monthly (MRR)  Quarterly (QRR)  But there is a gotcha even with RR… Churn Rate of Annuals is often not the same as Churn Rate of Monthlies So, even if annuals have lower MRR, can be worth more
• 6.
  Lifetime Revenue  CustomerLifetime Revenue (CLR)  Subscription Lifetime Revenue (SLR)  All time expected revenue  Note : different from CLV  Multiple ways to calculate it…
• 7.
  Lifetime Revenue 1 Gold monthly  Recurring Cost $100  Churn 5%  Expected return is  $100 in month 1  $100 – 5% month 2  $95 – 5% month 3  Etc. (see chart) More details:  Total expected return is http://chargethru.com/profiles/blogs/weighin g-up-the-true-value-of-a-customer area of chart  $100 / 5% = $2000
• 8.
  Lifetime Revenue 2 Use actual aggregated churn data  Build a retention model  Multiply retention by recurring revenue  Sum across the chart
• 9.
  Lifetime Revenue 3 Find average lifetime of Subscriptions  Multiply by Recurring Revenue  Used by Sendgrid (see later)
• 10.
  Exercise  Experiment withthe three different approaches to modeling lifetime revenue  What are the pros and cons of each?  When would you use one over another?  Discussion Topic on Charge Thru
• 11.
  Modeling Revenue
• 12.
  Subscription Business Boost Revenue Per Customer Acquire New Customers Notes:  Boost can be positive or negative  Sometimes these are separated (see SendGrid) Reduce Churn  Alternatively Boost can be folded into Churn  So Churn can be positive or negative
• 13.
  Core revenue model: The leaky bucket Acquisitions B Boost: Up sell/Cross sell Recurring Revenue (RR) Churn
• 14.
  The Math Acquisitions Recurring Revenue Recurring Revenue (RR) B Boost Churn B C B C A Rt+1 A Rt t t+1 t+2 time Rt+1 = Rt+ At + Bt- Ct
• 15.
  Natural relationships  Churnnaturally modeled as % of existing ($)  Boost naturally modeled as % of existing ($)  Acquisitions is usually* independent of existing ($)  Define:  B = Bt / Rt  C= Ct / Rt  Assume At is fixed At = A Rt+1 = Rt(1 + B–C) + A  *In a viral (referral-base) model A is % of existing
• 16.
  Constant Acquisitions Recurring Revenue Acquisitions B C unchanged A B C A t t+1 t+i t+i time Rt+1 = Rt(1 + B–C) + A
• 17.
  Subscription Plateau “Water levelequilibrium of the Leaky Bucket” MRR for 2 businesses over 5 years  Same acquisition rate (100 customers per month,  Same ARPC ($100 per month).  Red has churn rate of 2.5%  Blue has churn rate of 5%  Both businesses are starting plateau  But the 5% faster and lower MRR
• 18.
  Understanding Churn  Cancellations  Obvious, easy to quantify  Learn what you can about why  Behavioral analysis  Questionnaire  Overdue payments  Failed payments  Chargebacks / Paypal cancellations  Covert cancellations  Hard to quantify  Establish a Dunnings (Overdue Enforcement) process  Make sure you understand the scale of covert cancels  Industry average (SaaS) annual churn of 10-20%  More details:http://chargethru.com/profiles/blogs/churn-to-the- power-three
• 19.
  Subscription Health Metrics
• 20.
  Warning about modeling costs  Cost models are more business specific  Be particularly careful about projecting costs  Fixed costs can be changed  Variable costs can change with volume  Always be aware of your assumptions when you construct business models
• 21.
  “The” Saas Magicnumber  Revenue growth per sales and marketing dollar M = (QRRt – QRRt-1)*4 / SMt-1  QRRt: Quarterly Recurring Revenue for period t  QRRt-1: Quarterly Recurring Revenue for the period t-1  SMt-1: Sales and Marketing Expense for the period t-1  1.0 => $1 S&M leads to $1 ARR growth  Under 0.75 problems, over 0.75 accelerate marketing  Over 1.5 “call me immediately” (Lars Leckie's Blog) http://larsleckie.blogspot.com/2008/03/magic-number-for-saas-companies.html
• 22.
  Joel’s SaaS Magicnumber  Average customer rate of return J = (ARR – ACS) / CAC  “ARR” is the average recurring revenue per customer  “ACS” is the average recurring cost of service per customer  “CAC” is the average customer acquisition cost  1/J time to profit per customer (Payback Period)  J = 1 profit in first year. J >0.5 profit in under 2 years  No reference to Churn (Joel York) http://chaotic-flow.com/saas-metrics-joels-magic-number-for-saas-companies/
• 23.
  The Only 3Metrics that Matter Retention (%)  How much ARR you keep (1 – Churn) Recurring Profit Margin (%)  (ARR – Churn – Non-growth spend)/ARR Growth Efficiency (ratio)  Cost to acquire $1 of new ARR  Profit vs. Growth Details: http://www.slideshare.net/Zuora/zuora-always-on20123-saas-metrics-that-matter-12301579
• 24.
  Industry Benchmarks Best Practice Model Retention 83% 86% 92% 90% Recurring 58% 47% 19% 50% Profit Margin Growth 0.75:1 1.26:1 2.15:1 1:1 Efficiency
• 25.
  SaaS Metrics CaseStudy Slides from Jim Franklin, CEO SendGrid Inc. (used with permission)
• 26.
  Key goals Growth Profitability
• 27.
  Metrics To MeasureGrowth  Monthly/(Annual) Recurring Revenue (MRR)  Roll forward of MRR (Beginning+New+Increase-Lost-Decrease)  Monthly growth rates  Churn analysis (cohort, by product, size, etc)  Customers  Roll forward of customer count  Monthly growth rate  Churn analysis (cohort, by product, size, etc)
• 28.
  # of Deals/Customers Increase in Deal Growth MRR/Customers Add New Product/Service Growth for upsell Churn Decrease in MRR/Customers Deal Reduction
• 29.
  MRR = MonthlyRecurring Revenue Understand each as it relates to your business, products, geo, etc.
• 30.
  Customer Count Understand eachas it relates to your business, products, geo, etc.
• 31.
  Customer Retention/Churn CohortAnalysis Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12 Month 13 Month 14 Month 15 Month 16 Month 17 Month 18 Month 19 Month 20 Month 21 Month 22 Month 23 Month 24 Customer 100% 99% 97% 96% 94% 94% 94% 93% 93% 92% 91% 91% 91% 91% 90% 90% 89% 89% 89% 87% 86% 86% 86% 86% Dollar 100% 103% 105% 110% 112% 115% 116% 115% 120% 124% 127% 130% 137% 138% 141% 141% 152% 162% 168% 168% 173% 161% 168% 182% Product/GEO/Vertical Analysis Customer % MRR % Product 1 110 53% $ 4,000 17% Product 2 75 36% $ 6,000 26% Product 3 20 10% $ 3,000 13% Product 4 4 2% $ 10,000 43% 209 $ 23,000
• 32.
  Metrics To MeasureProfitability  Customer  Customer acquisition cost  Lifetime value of the customer  Financial Statements  Cash flows (direct method)  Income statement  Employee  Revenue per employee  Cost per employee
• 33.
  CAC Customer LTV Cash Flow Financial Profitability Statement Income Statement Revenue per Employee Per Employee Expenses per Employee
• 34.
  Customer Acquisition Cost(CAC)  What does it cost to acquire a customer?  How many months of MRR does it take to recover your costs of acquiring that customer?
• 35.
  CAC = (Sales + Marketing +Deploy Costs) # of Deals Closed Sales Costs = $100,000 Marketing Costs = $150,000 # of Deals Closed = 600 $100,000 + $150,000 = $416 CAC 600
• 36.
  How long doesit take to recover the CAC? Payback Period = CAC/MRR per Customer Average MRR Per Customer = $100 $416/$100 = 4.16 months Rule of thumb: 12 months or less is good.
• 37.
  Lifetime Value ofCustomer (Average Lifetime of a Customer * MRR/Cust) - Cost of Revenue - CAC = Lifetime Value of Customer Lifetime of Customer = 36 mths 24 mths MRR per Customer = $100 $100 Margin = 80% 80% CAC = $416 (4.16 mth payback) $1,600 (16 mth payback) (36*$100)-$720-$416 = $2,464 (24*$100)-$480-$1,600 = $320 Rule of thumb: LTV that is greater than 3x CAC is good
• 38.
  Class Exercise …don’t leaveit too late
• 39.
  Guest Lecturer Celia House Director of Product Management, MLS Listings Inc.