SaaSRadar – Fuel, A McKinsey Company https://get.fuelbymckinsey.com Wed, 29 Jan 2020 20:31:19 +0000 en-US hourly 1 https://wordpress.org/?v=5.2.2 Does Your CLTV to CAC Ratio Stand Up? Does It Matter? – Infographic https://get.fuelbymckinsey.com/article/does-your-cltv-to-cac-ratio-stand-up-does-it-matter-infographic/ https://get.fuelbymckinsey.com/article/does-your-cltv-to-cac-ratio-stand-up-does-it-matter-infographic/#respond Sun, 01 Dec 2019 16:58:42 +0000 https://get.fuelbymckinsey.com/article/auto-draft/ Talking about LTV/CAC without clarifying which method you're using is a dangerous game.

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Don’t Get Blindsided Integrating a SaaS Company https://get.fuelbymckinsey.com/article/dont-get-blindsided-integrating-a-saas-company/ https://get.fuelbymckinsey.com/article/dont-get-blindsided-integrating-a-saas-company/#respond Tue, 14 Aug 2018 19:04:51 +0000 https://get.fuelbymckinsey.com/article/auto-draft/ Programmatic mergers and acquisitions (M&A) are a critical element of startup growth, as shown in McKinsey’s previous work “grow fast or die slow.” Most top performing SaaS companies need to extend growth by bulking up their product portfolio, bookings growth, market share, TAM, or talent and technology stack. Shareholder return-based studies suggest that programmatic M&A leads […]

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Programmatic mergers and acquisitions (M&A) are a critical element of startup growth, as shown in McKinsey’s previous work “grow fast or die slow.” Most top performing SaaS companies need to extend growth by bulking up their product portfolio, bookings growth, market share, TAM, or talent and technology stack. Shareholder return-based studies suggest that programmatic M&A leads to above average outcomes versus other M&A approaches.

Some SaaS companies have built strong M&A capabilities in this arena to become successful programmatic acquirers. If you look deeper at what top performing companies believe really separates the lowest and highest performers in M&A value capture, it is their ability to do “integration planning and execution,” as noted by the largest delta in the graphic below:

Global M&A Capability Building Survey, 2015. The online survey garnered 1,841 responses from C-level and senior executives.

Contemplating their first major acquisition can be a very stressful experience for a SaaS company CFO and/or CEO. Aside from whether it is the right target, or whether to proceed now versus later, or if the price is right – a big driver of success hinges on how well integration planning and execution is done. Yet many SaaS companies have no M&A team in place, so they are left scrambling to estimate the budget for integration efforts and activities, which can be hard to predict and plan for, much less having the capabilities and capacity to get the integration done.

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At Fuel, we find a common concern among SaaS companies is how much to budget for post-merger integration costs after that first big acquisition. These costs represent the one-time, non-recurring costs that companies will spend to rationally blend products, sales processes, operations, marketing efforts, brand, people, cultures, systems, and tools.  These are not the one-time transaction costs for the deal that sell-side investment bankers, M&A lawyers, and financial due diligence accountants earn.  These are the expenses borne both by internal employees and 3rd party consultants.

In order to better understand these costs, the Fuel team conducted an analysis on buy-side M&A deals in the SaaS industry. We reviewed 24 deals where the data was publicly available to calculate the implied one-time, non-recurring acquisition integration costs as a function of (1) acquired headcount and (2) purchase price paid.

Our analysis estimates that public SaaS companies will spend between:

  • “Per capita”basis: ~$18 to 33k per acquired FTE in one-time, non-recurring acquisition integration costs
  • “Deal value” basis: ~1.5 to 2.1% of the purchase price on one-time, non-recurring integration costs

For example: If a SaaS company is acquiring a startup with 70 full-time employees, our model estimates it would likely pay between $1.3 and $2.3 million in one-time, non-recurring costs to integrate the company on a “per capita” basis. On a deal value basis, a $300m acquisition implies a SaaS acquirer will spend between $4.5 and $6.4m for one-time, non-recurring integration costs.“Having a clearer idea of the true costs of integration should give SaaS leaders the sense of what value needs to be captured from a deal. ”

Having a clearer idea of the true cost ccs of integration should give SaaS leaders the sense of what value needs to be captured from a deal.

The $3-4m difference between ‘per capita’ and ‘deal value’ costs is because we used SaaS historical deal data to approximate the actual costs, so these estimates are via a calibration method. True costs will vary based on other factors: the negotiated purchase price, or if you have a full-time M&A integration team in house (where these costs are already baked into your recurring operating expenses). See the table below for an idea of the ranges within the companies we analyzed:

Source: Fuel, A McKinsey Company analysis of public data from 24 buy-side M&A deals in the SaaS industry between 01/2014 and 05/2018

Effective M&A integration can be challenging. It is wise for SaaS CFOs to budget on the higher-end of this spectrum for their first acquisition. Mistakes will be made. Hidden costs will emerge. But once muscle memory is developed from a few acquisitions and some scale, you can and should move down to the lower end of the integration cost spectrum.

Having a better understanding of the expected costs of integration, based on publicly disclosed, historical cost from past acquisitions in SaaS, will give C-level leaders the confidence to set aside adequate budget to ensure the proper resources are in place to achieve successful integration and to capture their fair share of benefits and value creation inherent in the acquisition.

Email Junaid or Oleg if you have any questions or want to discuss this article further. And follow Fuel on Twitter and LinkedIn for more SaaS insights.

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Channel Partnerships: Proceed With Caution https://get.fuelbymckinsey.com/article/channel-partnerships-proceed-with-caution/ https://get.fuelbymckinsey.com/article/channel-partnerships-proceed-with-caution/#respond Fri, 23 Mar 2018 19:22:37 +0000 https://get.fuelbymckinsey.com/article/auto-draft/ Conventional wisdom holds that channel partnerships can be a cost-effective way for SaaS companies to expand their reach and acquire more customers. But these relationships may come with significant costs—channel partners may not have the right incentives to push your product and they are difficult to monitor. Our analysis shows that SaaS companies considering channel […]

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Conventional wisdom holds that channel partnerships can be a cost-effective way for SaaS companies to expand their reach and acquire more customers. But these relationships may come with significant costs—channel partners may not have the right incentives to push your product and they are difficult to monitor. Our analysis shows that SaaS companies considering channel partnerships should proceed with caution. They are useful when companies need to grow beyond their internal capabilities, but in the long run they are not the best use of precious sales and marketing dollars.

In our post entitled “Want to Accelerate Value Creation?” we explained why we think growth efficiency—the net new ARR each dollar of sales and marketing generates—is an important and useful metric for SaaS companies. We’ve used that metric—along with detailed sales and marketing data from nearly 200 companies in our SaaSRadar database—to test several common SaaS sales and marketing practices. (See, for example, our post on “land and expand.”)

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As the chart above shows, channel partnerships are a mixed bag. We found that companies in our database that relied heavily upon channel partnerships to acquire new customers generally grew less efficiently. SaaS companies that did no marketing through channel partners had a 1.70 growth efficiency score, on average, while companies that relied on partners for 10% or more of their new customer acquisition only had a 0.71 growth efficiency or lower. Looking at new logo growth, however, yields a different picture. The companies in our survey that grew their new customers the fastest over a 12-month period were those who acquired 1-5% of those customers through channel partnerships. And with more channel partnerships, the data in our survey becomes a little noisy. This suggests that channel partnerships can be useful to achieve certain key growth objectives in the lifecycle of a company, but that they shouldn’t be relied upon too heavily at all times.

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Land vs. Expand: Finding the Right Balance for Your Salesforce https://get.fuelbymckinsey.com/article/land-vs-expand-finding-the-right-balance-for-your-salesforce/ https://get.fuelbymckinsey.com/article/land-vs-expand-finding-the-right-balance-for-your-salesforce/#respond Fri, 02 Mar 2018 20:24:01 +0000 https://get.fuelbymckinsey.com/article/auto-draft/ We all know that landing any new customer is something to celebrate, particularly because you can then “land and expand,” using sales and marketing resources to grow revenue from that same customer. But how much precious salesforce time should go to cross- and up-selling existing customers, versus new logo acquisition? We answered that question using SaaS […]

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We all know that landing any new customer is something to celebrate, particularly because you can then land and expand, using sales and marketing resources to grow revenue from that same customer. But how much precious salesforce time should go to cross- and up-selling existing customers, versus new logo acquisition? We answered that question using SaaS Radar, Fuel By McKinsey’s proprietary database of nearly 200 SaaS companies. Our analysis suggests that companies need to take a Goldilocks approach—not too little, but not too much. Companies that devote about 10-25% of their sales resources to farming instead of hunting do best.  If you devote more than that, the upside is less than it would be from devoting those resources to new customer acquisition, and the opposite is true if you invest less than 10%.

Source: Fuel By McKinsey SaaSRadar.

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In our post “Want to Accelerate Value Creation?” we described our approach to determining how efficiently a SaaS company is growing—we measure how much net new ARR each dollar of sales and marketing generates. Using that metric, we determined that if more than 25% of your customers are upsold in a quarter your growth efficiency is over 1.6. If less than 10% of your customers generate new revenue for you in a quarter your growth efficiency is less than 1; this means you are not generating sufficient new ARR to cover your sales and marketing expenses.  At the same time however, since upselling distracts from new customer acquisition, it is important to find the right balance. Your growth efficiency is at its optimal level when you invest between 10-25% of your existing sales resources on upselling and cross selling, as seen in the chart above.  This doesn’t mean you shouldn’t invest in customer success, but your salesforce should be spending the majority of its time on new logo acquisition.

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How Many Customers Should Each of Your Sales Reps Have? https://get.fuelbymckinsey.com/article/how-many-customers-should-each-of-your-sales-reps-have/ https://get.fuelbymckinsey.com/article/how-many-customers-should-each-of-your-sales-reps-have/#respond Tue, 27 Jun 2017 19:34:05 +0000 https://get.fuelbymckinsey.com/article/auto-draft/ Fast growth companies often lack basic data and benchmarks about how to organize and manage an effective sales force, a critical part of sustaining high growth.  We are often asked, for example, how many customers each sales rep should have.  To answer that question, we analyzed data from over 100 companies that participated in our […]

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Fast growth companies often lack basic data and benchmarks about how to organize and manage an effective sales force, a critical part of sustaining high growth.  We are often asked, for example, how many customers each sales rep should have.  To answer that question, we analyzed data from over 100 companies that participated in our proprietary SaaSRadar benchmarking survey.

We found that—as with many aspects of fast growth sales—one size does not fit all.  Among the companies in our sample, the number of customers per rep varies with average contract value—the blue line on the chart below.  Simply put, the larger the ACV, the fewer customers per sales rep.  This makes intuitive sense: larger customers have a longer sales cycle, require more ongoing care and feeding, and therefore more take significantly more time from individual account execs.  By contrast, when companies instead pursue a sales strategy aimed at smaller customers, they need to leverage their sales reps to generate more deals.  At the same time, we also found that our survey companies set roughly the same quota value for their reps regardless of how many customers they served—the orange line on the chart.

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What does this mean for the SaaS sales organization?  While it is of course important to hire, train, and retain the best salespeople for your business, this analysis suggests that what you do with those reps depends mostly on your sales motion.  It is by now well known that there are many different ways to build a $100 million SaaS business.  How many reps you have and how they are organized should depend less on their productivity and more on the choice whether to build your business out of a small number of high-value customers or a large number of small customers.

Figure 1 – Customers and quota per rep versus average customer value

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Does Your CLTV to CAC Ratio Stand Up? Does It Matter? https://get.fuelbymckinsey.com/article/does-your-cltv-to-cac-ratio-stand-up-does-it-matter/ https://get.fuelbymckinsey.com/article/does-your-cltv-to-cac-ratio-stand-up-does-it-matter/#respond Wed, 31 May 2017 21:09:09 +0000 https://get.fuelbymckinsey.com/article/auto-draft/ Many SaaS businesses use the ratio of customer lifetime value (CLTV) to customer acquisition cost (CAC) to measure their sales efficiency.  The higher the CLTV/CAC ratio, the greater the value the business creates for every dollar of sales and marketing spend.  Of course, CEOs and especially investors are not interested solely in the absolute value […]

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Many SaaS businesses use the ratio of customer lifetime value (CLTV) to customer acquisition cost (CAC) to measure their sales efficiency.  The higher the CLTV/CAC ratio, the greater the value the business creates for every dollar of sales and marketing spend.  Of course, CEOs and especially investors are not interested solely in the absolute value of this metric—they also want to know how their businesses, portfolio companies, or potential investments stack up against their peers.

The conventional wisdom is that SaaS companies should aspire to a CLTV/CAC ratio of 3 or higher.  But the reality is that most businesses do not achieve that aspiration.  We used our proprietary SaaSRadar database of company metrics to calculate the CLTV/CAC ratio for a sample of 40 companies.  The results are shown in the histogram below:

View the Infographic

Learn more about how LTV/CAC is calculated in our infographic.

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As this chart shows, a plurality of SaaS companies have a CLTV/CAC ratio of between 1 and 3.  And while the mean CLTV/CAC ratio in our sample was 3.4, the median was only 2.8.  Most companies therefore appear to fall on the other side of the conventional wisdom.

That said, we share the popular skepticism over CLTV/CAC’s effectiveness as a metric.  Calculating this metric poses challenges and it can be susceptible to wild swings that might not be representative of the health of the underlying business.  Computing customer lifetime value requires companies to make assumptions about their customers’ lifecycles that often are not grounded in data.  Even when they are data-driven, the data used for the estimate is historical rather than forward looking, and may change significantly depending on the company’s product cycle and sales strategies.  Alternatively, companies compute CLTV by dividing their monthly recurring revenue (MRR) by their churn rate.  While this approach may be preferable because churn is easily calculated at a snapshot in time, small changes in churn can result in large swings in CLTV, particularly at low churn rates.

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Although it’s true that the metric does correlate with growth rate—in our sample, those companies with a CLTV/CAC above 3 grew at an average annual rate of 42%, while those at 3 or below grew slower—28% per year on average—we don’t believe that SaaS health can be boiled down to a single KPI.  As we will detail in forthcoming research, we think that these businesses should be judged through a more holistic series of metrics that provide insight into specific operational levers that SaaS companies can use to optimize their growth and profitability.

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Focusing on Customer Success to Drive Growth https://get.fuelbymckinsey.com/article/focusing-on-customer-success-to-drive-growth/ https://get.fuelbymckinsey.com/article/focusing-on-customer-success-to-drive-growth/#respond Thu, 01 Dec 2016 21:33:26 +0000 https://get.fuelbymckinsey.com/article/auto-draft/ While customer acquisition is a clear part of revenue growth, a less obvious but critically important driver is customer success, as measured by high retention rates. Once you have invested the time and money to acquire a new customer, you lose out on the full revenue potential of that customer if they leave, or churn, […]

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While customer acquisition is a clear part of revenue growth, a less obvious but critically important driver is customer success, as measured by high retention rates. Once you have invested the time and money to acquire a new customer, you lose out on the full revenue potential of that customer if they leave, or churn, earlier than desired. By reducing the revenue headwinds caused by churn, companies with strong levels of customer success grow faster.

To better understand the impact of customer success on the growth of technology and software companies, we developed a set of hypotheses and perspectives on key metrics behind customer success, as well as best practices for reducing churn that we validated with input from leading innovators in venture capital and SaaS. We then dug into our proprietary database, SaaSRadar, which tracks key financial and operational metrics across nearly 200 growth-stage SaaS businesses with revenue between $10 million and $200 million. We used that data to look at how top-quartile performers in revenue growth compare with mean performers across a range of churn and related metrics for each of three customer types: small and midsize businesses (SMBs); SMBs and enterprises; and enterprises (see sidebar, “About the research”).

Companies typically track three churn metrics: customer churn, gross-revenue churn, and net-revenue churn. The most comprehensive of these three metrics is net-revenue churn, as it captures both the dollar value lost from churning customers and the dollar value gained from expansion revenue (which comes from both up-selling and cross-selling to existing customers). Our analysis showed several results:

  • Across all three customer types, companies in the top quartile of growth maintained lower net-revenue churn than mean performers.
  • The net-revenue performance of the top-quartile-growth performers was driven most significantly by advantages in gross-revenue churn as opposed to logo churn or revenue expansion (upsell/cross sell) within existing accounts.
  • Companies that excel at lowering gross-revenue churn emphasize several key customer-success best practices throughout their organizations.

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Lower net-revenue churn is correlated with higher growth

The results of our analysis show that top-quartile-growth performers have much lower net-revenue churn than mean performers. The analysis also shows that net-revenue churn improves with larger average contract value (ACV), likely due to more structural churn among SMB customers and higher switching costs associated with larger contracts (Exhibit 1). In particular, between the SMB and the SMBs-and-enterprises customer types, top-quartile performers not only have net-revenue churn that is 14 to 23 percentage points less than mean performers but also have net-revenue churn that is negative in an absolute sense. Negative net-revenue churn means that these top-quartile performers would continue to grow even if they did not acquire any new customers (their ACV expansion in existing accounts is greater than any revenue churn from existing customers).

Exhibit 1 – Maintaining low net-revenue churn is critical to ensure top-quartile growth.

The difference in net-revenue churn between top-quartile performers and mean performers is less pronounced among companies serving large enterprises—top performers have net-revenue churn that is seven percentage points lower than mean performers. However, because of the size of these contracts, even small differences in net-revenue churn have very real implications for a company’s top line.

Why focusing on gross-revenue churn can lower net-revenue churn

Breaking down net-revenue churn into its two primary subcomponents, gross-revenue churn and expansion revenue (also called “antichurn”), reveals that top-quartile-growth performers achieve such low net-revenue churn by outperforming on gross-revenue churn.

While it is true that some of the net-revenue-churn advantage enjoyed by top performers stems from expansion revenue, the majority of the benefit stems from reductions in gross-revenue churn (Exhibit 2). Across all three customer types, the gross-revenue churn of top-quartile-growth performers is about 40 to 50 percent lower than mean performers. In other words, relative to mean performers, top-quartile performers achieve their success more by retaining existing customers than by convincing their customers to buy more or move to higher-priced tiers of the product.

Exhibit 2 – To help ensure top-quartile growth, companies can focus more on gross-revenue churn than expansion revenue.

The skew is a little more balanced when serving midmarket customers. Here it is important to excel at both gross-revenue churn and expansion revenue to maintain top-quartile performance. This is likely a result of the “land and expand” strategy that companies with midmarket customers are pursuing, where success at expansion within existing accounts is critical to achieve top-quartile growth.

Coming back to the overall picture, focusing on gross-revenue churn is also more important than focusing on customer churn alone. In other words, it’s important to take into account the fact that not all accounts are created equally—some customers are clearly more valuable than others. Companies with top-quartile growth have lower customer churn than mean performers—from about 10 to 30 percent lower depending on customer type (Exhibit 3). But the bigger gap between top-quartile performers and mean performers, again, lies in their gross-revenue churn, which, as mentioned before, is 40 to 50 percent lower depending on customer type.

Exhibit 3 – Focusing on gross-revenue churn over customer churn helps to ensure top-quartile growth.

One clear implication of these findings is that top-quartile-growth performers know how to protect their base—in other words, they understand how to keep their most important customers for long periods. The second implication is that top-quartile performers realize that there is a healthy level of churn and that losing low-revenue accounts can be acceptable, as long as they protect the core accounts that drive the bulk of their top-line revenue.

How to lower gross-revenue churn

Given that gross-revenue churn drives most of the difference between top-quartile-growth performers and mean performers, how can companies effectively lower their gross-revenue churn? In our experience advising SaaS businesses on customer success, there are five areas for companies to focus on.

1. Invest appropriately in building a high-performing customer-success organization

Top-quartile-growth performers invest in a customer-success model that fits their customer needs (Exhibit 4). At the SMB level, top performers are actually investing less than the mean, as they are more efficient in addressing customer needs. This translates into best-practice digital support as well as products that more seamlessly integrate with existing systems, thereby reducing head-count spend in the customer-success function. Alternatively, companies serving enterprise customers invest more heavily than the mean in customer-success professionals, fitting well with the hands-on expectations of their large deals and customers. The midmarket is a mixed bag, as smaller customers will be served more through a digital model and larger customers will require a more hands-on approach.

Exhibit 4 – High growth requires an appropriate level of investment in customer success.

2. Think about the full customer journey and tailor your approach

The seeds of churn are sown throughout the customer experience, so it’s necessary to have a clear engagement strategy for each leg of the customer journey. During deployment, companies should ensure rapid installation and seamless integration with their customers’ systems. But the best companies solve deployment challenges with great products. Top-quartile-growth performers spend more on R&D and product development than mean performers. They then reap the benefits of this product focus with lower implementation costs and a more positive customer experience at deployment.

As customers then move into the early days of usage, companies should ensure appropriate onboarding and training and also manage work flow actively. Finally, during renewal, companies should identify in advance what accounts are at a high risk for churn and identify and resolve customer issues to ensure a seamless renewal process.

3. Use analytics to gain an advantage

Analytics and predictive modeling can help to both identify drivers of churn and prioritize resources and contact strategy for customers that are at the highest risk and of the greatest value. Analytics and predictive modeling should be employed across three dimensions: key business benefits, technical and feature shortcomings, and pure customer service. Each presents different dynamics and challenges.

For key business benefits, companies should analyze the metrics that matter most to their customers (web traffic, engagement time, or conversion rate, for example). For technical and feature shortcomings, companies should track customer frustration with issues such as bugs and glitches, poor user experience, slow load time, and integration problems. For pure customer service, companies should analyze customer happiness with engagement, response time, and issue resolution across all customer-care channels including phone, email, and live chat. 

4. Measure, measure, measure

While predictive analytics will help identify at-risk customers, it is still important to measure a broad range of key performance indicators to keep your customer-success organization accountable to a high standard. As such, consider segmenting your customer-success metrics into three types: lagging indicators, activity indicators, and leading indicators—and having a scorecard to track all three.

Lagging indicators include renewal rate, expansion (again, cross-selling and up-selling existing customers), and advocacy (through case studies and reviews, for example). Activity indicators include a customer’s receptiveness to engaging in activities like interviews, focus groups, and product-feedback surveys. Leading indicators include measures of customer satisfaction, such as net promoter score; adoption, such as the number of seats or features being used; and client engagement, such as the rate of attendance at meetings and events.

5. Let your customer-success organization be the ‘learning engine’

Ultimately, the customer-success organization cannot live in a vacuum. One hallmark characteristic of a strong customer-success organization is that customer insights are shared across the entire organization. In that way, the customer-success organization becomes the company’s “learning engine”—relaying their findings from the field to the sales, product, and marketing teams. This feedback loop is critical in allowing for the overall product, value proposition, and delivery model to improve.

In summary, our analysis clearly shows the extent to which a focus on customer success is critical to attaining top-quartile growth. Net-revenue churn is correlated with higher growth. And the key driver behind low net-revenue churn is maintaining low gross-revenue churn. A relentless focus on customer success allows technology and SaaS companies to lower gross-revenue churn and keep it there—complementing the efforts of their sales teams, as well as kicking revenue growth into higher gear. Ultimately, the focus on customer success not only accelerates revenue growth but also creates a more efficient and effective go-to-market organization.

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Is Your Pricing Page Slowing or Accelerating Growth? https://get.fuelbymckinsey.com/article/is-your-pricing-page-slowing-or-accelerating-growth/ https://get.fuelbymckinsey.com/article/is-your-pricing-page-slowing-or-accelerating-growth/#respond Fri, 28 Oct 2016 20:36:19 +0000 https://get.fuelbymckinsey.com/article/auto-draft/ Savvy SaaS players think carefully about what pricing information they publish, when, and how. We’ve identified three pricing communication practices that set winners apart from the rest. Consider ditching your pricing page once you pass $10,000 in ACV More than 90% of the SaaS companies in our database stop displaying a transparent pricing page on […]

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Savvy SaaS players think carefully about what pricing information they publish, when, and how. We’ve identified three pricing communication practices that set winners apart from the rest.

Consider ditching your pricing page once you pass $10,000 in ACV

More than 90% of the SaaS companies in our database stop displaying a transparent pricing page on their website once their average annual contract value (ACV) exceeds $10,000. Furthermore, those that ditch their pricing page are often able to tilt up-market with annual ACV increases of 24% by adding larger customers. Compare that with just 14% for their peers who still have a transparent pricing page.

Why would removing your pricing page help you attract bigger customers? One reason may be that when customers see prices on your site, the phenomenon known as “anchoring” kicks in. Larger customers pigeonhole your solution as “too cheap to be good,” or they may start negotiations at a lower point instead of finding the right price for the value they will likely capture.

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You may also want to stop advertising free trials

Equally interesting, our data show that taking free trials off the website also correlates with healthier ARR growth. Of the SaaS companies in our database who ditched their pricing page, 50% continued advertising free trials of their product on their site. On average, their ARR growth was 40% lower than that of our member companies that don’t advertise free trials. The reason? One possibility is that customers who like to “try before they buy” may take longer to make a purchasing decision. They spend more time shopping around and may eventually get distracted and settle for the “do nothing” solution. If you can close a deal without having to wait for the customer to play with your product first, you close it faster.

As another intriguing point, the companies we examined that offer free trials have higher average sales costs—66% of ARR, compared with just 21% for companies that don’t advertise their trials. Hence, we see that free trials can be more expensive if the wrong leads are signing up. This can also distract salespeople, if those prospects need frequent “touches” throughout the trial.

Are there any downsides to taking the free trial off the website? Companies that don’t advertise trials spend significantly more to onboard new customers: $32,000 versus only $13,000 for companies that advertise their trial. Hence it may make sense to keep advertising your free trial despite the higher cost of sales if you are adding lots of customers. It’s also worth noting that just because you don’t advertise free trials doesn’t mean you can’t offer them if you need to.

If you keep your pricing page, shoot for more tiers

If ACVs are below $10,000 or you have decided to keep your pricing page anyway, think carefully about what’s on it. The number of tiers you define can make a big difference in your revenue growth.

Of the SaaS companies in our database that offer transparent pricing information, about 60% have defined three or fewer pricing tiers. Those that have defined more than three tiers boast 25% higher ARR growth and significantly lower discounting rates than the others. These differences in ARR growth and discounting rates suggest that companies with more tiers may be able to align their pricing more tightly with customers’ willingness to pay.

Another phenomenon we often see on pricing pages is tiers with nonsense names. Potential customers have a much harder time understanding what names like “standard” and “premium” mean versus more descriptive names like “freelancer,” “small business,” and “enterprise.” Descriptive names help customers sort themselves into the right category rather than looking for the cheapest category that meets their needs.

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Our analysis shows that when it comes to conveying pricing information, less can be more in some cases—while in other cases, more is more. With that in mind, ask yourself:

  • How is your ACV and ARR growth?
  • What changes could you make today in your pricing communication strategies to get those growth numbers up?

The findings we’ve shared here are the latest from McKinsey’s SaasRadar database—a proprietary benchmark of private and public B2B SaaS companies with annual revenues ranging from $10 million to $500 million. Participants receive a report comparing their performance and metrics to those of a hand-picked cohort of peers. The report’s findings help management teams to gain actionable insight into the drivers of growth and customer lifetime value.

The post Is Your Pricing Page Slowing or Accelerating Growth? appeared first on Fuel, A McKinsey Company.

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So You Want to Grow Revenue? How to Tilt Up Your ACV https://get.fuelbymckinsey.com/article/so-you-want-to-grow-revenue-how-to-tilt-up-your-acv/ https://get.fuelbymckinsey.com/article/so-you-want-to-grow-revenue-how-to-tilt-up-your-acv/#respond Sat, 01 Oct 2016 20:42:00 +0000 https://get.fuelbymckinsey.com/article/auto-draft/ Zendesk has become the darling of the software as a service (SaaS) industry. Following a lucrative IPO last May that raised about $100 million, the company has handily beat analysts’ financial projections. Much of that impressive success comes from the shrewd ways in which Zendesk has managed its annual contract value (ACV). For the past […]

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Zendesk has become the darling of the software as a service (SaaS) industry. Following a lucrative IPO last May that raised about $100 million, the company has handily beat analysts’ financial projections. Much of that impressive success comes from the shrewd ways in which Zendesk has managed its annual contract value (ACV). For the past two years, Zendesk has grown its ACV by at least 30% per year. To understand ACV growth better, we studied dozens of SaaS companies with annual recurring revenues of $2M to $25M. We specifically tracked their ACV figures and found that successful firms were able to “tilt up” their ACVs, achieving growth that was three or more times that of other SaaS companies.

In an earlier blog, we discussed when to tilt up. In this blog, we focus on how firms can grow their ACVs by at least 10% from one year to the next. Our research indicates three main drivers:

  1. Increasing prices
  2. Upselling and cross-selling
  3. Adding bigger customers (with larger contract sizes).

1. Increasing Prices

Increasing prices can be a major business driver and is especially important as a product’s value improves rapidly.

One tactic is to keep prices high from the start but offer large discounts to early customers who agree to provide feedback to help improve the product. Such discounting is an easy way to quickly (and opaquely) lower the pricing for a temporary amount of time.

In our research, we found that “tilt up” companies often have discount maximums that are two times that for other firms. The trick here is to increase prices from those discounts without alienating customers. Make sure to message this appropriately.

2. Upselling and cross-selling

Upselling and cross-selling helps grow revenues in existing accounts and is a critical driver of customer lifetime value (CLTV). (By “cross-sell,” we mean a customer that buys a separate offering from the same company versus buying more licenses or seats of the same offering.)

All of the firms in our study had very similar upsell rates, suggesting that they are all doing a good job of growing their businesses along with their customers. But the “tilt up” companies tend to cross-sell to about 5% of their customers per quarter whereas other companies have almost no upsell by comparison. To accomplish that, the “tilt up” companies had about twice as many salespeople dedicated to revenue growth within their existing customer base as others.

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3. Selling to new, larger customers

Selling to new, larger customers is the final way to grow ACV – a process that requires an efficient sales process. Our data indicate that “tilt up” companies tend to have shorter sales cycles (two versus four months), double the annual customer growth rates (60% versus 30%), and lower customer acquisition costs (lower by 20%). But having a more efficient growth engine is only half the battle. “Tilt up” companies are more adept at engaging higher-value customers by tailoring their value proposition and by focusing on more senior buyers who have the ability to make larger purchases. Zendesk, for example, started off by focusing on the small and medium business (SMB) market, but the company has since begun to target larger enterprises with a “land and expand” strategy: first it sells into a single department or location and then grows by adding other business units and geographies within the same corporation and by upgrading those customers to more expensive subscriptions with richer features. As part of that strategy, Zendesk has been investing in expanding its field service team to handle the account management of large corporations.

The post So You Want to Grow Revenue? How to Tilt Up Your ACV appeared first on Fuel, A McKinsey Company.

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Time to Rethink Per-User Pricing for Your Enterprise Saas? https://get.fuelbymckinsey.com/article/time-to-rethink-per-user-pricing-for-your-enterprise-saas/ https://get.fuelbymckinsey.com/article/time-to-rethink-per-user-pricing-for-your-enterprise-saas/#respond Sat, 01 Oct 2016 20:40:37 +0000 https://get.fuelbymckinsey.com/article/auto-draft/ The message is loud and clear: In a McKinsey survey of enterprise software customers, more than 75% said they want pricing metrics that are… Easy to understand. Think “number of employees” versus “rate-adjusted user equivalents.” Legacy on-premise software customers have long complained about the complexity of pricing metrics, and SaaS companies are now rethinking those metrics. […]

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The message is loud and clear: In a McKinsey survey of enterprise software customers, more than 75% said they want pricing metrics that are…

  • Easy to understand. Think “number of employees” versus “rate-adjusted user equivalents.” Legacy on-premise software customers have long complained about the complexity of pricing metrics, and SaaS companies are now rethinking those metrics.
  • Aligned with how customers perceive value. Price goes up only when the customer captures more value—such as greater revenue or lower costs. For example, Zuora, a subscription revenue management company, charges based on a customer’s total amount of recurring revenue.
  • Easy to track and predict. Customers can predict the amount they have to pay as they use the software. For instance, Salesforce.com charges based on customers’ number of salespeople, not number of CRM contacts. Number of salespeople is easy to track and control, but number of CRM contacts may shoot up unexpectedly

The most classic software pricing metric is “users.” Sometimes, user-based pricing metrics make perfect sense. At Salesforce.com, the number of users (i.e., sales reps) aligns with Salesforce customers’ perceptions of value, because each additional salesperson will likely bring in new revenue. Other times, non-user metrics (such as “revenue,” “employees,” or “beds in a hospital”) can be easier to understand and can align more tightly with what customers value. (See Exhibit 1.)

Most sales reps still prefer user-based metrics. When we interviewed enterprise sales reps, over 80% said they viewed user-based metrics as easy to understand and sell, while less than 50% expressed enthusiasm about more novel metrics.

A missed opportunity

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Companies that don’t broaden their view of pricing metrics may be missing out: When we analyzed participants in our SaaSRadar database, we found that companies with non-user based metrics tend to grow about 40% faster than those that don’t. (See Exhibit 2.)

That said, there are still plenty of user-based metrics in the SaaS world: about 50% of our database participants are sticking to per-user as their pricing metric (for instance, $10 per user per month). As much as 27% base their pricing on usage (for example, $10 per gigabyte of data stored), and only about 10% use customer revenue as their pricing metric. (See Exhibit 3.)

What’s going on? Despite customers’ interest in more creative pricing metrics, most legacy sales reps have difficulty understanding and communicating pricing metrics that are based on something other than number of users. That’s especially true when they’re selling to legacy software buyers, such as old-guard procurement professionals vs. newer line-of-business buyers.

Mix it up to grow your ARR

To capture greater ARR growth, companies have to do more than just sprinkle a few novel pricing metrics into their mix. Instead, they need to think strategically about their metrics—and tailor them to the unique circumstances and nature of their business.

Zuora, for instance, links pricing to the amount of subscription revenue the customer has on the Zuora platform. That creates an efficient and optimized billing cycle. Each customer’s value scales with overall amounts billed. For Zuora, pricing by customer revenue aligns tightly with customers’ perceptions of value. The more a customer’s revenue grows, the more it needs a service like the one Zuora provides. And that creates automatic upsell as subscription revenue rises.

At times, using a hybrid pricing model—one comprising both user and non-user metrics—may be the best move. As we noted earlier, Salesforce.com’s pricing per sales rep aligns well with its customers’ perceptions of value since each additional sales rep will probably generate new revenue. But pricing pegged to a salesperson’s productivity would link even more directly to their revenue, making it easier for certain customers to say, “yes.” So Salesforce.com might further grow its ARR by augmenting its per-user pricing with metrics like seller productivity.

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In all of these examples, the non-user metrics are easy for customers to understand, align with what customers value most, and are easy for sales reps to negotiate and sell. Result? Everyone wins.

The upshot

You don’t—and you shouldn’t—have to give up per-user pricing if it aligns best with your customers’ perceptions of value and is easiest for them to understand and track. But to sweeten the odds of growing your ARR, you can—and you should—consider experimenting with metrics that align even better with what matters most to your customers.

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