Understanding-SaaS-Why-the-Pundits-Have-It-Wrong #

Take a look at the cumulative cash flow for a single customer under a SaaS model — the company doesn’t even break even on that customer until after a year: Company A, which is spending $6,000 to acquire the customer and billing them at a rate of $500 per month, doesn’t break even on the customer until month 13. ** Because once a SaaS company has generated enough cash from its installed customer base to cover the cost of acquiring new customers, those customers stay for a long time. While this is a good measure to understand a company’s ability to satisfy and retain its customers, it is more telling to look at revenue churn, the % of revenue lost due to churned customers as a % of total recurring revenue. There are several ways that a company can offset or overcome churn: add new customers at a faster and faster pace; have “negative churn” (which happens when expansion revenue is larger than the revenue lost from churned customers); and reduce churn itself — that is, retain customers! As the company starts to recognize revenue from the SaaS service, it reduces its deferred revenue balance and increases revenue — so for a 24-month deal, as each month goes by deferred revenue drops by 1/24th and revenue increases by 1/24th. Billings is a much better forward-looking indicator of the health of a SaaS company than simply looking at revenue for two reasons: (1) Revenue understates the true value of the customer because it gets recognized ratably; and (2) Because of the recurring nature of revenue, a SaaS company could show stable revenue for a long time (just by working off its billings backlog) which could make the business seem healthier than it truly is. CAC/LTV Workday does not disclose customer acquisition costs, so the proxy we used to get to CAC was sales and marketing spend for new customers: Assumes 70% of total sales and marketing spend for the year is for new customer acquisition, divided by the total new customers in the year.