The SaaS/Recurring revenue business model Reducing CAC (Cost to Acquire a Customer) The new rules of Customer Acquisition

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2 Agenda Business Model Innovation CAC and LTV The SaaS/Recurring revenue business model Reducing CAC (Cost to Acquire a Customer) The new rules of Customer Acquisition Increasing LTV (Lifetime Value of a Customer) Conclusion: Lessons Learned

3 Anatomy of a Startup Unmet Need New Technology The Old Model

4 The New Model Unmet Need New Technology Entertainment New Business Models Consumer Technology leads the Enterprise

5 Business Model Innovation: The Major Change Agents The Internet Google SEO/SEM Enables low-cost customer acquisition Web 2.0 Social Networks Mobile Web

6 B2C Breakthrough Companies The Fastest Growing Companies ever: Zynga Groupon Gilt All use Social and Viral techniques for customer acquisition

7 The Key Elements behind Business Model Web-based companies make this abundantly clear: Spend some money to drive traffic to your web site Come up with a Monetization strategy Transactions Subscriptions Ads Virtual Goods Etc.

8 The Key Elements behind Business Model Cost to Acquire the Customer (CAC) Profit from that Customer For subscription revenue businesses = the value of that customer over their lifetime (LTV) This number takes into account the COGS or cost to serve There is a common problem: Startup Killer

9 An out of balance Business Model Entrepreneurs are over-optimistic Cost to Acquire a Customer (CAC) Monetization (LTV)

10 CAC for a Web driven business Input Variables Total Web Visitors 10,000 SEM cost per click $ 0.50 Conversion to Trial % 5% Trial conversion % 10% No of Sales & Marketing Staff 3 Cost per employee per month $ 16,500 Flow Qty. Conversion % Total Paid Web Vistors 10,000 Trials 500 5% Customers 50 10% SEM Marketing Spend $ 5,000 Total Headcount Costs $ 49,500 Cost of Customer Acquisition Without headcount costs $ With headcount costs $ 1,090.00

11 CAC for a Direct Salesforce Sales Sales Eng Inside Sales Team composition On target earnings $ 230,000 $ 140,000 $ 90,000 Salary Cost $ 230,000 $ 140,000 $ 45,000 Salary + Overhead $ 310,500 $ 189,000 $ 60,750 Annual numbers Total Team Cost $ 560,250 Avg. team Failure Rate 25% Adjusted Team Cost $ 747,000 No. of Marketing people 0.5 Average cost per person $ 200,000 Marketing Programs Spend $ 150,000 Total Marketing Costs $ 350,000 Total Sales & Marketing spend $ 1,097,000 No of deals per team per year 10 Cost of Customer Acquisition $ 109,700

12 What we are looking for A well balanced business model Monetization (LTV) Cost to Acquire a Customer (CAC)

13 The Balancing Act Viral effects Inbound Marketing Free or Freemium Open Source Free Trials Touchless conversion Inside Sales Channels Strategic partnerships High Churn Rates Low customer satisfaction Cost to Acquire a Customer CAC) Monetization (LTV) Field Sales Outbound Marketing Recurring Revenue Scalable Pricing Cross Sell/Upsell Product line expansion Lead Gen for 3 rd parties

14 Business Model Disruption in B2B Open Source Use Free Software to acquire customers cheaply When done right, free creates viral spread Monetize a portion of the free customer base

15 Business Model Disruption in B2B SaaS Rent software to customers monthly Remove complexity (no IT) Lower buying barriers No big $ purchase decision Easy to cancel if not working No IT means that the business buyer can purchase

16 Business Model Disruption in B2B The Low Cost Sales Model The Touch-less Conversion Freemium

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18 Recurring Revenue One Salesperson Selling 5 Customers a $1000 per month each Means an additional $5,000 in new additive revenue every month Turbocharger: Adding Salespeople increases monthly new bookings

19 Churn Churn Rate plays a huge role in success 1% to 2.5% churn per month is acceptable Higher than that, you are filling a leaky bucket Need to understand why you have low customer satisfaction and address the problem

20 How Churn affects LTV Customer lifetime in months = 1 / Monthly Churn Churn of 1% = 100 months lifetime Churn of 2% = 50 months lifetime Churn of 5% = 20 months lifetime Impact on LTV for $1,000 average subscription Churn of 1% = $100,000 LTV Churn of 2% = $50,000 LTV Churn of 5% = $20,000 LTV

21 The Big Issue with SaaS Investments to acquire customers are all upfront Revenue from each customer comes in slowly Creates a cash flow problem in the early days But once through the valley of death, cash flow is amazing

22 My rules for CAC/LTV balance in a SaaS model LTV > 3x CAC Months to recover CAC < 12 months Required for Capital Efficiency

23 Another key SaaS benefit Rapid development Only one version of your code base at all customers Rapid customer feedback on new features Immediate deployment of new features to all customers

24 Other Recurring Revenue Benefits Predictability Highly valued by Wall St Future revenue and cash flow for an acquirer

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26 Buying Behavior has Changed Please understand that I get dozens of these types of messages a week. I simply do not have time to read them, dig into them, follow-up on them, or reply to them. The most effective solution to this problem is for me to ignore the messages, which is what I usually do. Finally, a small comment. As a customer, I find this type of approach to sales to be largely annoying to me and unproductive for you. We learn far more about what we want to purchase by searching the web, looking for customer references in blogs and forums, word of mouth, and by finding white papers on your site that concretely describe solutions to problems we are having. CIO of Large Pharma Co.

27 Buying Behavior has Changed Outbound Marketing: Annoying to your customers Expensive Increasingly less effective What is the new process? Google Search Web Site Reviews Blogs & Social Media Influencers Trials or Free software / services Avoid sales people Requires Inbound Marketing thought processes

28 HubSpot: Inbound Marketing

29 Remarkable Content Write a Blog Create content that is REMARKable Educational Humorous Controversial Optimize that content for Search Keywords used by your buyers Use social media (Twitter, Facebook, etc) to build a following If the content is good it will spread virally

30 A Crucial Insight Never sell or promote your product in your blog Instead Educate and Entertain Focus on the areas of greatest interest to your buyers

31 The Power of Free Wired Magazine: Free! Why $0.00 Is the Future of Business Free is dramatically different to even $1 If done right can lead to viral spread Examples: Open Source software (JBoss, Asterisk) HubSpot s WebSiteGrader Monetize some portion of your free customer base Use of a free product/service develops a level of trusted relationship Makes it easier to sell something to them

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34 Using Engineering for Marketing

35 Freemium Dropbox Example Get you hooked for free Storage slowly increases to the point where you need to pay But by then they have established trust And it is hard to move your data that is shared with others

36 Virality Often hoped for, rarely achieved The best businesses: Virality plus Monetization Examples: Google Gilt.com Zynga Entire Blog post devoted to this topic:

37 Old World evolving to a New World Charge for everything (including on-site trials) Free Trials Free Product Monetize a Fraction of Custs

38 Old World evolving to a New World New World Give things away to optimize spread Large Footprint of customers = Great brand value Price low to get fast decisions Old world Optimize pricing to extract the most But the customer is quite happy to pay that much Key realization CAC is one of the highest P&L expense items Optimal Pricing limits spread Optimal Pricing damages CAC

39 The Low Cost Sales Model Web & Inbound Marketing Free product, or Free Trial Insides Sales Examples SolarWinds Constant Contact LogMeIn JBoss HubSpot

40 The Touchless Conversion ZenDesk Common Funnel Metrics: 10% of visitors do a trial 20% of trials convert to paid Extraordinarily scalable Extremely low cost

41 Free Trials require different Product Thinking The product is your salesperson Extreme focus on: Ease of installation Ease of use Clear instructions on how to test (short videos, etc.) Fast proof that it works

42 Enables you to reach the SMB market Not economically feasible in the past Now opens up a vast new market In many ways a better business than Enterprise Software

43 Need to Build a Sales & Marketing Machine Automated Top of the Funnel Middle of the Funnel (lead nurturing) CRM Scalable Instrumented Clear understanding of Costs and Returns

44 Metrics are crucial for success Campaigns to drive traffic Visitors Overall Conversion % Conversion % Trials (by lead source) Conversion % Closed Deals

45 Experimentation and A/B Testing Constant Experimentation New Lead Sources New Messaging New Pricing New Product Features A/B Testing immediately reveals what is working

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47 Sales Complexity Freemium No Touch Self-Service Light Touch Inside Sales High Touch Inside Sales Field Sales Field Sales with SE s

48 How I assumed the two would relate

49 A rough estimate of CAC versus Sales Complexity Freemium No Touch Self-Service Light Touch Inside Sales High Touch Inside Sales Field Sales Field Sales with SE s Rough Estimates of Cost of Customer Acquisition (CAC) $0- $10 $50 $200 $1,000 - $2,000 $3,000 - $8,000 $25,000 $75,000 $75,000 $200,000

50 The relationship is roughly exponential Clearly adding Human Touch dramatically increases costs

51 CAC (logarithmic) 10x 10x 10x Sales Complexity

52 High CAC requires higher pricing Higher pricing unfortunately leads to greater approval complexity To get deals through requires high scores: Product value Customer Pain Urgency to get something done

53 High CAC, requires high scores for: Value, Pain, Urgency Value / Pain / Urgency = LTV (logarithmic) Sales Complexity

54 Value / Pain / Urgency = LTV (logarithmic) Unprofitable: LTV < CAC Sales Complexity

55 Value / Pain / Urgency = LTV (logarithmic) Blue Zone 2 Blue Zone 1 Red Zone 2 Red Zone 1 Sales Complexity

56 Value / Pain / Urgency = LTV (logarithmic) Amber Zone 1 Amber Zone 2 Sales Complexity

57 Value / Pain / Urgency = LTV (logarithmic) Green Zone 2 Green Zone 3 Green Zone 1 Sales Complexity

58 How SaaS changes Sales Complexity Value / Pain / Urgency = LTV (logarithmic) Sales Complexity

59 Levers you can use to move from Red to Green Make it easy for customers to sell themselves Make the first decision to work with your product easy Simple product Free versions, Free Trials, Open Source Remove Complexity from closing the Sale Remove IT (SaaS) Eliminate committee decision making Make the first financial commitment easy $10,000 or below for enterprise sales $250 per month for very small business SaaS

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61 Able to leverage the Internet revolution Human Costs dominate: Old world business model Value/Pain/Urgency Sales Complexity

62 What can happen when you get this right SolarWinds 2009 Revenues: $116 million EBITDA: $60 million 52% operating margins Others: JBoss, LogMeIn, Constant Contact, Salesforce.com, etc.

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64 The Balancing Act Viral effects Inbound Marketing Free or Freemium Open Source Free Trials Touchless conversion Inside Sales Channels Strategic partnerships High Churn Rates Low customer satisfaction Cost to Acquire a Customer CAC) Monetization (LTV) Field Sales Outbound Marketing Recurring Revenue Scalable Pricing Cross Sell/Upsell Product line expansion Lead Gen for 3 rd parties

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66 The Highlights Breakthrough Business Model Open Source A great example of the power of Free 5 million downloads The first challenge: How to monetize The second challenge: Conversion While keeping CAC low Solution: Build a Sales & Marketing Machine

67 The Original Brainstorming Session

68 The First Blockage Point 5 million users had downloaded JBoss But none had given their names The problem: registration in front of download reduces conversion rates significantly The Solution Look for something that those developers really wanted JBoss had been earning $27k per month for documentation Solution: give this away, in exchange for address

69 JBoss - Sales & Marketing Machine Suspects Closed Deals Enterprise Rollouts Web Leads Web Scoring Phone Call Inside Sales Lead Nurturing

70 Metrics: The End Goal Web activity scoring Telemarketing Telesales

71 Using the model to work backwards Web activity scoring Telemarketing Insidesales To do $4m in the month: If Average Deal Size is $10k Need $4m divided by $10k deals to reach target = 400 deals Means 1,200 deals being worked in Inside sales (400x4) Know that each rep can work 60 deals at a time, means 20 reps Means 3,600 telemarketing contacts (1,200x3) Means 14,400 Raw Leads (3,600x4)

72 The next challenge: Increase LTV Multi-pronged approach Add services to the subscription (beyond just support) Key service was JBoss Operations Network Broaden the product line and upsell JBoss Enteprise Middleware Suite (JEMS) Scalable Pricing Result 4 axes to drive pricing higher Drove average deal size from $10k to $50k While maintaining the same pipeline flow and conversion rates

73 The Results Before venture financing 2003 $2m Early 2004 venture round closes Revenue Growth: 2004 $11m 2005 $26m 2006 on plan to do $65m

74 JBoss Summary Business Model disruption Gave the product away entirely free Monetized support & management Low CAC Leveraged free and virality to acquire non-paying customers Sales & Marketing Machine Careful study of customer motivations Low cost Sales model Excellent Metrics Scalable pricing model

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76 Lessons Learned Business Model Innovation The new trigger for startups Understand the CAC / LTV balance Look for the breakthrough techniques for acquiring customers Free products / services Use R&D as a marketing tool Free Trials Viral Social Etc.

77 Lessons Learned - (continued) Understand the new buying behaviors Think Inbound versus Outbound Build a Sales & Marketing Machine Look for the breakthrough techniques Look for the next evolution in the business model

78 This is all obvious Vision is easy Execution is the hard part All comes down to hiring great teams

79 For More information Visit my blog at