Presentation from Peter Weed, McKinsey at CloudNY

1. 0
Value Creation
in SaaS Businesses
CloudNY

2. 1
The basic SaaS business modelToday’s agenda
▪ What drives value in a SaaS business?
Efficient Growth!
▪ What simple, holistic operational metrics
predict efficient growth?
▪ What practical operating levers create
the most impact?
▪ Double click on two operating levers:
– Customer acquisition efficiency
– Pricing and packaging

3. 2
Growth matters a lot – software/SaaS players with a >50% growth rate through $50-
100MM revenue…
>50%
of reaching
$0.5-1B
revenue1
Have a
4-5x
greater 3-year
equity return1
Deliver a
1: 2016 data; all public software companies since 1980; 3-year returns on equity from the point they passed the $50-100MM range

4. 3
It’s not just valuation, it’s survival: growth is critical to outpace the competition
Mobile payments
Is your market space feeling crowded? E.g.,
Content
Communications
Task / calendar mgmt
Common trend
1. Proliferation of
“differentiated” market
specific players
2. Players move into direct
competition through
adjacent geo/feature entry
3. “Weaker” players wash out

5. 4
2x
3x
4x
5x
6x
7x
1/11 7/11 1/12 7/12 1/13 7/13 1/14 7/14 1/15 7/15 1/16 7/16
But growth is expensive! Efficient growth is critical to reduce market-timing risk in
fund raising and to manage dilution
SOURCE: Battery Ventures Analysis, Capital IQ
Index since January 2011
SaaS Revenue Multiple

6. 5
The sheer number of SaaS metrics can be overwhelming!
“Magic Number”
Quick Ratio
Revenue Growth
“Rule of 40”

7. 6
What do we propose? Break down a SaaS business into two components
Growth Engine
Key Metric: “Growth Efficiency”
How much net new ARR you add
per $1 of sales & marketing.
Calculation:
 ((GAAP Revenue in Period 3) – (GAAP
Revenue in Period 2 ) x 4
 Divided by: S&M in Period 1
Cash Engine
Key Metric: “Recurring Margin”
How much free cash you
generate from $1 of ARR on
your platform.
Calculation:
 Gross Margin (% revenue)
 less: R&D (% revenue)
 less: G&A (% revenue)
COGS R&D G&A
Gross ARR
Churn
Expansion
ARR
Customer
Acquisition

8. 7
Why do we like it? It can be treed down into actionable operating metrics
Cash engine
Growth engine
COGS
G&A
R&D
Net New ARR
Average ARR
# Customers
Current ARR
Recurring Costs
S&M
Spend
ARR From New
Customers
Expansion ARR
Gross ARR Churn
Sales
Marketing
+
# New Customers
Avg ARR
x
# Qualified Leads
Win Rate
x
Sales Reps
Sales Ops/Mgmt
+
Base
Commissions
Travel, etc.
Personnel
Program Spend
+
+
Content Mktg
Paid Advertising
Other channels…
+
ARR From Existing
Customers
+

9. 8
Creating more efficient growth in SaaS: the “first four” places to look
Customer acquisition
“Efficiently add more customers”
Success
“Increase ACV, decrease churn”
Recurring Margins
“Improve offering’s profitability”
Pricing
“Participate more fairly in the
value you create”

10. 9
“Free-cash-flow” impact of improving each Growth Efficiency lever 25%?
A “common” high-growth, $20MM ARR SaaS business will see the most impact in...
1.00
4.40 4.40
1.40
Retention
Reducing
churn from
10% to 7.5%;
increasing
upsell from
10% to 12.5%
Customer
Acquisition
Improving GE
from 1 to 1.25
Pricing
Increasing price
by 25% for all
new customers
and 10% of
existing
customers
Recurring
Margin
Increasing
recurring
margins from
25% to 32%
Approximate change in Free Cash Flow (FCF), dollars in year 1
Example Growth-Stage
SaaS Business
▪ $20M ARR
▪ 100% ARR Growth target
▪ 10% Gross ARR Churn
▪ 0% Net ARR Churn
▪ 1.0x Growth Efficiency
▪ 25% “Recurring
Margins”

11. 10
Let’s explore example opportunities: Acquisition
“Free-cash-flow” impact of improving each Growth Efficiency lever 25%?
1.00
4.40 4.40
1.40
Retention
Reducing
churn from
10% to 7.5%;
increasing
upsell from
10% to 12.5%
Customer
Acquisition
Improving GE
from 1 to 1.25
Pricing
Increasing price
by 25% for all
new customers
and 10% of
existing
customers
Recurring
Margin
Increasing
recurring
margins from
25% to 32%
Approximate change in Free Cash Flow (FCF), dollars in year 1
Example Growth-Stage
SaaS Business
▪ $20M ARR
▪ 100% ARR Growth target
▪ 10% Gross ARR Churn
▪ 0% Net ARR Churn
▪ 1.0x Growth Efficiency
▪ 25% “Recurring
Margins”

12. 11
CUSTOMER ACQUISITION
We tested several points of conventional wisdom on sales efficiency
‘Land and expand’ strategies (i.e., upselling)1 Confirmed
Deals with larger Annual Contract Value (ACV)2 Confirmed
Using channel partnerships to sell3 Busted
Higher % of quota bearing salespeople4 Busted
More scale (i.e., ARR of the SaaS company)5 It depends +
Conventional wisdom on what drives higher efficiency What data shows

13. 12
Greater upsell leads to higher sales
efficiency
% of customers
upsold per quarter
10-25% of sales team farming is sweet spot
% of sales force focused on
existing customers
Land and expand strategy is good… but not too much
1.64
1.03
0.90
<10% >25%10-25%
1.011.08
1.65
0.49
25-50% >50%10-25%<10%
SOURCE: McKinsey SaaS Radar
Growth efficiency (higher is better) Growth efficiency (higher is better)
CUSTOMER ACQUISITION

14. 13
% of customers acquired through channel partners
Customer
growth, %
58 50 52 35 27
>25%10-25%
0.480.48
5-10%
0.92
1-5%
1.13
0%
1.39
SaaS companies relying on channel partners for customer acquisition see lower
customer growth and thus lower sales efficiency
Growth efficiency (higher is better)
Using channel partnerships to sell does not always correlate with growth
CUSTOMER ACQUISITION

15. 14
Medium sized SaaS companies see lower sales efficiency
Growth efficiency (higher is better)
Size of SaaS company ($M of ARR)
Size of the SaaS company – how to avoid the “valley of death”?
2.36
0.72
0.94
1.13
<$10M $10-25M >$50M$25-50M
SOURCE: McKinsey SaaS Radar
CUSTOMER ACQUISITION

16. 15
Let’s explore example opportunities: Pricing
“Free-cash-flow” impact of improving each Growth Efficiency lever 25%?
1.00
4.40 4.40
1.40
Retention
Reducing
churn from
10% to 7.5%;
increasing
upsell from
10% to 12.5%
Customer
Acquisition
Improving GE
from 1 to 1.25
Pricing
Increasing price
by 25% for all
new customers
and 10% of
existing
customers
Recurring
Margin
Increasing
recurring
margins from
25% to 32%
Approximate change in Free Cash Flow (FCF), dollars in year 1
Example Growth-Stage
SaaS Business
▪ $20M ARR
▪ 100% ARR Growth
Target
▪ 10% Net ARR Churn
▪ 0% Gross ARR Churn
▪ 1.0x Growth Efficiency
▪ 25% Recurring
Margins

17. 16
Weighted
average
Won 72.6
Lost 60.7
Remember: lower prices do not necessarily mean more wins
0
20
40
60
80
100
120
140
160
100,000 1,000,000 10,000,000 100,000,000
Deal size
Dollars
Relative price vs. total deal size
Percent of benchmark price
DISGUISED EXAMPLE
PRICING & PACKAGING

18. 17
Pricing challenge is especially tough for SaaS innovators
Highly dynamic
environment
Rapid innovation +
competitive pressure
“Winner takes all”
phenomena
Discipline can be lost in
rush to capture market
Communication of value
Sometimes hard to
quantify; discounting
pressure due to customers’
cost assumptions
Complexity over lifecycle
So many aspirations to
balance (paid up front,
upgrades, etc.), so many
possible approaches
PRICING & PACKAGING

19. 18
How do we approach SaaS Pricing? 5 major components
PRICING & PACKAGING
Pricing organization and infrastructure
Packaging/
bundling
(“Package to
value”)
Model/
architecture
(“Structure to
value”)
Price levels
(“Price to value”)
Getting the
price
Price execution
(“Sell to value”)
1 2 3 4
5
Setting the price

20. 19
Clear rules for what to bundle…
PRICING & PACKAGING
Items that address the same
customer need, pain point, or use
case
Items that target the same buying
center
Lower-value items that would be a
distraction to the customer
conversation or sales motion
Highly valuable or differentiated
functionality as part of base
bundles
Items that have high value only for
small subset of customers
What to bundle What not to bundle
Items that create difficulty aligning
with perceived value and paradox
of choice

21. 20
Willingness-to-pay premium for value-
aligned units1
Percent of customers
Examples
Buyers’
business
metrics
▪ Employees
▪ Annual Revenue
▪ Annual COGS
Success-
based
▪ Increase in MROI
▪ Reduction in “days
outstanding”
▪ Not sys-
tematically
used
HW-linked
usage
▪ Cores
▪ Devices
▪ Data volume
Software
Usage
▪ # of Marketing campaigns
▪ Subscription revenue
▪ API calls
Seats
▪ Named users
▪ Concurrent users
▪ Time used
…and how to design scalar units: 2/3 of customers will pay a premium when unit
scales closest to value
26%
10% Premium
5% Premium
25%
0% Premium
17%
32%
15% or more
PRICING & PACKAGING
SaaS businesses use a wide variety of price units…
…customers will pay a premium when units
scale with value received

22. 21
Have you drawn this chart? Often significant (and hard to justify) discount variation
SOURCE: Pricing service line
0
10
20
30
40
50
60
70
80
100 1,000 10,000 100,000 1,000,000
Discount, %
Customer contract value, $
What is
justification
for such
widely
varying
discounts for
similar-size
customers?
Why do low value
customers received such
large discounts?
Deal level pricing analysis
PRICING & PACKAGING
DISGUISED EXAMPLE
Significant
“banding” –
are reps
offering
max
discounts
without
rationale?
Dedicating
“deal desk”
resources,
and building
“deal scoring”
tools can pay
for itself many
times over

23. 22
Thank you!
Peter Weed
Partner
Global Co-head Growth Tech
peter_weed@mckinsey.com
Junaid Mohiuddin
Global SaaS Market Lead
Growth Tech Practice
Junaid_mohiuddin@
mckinsey.com