3 minute read / Feb 11, 2016 /
How to Become Profitable Faster in SaaS
As the fundraising environment changes, some SaaS companies will look to reach cash flow break even on their existing reserves. Founders may reduce staff, particularly in recruiting or new projects that the company prefers not to finance. But there are three other ways to become profitable that limit reductions in force, enable the company to continue to grow with greater efficiency and increase the value of the company in the process.
First, collect cash sooner with annual pre-pay contracts. All of the cost of customer acquisition for a SaaS company is borne in the first month or so. The chart above, copied from David Skok’s great SaaStr presentation, shows the unit cash flow for monthly payment plans. This company invests $12k in month one to acquire a customer and receives $1k in payment, netting -$11k in cash flow. Each subsequent month, the startup receives another $1k in cash and breaks even on that customer a year later.
Growing this way requires a lot of cash to finance the acquisition investment. 25 new customers per month implies a cash investment of $300k. By collecting the cash up-front, startups neutralize this effect.
The transition to annual prepay isn’t easy. It requires changing the sales process, likely suffering some decreased sales velocity and tinkering with compensation structures. But the impact on cash is hard to overstate.
Second, slow sales hiring. When a startup hires a salesperson, they don’t just bear the cost of that new account executive, but all the infrastructure to support and ensure the success of the AE. This collection of people and capital is the fundamental unit of SaaS growth.
Some fraction of a sales development rep to qualify leads. Some fraction of a marketing person and some incremental marketing spend. Some fraction of a customer success manager. Some fraction of a post-sales/professional services consultant. All in, the investment could be close to a $1M.
The payback period for that investment can be quite long. Three months to recruit a new account executive. Six months to ramp. During those nine months, the company continues to outlay cash without generating much revenue. Hiring substantially ahead of plan or ahead of unit economics can be quite expensive.
The longer new sales reps need to attain quota, the longer the payback period on the fundamental unit.
|Improve Leakiest Part by 5 pp
|Improve Most Efficient Part by 5pp
Examine the lead-to-close funnel and fix the leakiest part. The table above describes a hypothetical sales funnel of a startup. The first row describes the status quo: 15% email to lead conversion, 20% lead to sales call conversion, 50% sales call to demo, and an 80% demo-to-close. The later parts of the funnel are quite efficient. Overall, the funnel converts about 1.2% of emails.
Suppose we could improve the funnel conversion rates by 5 percentage points. If we apply those 5 percentage points to the email-to-lead stage, our funnel yield improves to 1.6%, a sales pipeline efficiency gain of 33%. If instead we apply those five points to the most efficient step, demo-to-close, our yield improves to 1.3% for an 8% gain. Improving the leakiest part of the funnel will improve overall efficiency much faster.
These three techniques can help companies explore ways to attain profitability more rapidly.