Metrics in new world order #aaS

Pay per use models, including SaaS, and other products and services that flip from capital- to recurring-revenue, all need new metrics to test if they're on track. Front-loaded vendor cost, revenue gathered in the mid-term, and profits accumulated later...

... but the benefit is not all skewed to the customer-side. This new way of working enables fine-tuning of supply-side businesses that was impossible before. That is why investor markets are 'Uber-valuing' SaaS businesses - there is sound rationale. Read on.

Vendors underwriting customer success

Customer retention is vital, so focus on customer success is more acute. Financing that, plus upfront cost of sale, demands quicker revenue-growth and higher working capital.

I co-launched a first-of-kind pay-per-use financial application in 1997. Then in a large software project firm I introduced these models in 2002. I then began disrupting brown-field markets by mainstreaming pay-per-use IT propositions from 2009 onwards.

NOW - this shift of business model is pervasive and businesses face the tipping point.

Measure wrongly - Manage wrongly

Creative disruption to improve technology or services, results in untested financial outcomes, mainly because these innovations rely on unfamiliar business models. As a sales leader, and more broadly in business management, metric setting is a critical skill. Directing resources in the right way leads to the business achieving shareholder goals.

What's different now?

We need to know if the growth we achieve is sustainable. Marginal profitability tests whether, as the monthly recurring revenue scales, will that increase or decrease profit margin? Financial wellbeing is more complex to understand, and we need to understand that better than before. Investment and hiring decisions need greater scrutiny as we, and our businesses, are now far less fault tolerant.

...and the Metrics we must use?

• Monthly Recurring Revenue: Predicting lumps of 'sales order value' or 'total contract value', is giving way to measuring patterns of monthly or annual recurring revenue (MRR/ARR), in deals, customers, and across business-types. Accounting will recognise non-recurring revenue, but business strength is measured on growth of MRR/ARR. This is the annuity goal of the business, and should be targeted and measured at every level.
• MRR Quick Ratio: Balance between (i) pace of MRR growth from new-deals or up-selling, versus (ii) loss of MRR (failure of retention). Delaying signature of renewals until too close to the cancellation date, exposes a renewal risk. The ratio between these two factors is critical to prove momentum and ability to execute, both in the product functionality and in customer success management. The total of new or increased MRR should be about 4x the value of cancelled or reduced MRR, and this should be secure into the foreseeable future.
• Account Churn Ratio: Keeping customers has the lowest cost of sales. In MRR/ARR business models this reflects how successfully we execute customer success management. Though MRR growth (quick ratio) is key, the 'Account Churn' metric avoids over-dependence on revenue from a few large customers. If revenue grows steadily in a high account churn company, one may end up with a high customer-dependency business, which is very bad for market valuation. Monitor the net churn in terms of numbers of MRR customers (new accounts, minus lost accounts), and then measure what is the percentage of net churn, versus total customer base size. The lower the better, of course (2-4% is great).
• Retention Patterns: Even if 'Account Churn' looks great, high numbers in account acquisition rates might conceal a dangerously high number of account losses. Therefore, keep a close watch on the actual customer retention rate, for avoidable losses and potential danger-signs. Think about time-slicing customer groups to examine the customers that started in the same time-band, and whether those distinct groups show differences of retention rates registered over time. That can help to pinpoint product, service or personnel issues, and of course root cause analysis and mitigation are vital.
• Revenue Churn Patterns: Overall MRR growth might appear healthy, but this might conceal patterns of weakness that arise in smaller groups of customers. Think about time-slicing customer groups to monitor their revenue churn or growth over time. One should see a net increase in the revenue from each time-band group of customers (even a small growth % is good). If a net negative appears in the revenue churn, then this is an opportunity to investigate root cause (e.g. on-boarding process issues) and to mitigate against those of course. Imagine spotting that recently commenced groups of MRR customers are reducing spend over time, and having an opportunity to resolve potentially systemic issues affecting growth prospects.
• Revenue Renewal Rate: How much revenue is up for renewal versus how much is actually renewed. Clear-cut, simple metric, not blurred by acquisition of new business customers, and that is absolutely fundamental to measuring effectiveness of customer success management and account development for retention. I recall a large Telco predicting a year-on-year 65% revenue renewal in telephone lines and calls revenue from public sector markets. Due to widespread digital transformation attacking this hundred year old MRR business model, a 35% loss in such a margin rich product created a huge marginal profitability impact. One sector bucked the trend, and secured a 96% revenue renewal rate. Though unglamorous, the measurement and reward of that revenue renewal rate was strategically important.
• Customer Lifecycle Value: We need to know what each average customer will be worth to us over the average lifetime using a service or product. Reducing the MRR value by the effect of 'Account Churn Ratio', provides a realistic MRR figure. Then multiplying that by average contract length, allows us to understand how much we are likely to earn per customer. This equips investment and resourcing decisions, for development, retention and customer success.
• Lifecycle Value versus Acquisition Costs: Are the individual customers paying their way? This allows us to manage with unit economics, balancing acquisition costs versus the likely customer value, and prioritising target segments, product types or investment projects. Perhaps a whole category of customer-type is costing more than the value they will deliver to the business. Perhaps as time passes, we observe individual customers or segments of customers that are not paying their way sufficiently well. Assuming Lifecycle Value is greater than Acquisition Costs, then what is the ratio. In general if it is 2x that's healthy. If it's >3x then you have a good case to invest and grow.

These are great instruments available to enable us to fine tune #aaS management plans according to measurable changes in the business. Therefore, #aaS pay-per-use business models don't just serve the interests of customers, but also enable fine-tuning, and far more granular and focused management of resources and investment in supply-side leadership.

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