Unpacking the TSIA Playbook for High-Growth SaaS Companies

I recently had the opportunity to talk with Thomas Lah , the co-founder of the TSIA, a leading figure in software business models, and a prolific author, on Maxio 's SaaS Expert Voices Podcast. Thomas shared valuable insights for how SaaS enterprises should navigate their growth in the midst of shifting industry dynamics using insights from the TSIA Cloud 40 Index. He also explained the TSIA’s “Rule of 35,” which focuses on operational efficiency versus the more common “Rule of 40” (introduced by the VC-Brad Feld in 2015), which focuses on ARR growth versus profitability (i.e. EBITDA margin) tradeoff.?

This article distills our discussion's core insights and offers practical advice for SaaS leaders aiming to grow efficiently in this challenging market.?

The Evolving SaaS Landscape

Having been in the software industry a long time, Thomas pointed out the substantial shift in the software sector towards cloud-based models over recent years. There have been and still are three primary types of software providers:?

• born-in-the-cloud providers
• legacy on-prem vendors
• companies in a hybrid mode

When I attended a TSIA conference in 2013, a majority of legacy software companies did not have a serious SaaS strategy. Being a “born-in-the cloud” guy, I was surprised to learn that 60% of software companies were still primarily on-prem software providers. While the mix has certainly shifted over the past 10 years, Thomas points out that these legacy software providers still “grapple with the transition to cloud-based models, balancing the allure of recurring revenue against the legacy of on-prem solutions. This poses financial challenges for some, potentially undermining their competitive edge unless they fully leverage cloud efficiencies.”??

This shift has clearly been driven by customer demand. As a recent Forbes article noted: “around 94% of all companies globally use cloud software [in 2023], according to a report from Colorlib. That is a 14% increase since 2020, suggesting that the pivot to remote working during the pandemic accelerated the adoption rate of cloud technologies.” Today, the majority of pre-cloud software providers are in hybrid mode as they continue to migrate their legacy install base to true SaaS offerings.?

The dirty little secret is that many of the pre-cloud companies switched their on-premise customers to subscription pricing models, but did not necessarily migrate their customers to the cloud. Buyer beware! Thomas emphasized that to stay competitive, these companies must embrace the cloud fully. Half-hearted approaches won't cut it in achieving the economies of scale and operational efficiencies that true cloud platforms offer. As a native “born-in-the-cloud” CEO, I could not agree more. So then the question becomes, how do you define success as an “in-cloud” provider?

Financial Performance and the TSIA Cloud 40 Index:

One way to define success is to look to the public markets. Thomas discussed the TSIA Cloud 40 Index, which benchmarks the largest born-in-the-cloud companies. Each quarter, he and the TSIA team dive into the earnings reports trying to uncover what is really happening in each of these company’s business models. They then aggregate their findings to highlight key trends. For example, he noted that most Cloud 40 companies are now trying to offset decelerating growth rates with improving gross margins through focused operational efficiencies (i.e cuts). However, that data shows that profitability remains elusive for many. For Thomas, the tea leaves are clear: SaaS companies need to refine their financial and investment strategies to ensure sustainable growth, what we at Maxio have been calling growth efficiency. I wrote a bit on this topic in this LI article on the “Dolphin Strategy”–a concept popularized by Todd Gardner.

The Rule of 40 vs. Rule of 35

In the quest for profitability and growth, Thomas challenges traditional metrics such as the popular Rule of 40 and proposes a new metric: the "Rule of 35." I know, I know. All we need is another metric. However, I think Thomas has a point. The “Rule of 35” underscores the importance of operational efficiency over growth metrics, advocating for a company to convert 35 cents of each dollar into profit.

So how can you compare the Rule of 40 to the Rule of 35??

Thomas’s Rule of 35 suggests a company achieve a minimum of 35% EBITDAS margin. This would mean that the Rule of 40, which is defined as ARR growth rate + EBITDAS margin should be–at the minimum–the Rule of 50 (assuming 15% growth+35% EBITDAS). Talking to many of my SaaS CEO friends, this would be a VERY hard profile to realize. However, Thomas argues that this is exactly the type of shift in mindset companies need to be better aligned with today's market realities. I just hope Thomas never meets my investors :).?

Revenue Acquisition Cost (RAC) and Sales Efficiency

Thomas also emphasized the significance of the Revenue Acquisition Cost (RAC) – a metric that compares investment in sales and marketing to revenue growth yielded. Currently, the average RAC number for the TSIA Cloud 40 stands at 2.84, meaning they are spending $2.84 to gain $1 in sales.?

I have written a bunch about the CAC ratio, which is similar to RAC in that it measures how much ARR is generated by $1 invested in Sales and Marketing over a specific period of time. (You can read more about best practices here.)

Ultimately, RAC or CAC ratio is most helpful when you understand your performance relative to similar companies (defined by size and average ACV). Thomas’ final point was that the best in the Cloud 40 are able to grow much more efficiently than their peers and that companies need to optimize their sales strategies and improve their RAC to remain competitive and profitable.

To that point, Ray Rike, CEO of Benchmarkit, produces a great B2B SaaS metrics benchmark report that slices and dices ~2000 private SaaS financials to provide just this level of insight. We actually used his report as part of our budget cycle this year to help frame where we were with regards to CAC vs our cohort.?

The Role of the Modern SaaS CFO

We pivoted away from discussing the metrics of success to the paradigm shift needed in the front office of most early-stage SaaS companies. Thomas noted the prevalence of loss-accepting cultures in SaaS especially with SaaS executive teams that have never managed a profitable software business model. At Maxio we have described this as the “growth-at-all costs” mindset, which was popular when the cost of capital was basically zero and investors (VCs and PE firms) were flush with cash. As we all know, this changed almost overnight in the COVID dark ages.?

Thomas discussed the need for CFOs to develop new competencies to drive profitable business. Again, we were aligned in that this is exactly the idea behind the "dolphin strategy" I noted above (i.e., companies should periodically prove profitability to maintain strategic control over their growth trajectory) as a framework for achieving efficient growth.

Strategies for SaaS Profitability

Despite the market challenges, achieving profitability doesn't require reinventing the wheel. TSIA's research has identified several strategies used by leading SaaS companies to build profitable recurring revenue models including:

• Monetizing service efforts: Transition from offering services at break-even or as free add-ons to monetizing these efforts, aligning service provision with profitability.
• Diversifying sales channels: Tailor sales approaches to different customer segments, leveraging specialized strategies for various markets, thereby enhancing sales efficiency and reach.
• Leveraging customer data: Utilize analytics to drive customer-led growth, identifying patterns and trends that can inform targeted upselling and cross-selling strategies.?

Here is the advertisement–you can use a SaaS metrics platform like Maxio to monitor your customer usage data and manage the revenue streams. The real power comes when you combine the metrics platform with our billing/invoicing engine so that you can aggregate this data into the insights you need to understand how your monetization strategies and plays are working.

Navigating Price Increases

Lastly, we tackled the sensitive subject of price adjustments. He cautioned against expecting customers to passively accept significant price hikes. If your business plans a 10-12% increase in prices without being able to articulate a distinct competitive edge or already enjoying the category-leader status, the likely outcome is a loss of customers over time. It's that straightforward.

Thomas recommends a calculated method before introducing higher prices to customers.?

Start by differentiating which customers see your product as a “must-have” vs those who see it as a “nice-to-have.” This customer segmentation is crucial for developing an effective pricing strategy, whether that involves creating discount packages, adopting a usage-based pricing framework, or enhancing customer relationships to achieve revenue objectives. You are then able to convert a pricing conversation into a value “realization” conversation.

Final Thoughts: Playing to Win

It is hard for people like me to remember a pre-cloud world. My conversation with Thomas reminded me that this transformation is far from over. The industry is on the cusp of another major AI-powered step forward.. . . oh and capital has become much more expensive. Given this, SaaS leaders need to rethink and rewrite their playbooks–adopting new performance metrics, pricing models, and leadership responsibilities that align with the realities of modern cloud-native enterprises. This is how you can play not only to survive, but play to win.

For more insights and in-depth discussions on SaaS growth strategies and industry trends, tune in to Maxio’s SaaS Expert Voices podcast (fresh episodes every week).