Table of Contents
With nine weeks left in the year, many SaaS leaders are looking at their revenue dashboards rather nervously. If you foresaw how tough Q4 would be and set expectations appropriately, you still have a miss but none of the fallout that comes with it. For those who couldn’t or didn’t, what follows is for you.
A Miss Is a Miss
Big or small, a revenue miss is a revenue miss. Even a 5% revenue miss can have a dramatic effect on valuation. Let’s say you were expecting to come in at $10M ARR for the year, and you’re going to come in 5% below target. Assuming no change in growth rates or gross margins or other valuation drivers, it means a 5% drop in valuation. In this scenario, a $500k revenue miss resulted in a $9M drop in valuation!
So, let’s take another reality check. Any SaaS business today is having a problem with new business. Don’t let the external posturing or the dramatic growth numbers stated in isolation fool you: every sales leader is sweating. As hard as it has always been, the buyer has become more conservative, and winning new business has gotten harder. For those who’ve been through 2001 or 2008 macroeconomic slumps, this might be a well-exercised muscle, but for a fresh cohort of leaders, this is new.
When Is This a Big Deal, and When Is It Not?
In the scenario above, the valuation multiple on growth doesn’t change. So while on an absolute dollar basis you’re getting less money for your dilution, you’re not getting a lower valuation.
But this is an academic exercise.
A revenue miss rarely arrives at the party without an entourage of other bad news. Most experienced investors know this, as do seasoned sales leaders. Multiple funnel metrics go haywire, placing your go-to-market strategy (how well are you selling your product?) and perhaps even the product-market-fit (are you selling the right product?) under the microscope.
You have to know your funnel. The funnel is the leading indicator of new revenue. There is a correlation between the length of the free trial, for example, and the likelihood of the customer converting to a paying customer. There is a correlation between raw leads, marketing qualified leads (MQL), and sales qualified leads (SQL). You have to know that as well. Even if your investors are giving you a pass on the new revenue, they are noticing if you know why the funnel is failing and if you can tell the story succinctly.
While the funnel will be clamoring for your attention, there is another part of the business that should be looked at first.
What’s More Important Than New?
In any business, the repeat customer is the ticket to growth. In the software business, automation allows you to make a repeating user a recurring one. When selling the growth narrative, new customer acquisitions get the spotlight. It is the repeat customer, however, who carries water for the business.
The best repeat customer is the one who upgrades at the time of renewal. At the point when there was no contractual obligation to do so, this customer not only stayed but ended up asking for more.
The repeating customer is the true bellwether of your business. They are partners in your growth as much as you are a partner in theirs. The good times strengthen the relationship; the tough times test them. How well they’re sticking with you and even increasing usage is a good way to see if there are underlying problems with the business.
The Two Metrics
Two metrics spotlight the relationship with the repeating user: net revenue retention (NRR) and gross revenue retention (GRR). The calculation formula is pretty simple.
For any given time period, NRR is the prior period’s recurring revenue, adding to them the current period upgrades, the current period downgrades, and the revenue churned over the prior period’s recurring revenue.
The GRR is the formula without taking into account current period upgrades. Neither formula takes into account the new business you’ve earned in that period. Cube’s founder and CEO, Christina Ross says it best:
“GRR looks at only what you started with and how much you lost. NRR tracks your company’s ability to retain and acquire revenue from existing customers.”
Put into context, NRR is both a growth and a retention metric, while GRR is a retention metric. The common thread is they reflect directly on your relationship with your existing customer.
Ross provides a good correlation between NRR and GRR: If both NRR and GRR are high, you’re on a great trajectory and must focus on winning new customers. If your NRR is low but GRR is high, then you lack the ability to upsell. If both NRR and GRR are low, then you have serious problems with either your GTM or your PMF, and they need to be fixed quickly.
The market sentiment for what is good NRR and GRR will fluctuate. For NRR, however, 100% is a good starting point. This means your existing book of business is healthy enough that you’re at the very least retaining all the revenue you earned from the prior period.
In many ways, NRR/GRR is better than measuring user churn or logo retention. In fact, tracking NRR/GRR is an acknowledgment that a zero customer churn world does not exist. Thanks to Zipf’s law, it will always be the case that a simple minority of customers will be responsible for the majority of your income. It just is, as it always has been in business and in life. Pareto distribution is just one manifestation of Zipf’s law.
So New Business Doesn’t Matter?
That’s not what I’m saying. But when times are tough, blind panic can masquerade as aggressive opportunism. You can overspend on a marketing initiative or make aggressive media buys to try to generate interest without knowing (or fixing) the underlying issues in the business. Be aggressive, but not without understanding the boundaries and limitations of the business.
This Is Personal
For me, these times do feel familiar. My EZ Texting co-founders and I went through it during the 2008 (and 2009) crashes. Back then, we didn’t have a fancy term for it (or metrics), but we instinctively knew what we had to do: focus on delivering value to every customer, current or new. We didn’t have funding then, and maybe that was a blessing in disguise. The only people we had to please were our customers and our employees.
Today I work with founders and startup leaders from across the funding spectrum, but they face the same pressures. Some of them are paralyzed by analysis, unable to decide where they should double down on protecting the business (or what that even means). Yet, they get universal, useless, and seemingly orthogonal advice to “drive” growth. This pressure creates perceptual narrowing (a.k.a. panic) that induces decisions detrimental to their company’s survival.
Finally
The task in these tough times is to seek clarity. What is it that makes the business special? Why is it that your customers keep coming back? What makes you the right person to lead? There is a storytelling answer to the question full of anecdotes and feel-good stories. But there are also hard metrics that either reinforce the narrative or obliterate it. Know them, understand them, befriend them.