It was near the end of the third day of our annual planning meeting. Matt joined the meeting late, listened for a few minutes as we tightened up the language around our big objectives for the year. As he took control of the meeting, Matt described the opportunity in front of us and asked each of us to go to the board and write what we thought our revenue goal for the year should be. We’d just grown annual revenue from $8.6 million to just over $20 million. Our bottom up planning approach suggested adding $15 million on top of the $11 million added last year would be challenging, but doable. Doubling was possible, at least according to the arithmetic, but in a professional services business that’s adding a lot of people and a lot of additional billing hours. “What should our target be? Can we double again? Are we ready to really scale this thing?”, I wondered.
How do you know when your really ready to take off?
Now that you’ve worked closely with a some customers and are confident you understand their problem, it’s time to start thinking about scaling. You know your solution addresses a key need and your research shows the market is big and growing. Trends are in your favor. But how do you know that you are ready for exponential growth? What is the foundation you need in order to “keep the wheels from coming off”, “stay out of the ditch”, “keep it between the lines”, “not run off the tracks”? There are good reasons and great examples that show why this is hard and explain why we have so many crash-laden cliches to describe a company growing too fast for it’s own good.
The one thing you must determine is the key metric that IS scaling success for you. Then you must understand, track, and improve the critical drivers to growing that number. For B2B SaaS companies, the critical metric is almost always recurring revenue, with new bookings, retention, and churn being key drivers. These items will drive growth, but growth alone does not make a business successful. (Want to learn about Saas metrics? Dave Skol does a great job of laying out metrics for Saas companies.)
In addition to cash flow, I want my clients and the companies I invest in to understand three items and how they work together to create long-term value. They are the complete Customer Value Stream, Unit Economics, and Marketing Funnel Metrics. I want these companies to continue testing and learning in each of these areas.
The Customer Value Stream is how value is created and delivered to the final customer. It complete value stream includes your supply chain and downstream activities, including those of the final customer. Your work on product market fit focuses on your role in this value stream and I’ve found a complete view helps companies find new opportunities to deliver value and cut waste.
Unit economics are critical to making sure your acceleration is driving your company toward profitability and not simply taking you over the side of a cliff more efficiently. It’s critical to fully understand your Customer Lifetime Value (CLTV) and Customer Acquisition Costs (CAC). Until the value customers deliver to you are at least three times your cost to acquire them you have work to do with your customer reach, pricing, and maybe even your product features.
Here are a few good rules of thumb:
- CLTV to CAC ratio of 3 or greater
- MGM to CAC of 12 months or better (I look for 8 months)
- Net Churn of > 0% (I look for -2% or lower.)
Net Churn = Churn – Change in Continuing Customer Revenue. This is a bit of a backwards metric. -2% Net Churn means your continuing customers are deliver 102% of last period’s revenue. But since it’s stated as churn it’s shown as a negative percentage.
A detailed understanding of your soon to be new customers, how you reach them, and how they flow through your marketing funnel are mandatory. Obviously, you can’t know your Customer Acquisition Cost (CAC) unless you know how many people you need to reach, how many times you need to reach them, and how many will end up being customers. So develop a customer Acquisition, Activation, Retention, Revenue, and Referral (AARRR) program early, create your AARRR, (known as Pirate Metrics thanks to Dave McClure) dashboard on day one, and refine it, refine it, refine it.
Once you have confidence in your CLTV and CAC you can begin to look at your customer acquisition strategy as a money multiplier machine. (e.g. For every dollar you put in, you get three or more dollars back over the next two and a half years.) With this model fully understood, you can maximize the return on available cash and begin to optimize your business. The impact on cash flow of lower CAC or higher CLTV is easily understood. It allows you to begin exploring which changes to CAC or CLTV have the biggest impact and helps you decide whether to invest next, be it in a broader more expensive marketing reach, a drive for a higher share of wallet, or to seek higher and longer customer retention.
Back to that planning meeting, so many years ago. Our targets ranged from $38 million to about $42 million. Of course these were not votes as much as they were suggestions and Matt (not his or her real name of course) “convinced” us $45 million “sounded like a nice round number”. So we set that as the target, signed the flip sheet and delivered over $48 million. How? By being ready to scale. We had the right in place to bring in customers and build the capability to deliver the work.
Pirate Metrics graphic from Pierre Lechelle, SaaS Marketing & Growth Hacking