Benchmarking Drives Faster Growth of Software and SaaS Companies

March 26, 2012

Fast-growing software and SaaS companies don’t navigate their growth by luck. Successful companies today are intensely metrics driven and constantly compare their performance to peers and market. Have you ever felt that critical executive or board-level decisions about sales spend, performance targets and other business drivers are based on anecdotes and emotion more than data? Benchmarking your software or SaaS company’s financial and operating performance will make you perform better, improve your decision-making process and position your company for faster growth. This article shows how many vendors are benefiting from routinely benchmarking their performance and how some critical software benchmarks have evolved over the past five years.

Software and SaaS benchmarking since 2006

Benchmarking has become a critical management process for leading software companies. At OPEXEngine we started benchmarking the sector in 2006 to give operating executives a high-quality toolset with which to manage their growth, including detailed expense ratios by department, metrics on revenue, bookings and profitability, as well as headcount by department, numbers of customers, average deal sizes and much more.

During my 20 years of building successful software and tech businesses, in startups and large public companies, I always wished that I had better quality data to support critical investment and business model decisions. So I started OPEXEngine to deliver those tools. And in today’s world, with rapidly evolving business models, it is more important than ever to see your own business in the context of what’s happening outside your company.

Over the years, we’ve witnessed the rise of the SaaS business model within the software sector, the slow-down of investment during the 2008-2009 recession, and the more recent rebound. In the first half of the decade, while a few companies could bootstrap their way to the break-even point by $10 million in revenue or sooner, the bulk of early-stage venture-backed software application businesses typically needed between $30-$50 million to reach break-even. This was especially true for SaaS companies building their own hosting facilities and cloud-based technologies, which were not as advanced or price-effective as they are today. And the vast majority of companies established since 2000 are following some form of the SaaS model.

By 2009, we started seeing the average for fast-growth, venture-backed companies breaking even with closer to $20-$25 million in invested capital, depending on the product and market. Small and midsized vendors clearly pulled in the reins on spending in 2008 and 2009, reducing negative cash flow. The message at that time from VCs and CFOs alike was unequivocal: Portfolio companies had to manage as though there would be no more or very limited outside capital.

Surprisingly, software and SaaS companies did pretty well during these tough years, continuing to grow despite stricter controls on cash spend and expense ratios – in part because more established cloud technologies made it less expensive and more efficient for fast-growing businesses. And the market for SaaS solutions took off. It also became easier to find sales people experienced with the subscription model; and sales compensation plans evolved that were appropriate for the subscription model, which don’t pay sales hunters on the lifetime of a subscription or overpay customer relationship specialists, or farmers.

You can see these trends reflected in the numbers. Operating expense as a percent of revenue averaged 181% for private software firms in our benchmarking for FY 2007, easing to 148% in 2008 and 2009. By 2010, the average for total operating expense dropped further to 132% for private companies.

With the SaaS model, new metrics and ways of interpreting those data give operating executives important information about how the business is developing. With the old perpetual model, revenue was recognized mostly all at once, and management tracked performance primarily by recognized revenue and bookings. But that model always tracked performance looking backwards – how a business performed last quarter or lastyear. At best, past performance was a proxy for what it might be the following year.

In contrast, contracted SaaS revenue is recognized ratably over the term of the contract or on a monthly basis. Contracted monthly recognized revenue (CMRR) and growth in CMRR give us a forward-looking view of where a business is going. To round out that future perspective, we can also benchmark the number, growth and value of subscribers – the real primary asset of a SaaS business – as well as subscriber churn rates, all of which produces a much firmer forecast of growth.

Churn, which didn’t really exist as a benchmark before the rise of SaaS, is watched like a hawk at most SaaS companies today. The reason is obvious: Any company routinely losing 20% of its customer base won’t have many customers left after five years.

At OPEXEngine, we benchmark churn in several ways: by the number of customers that renew subscriptions, the contract values that are renewed, and the number of seats that are renewed. Other critical measures for the SaaS industry include the cost of customer acquisition (COCA), customer profitability and lifetime value of a customer. We’ve been tracking these specific benchmarks for SaaS companies for four years as well as a host of other detailed income statement and balance sheet metrics and performance criteria. What’s important about these new SaaS metrics is that they not only give us ways to predict the growth of the business in ways we never had before – but also levers that we can affect to improve performance.

That which is measured improves

Companies use benchmarking to drive growth in a variety of ways. First and foremost, companies use benchmarking for information. For many, it is an efficient way to see the averages for a variety of business metrics at your size and along the way to growing bigger.

“As a fast-growth, midsized public software company, we are data driven in our management and planning processes and OPEXEngine’s software benchmarking is a critical information source,” says Ralph Bryant, vice president of finance at RightNow.

It’s not necessarily good or bad to be above or below a certain benchmark, but it is important to make decisions knowing where you stand in relation to your peers and what other companies are doing.

Secondly, SaaS companies use benchmarking to see the trends and take action in that context. You can see in the public filings that fast-growth SaaS company SuccessFactors didn’t cut back on operating expense as much as some others, and especially didn’t cut back on sales and marketing as much as many did during the recession; they clearly tracked what peers were spending to validate their decisions and stand out from the crowd.

Data-driven decision making made possible

Finally, SaaS companies use benchmarking to make their decision-making process more efficient, collaborative and profitable. Rally Software, a fast-growth venture-backed SaaS vendor leader in Agile application life cycle management (ALM), regularly incorporates the software and SaaS benchmarks into their budgeting process to achieve a more informed and efficient budget and target-setting process.

Adam Cecil, vice president of finance at Rally, tells it this way: “Like most companies, we have an annual planning process. A couple of years ago, we started a parallel process to the normal practice of collecting inputs from the executive team for each departmental budget. At the same time, we circulated a presentation with benchmarks for comparable companies and business models to each department head, 80% of which came from benchmarking with OPEXEngine and 20% of which came from public company data for other market leaders that we follow. The executive team reflected together on the benchmarks and how the internal plan related to those benchmarks. They then used the benchmarking data to adjust their plans as appropriate. The team said this was the most friction-free and productive planning cycle they had ever experienced – primarily because it was data-driven.”

Rally’s finance team continues to use the benchmarking data throughout the year to review performance and help the executive team review specific metrics in the context of outside data. As Jim LeJeal, Rally’s chief financial officer says, “By fundamentally integrating the OPEXEngine benchmarking into our planning process and using it on an ongoing basis, I believe that we are using our resources more efficiently, making better investments and more easily achieving our targets.”

Navigating the course of a SaaS companies is exciting in today’s dynamic environment. The software and SaaS industry has never had better data tools to steer through the shoals of growth — and has never needed those tools more urgently.

This article was originally  published on Sandhill.