Friday, November 21, 2014

When deers morph into elephants, SaaS nirvana is nigh

By now you’re probably sick of my infamous animal analogies. Sorry. But I just love them and want to resort to them one more time. :) Namely, what I want to talk about are deers that can morph into elephants, or more generally, smaller animals that can morph into bigger animals. (1) In other words, I want to talk about account expansions, which are the result of a successful “land and expand” strategy.

The premise of this strategy is that it’s usually easier to get a minor commitment from a customer first and then work your way up towards a larger ACV, rather than trying to get a large deal from the get-go. There are different ways how SaaS companies have successfully employed land-and-expand strategies:
  • Yammer is a classic example. Typically a small team in a company starts to use Yammer for internal communication. Then they add more and more people, usage might spills over to other teams or departments, and eventually Yammer’s sales team can come in and upsell the customer to an enterprise account. It’s hard to imagine a hotter, more qualified lead than a company where dozens or hundreds of people are using your product already!
  • Dropbox is similar, but the difference is that you can start using Dropbox even as single user. Plus, they have another great growth vector, since people keep adding more and more files to their file storage.
  • EchoSign: In this Quora post, EchoSign founder Jason M. Lemkin (one of the top SaaS experts and our co-investor in Algolia and Front) describes how EchoSign grew many departmental deployments into large, six-figure accounts over time (he also gives you the caveats).

Another way to get bigger and bigger accounts over time is of course to target startups and grow with your customers. Zendesk is extremely successful at employing land-and-expand strategies, but the company has also been fortunate enough to acquire customers such as Twitter, Uber and many others when they were still pretty small.

If your land-and-expand strategy works so well that your account expansions offset churn, then your MRR churn rate becomes negative – a state which I’ve previously described as the holy grail of SaaS. It’s hard to overstate how transformative this can be to a SaaS company. Think about it: Negative MRR churn means that even if you’re not growing, you’re still growing. More precisely, even if you stopped acquiring new customers tomorrow your recurring revenue would still continue to grow.

It’s no surprise that SaaS investors start to salivate when they see SaaS companies with negative MRR churn. Just a few days ago, Tomasz Tunguz of Redpoint highlighted that New Relic, which has filed to go public, has a negative MRR churn rate of about 14% per year. Especially for later-stage public SaaS companies, revenue churn is one of the most important metrics to look at. You cannot understand a company like Box, which is spending seemingly crazy amounts of money on customer acquisition, without understanding this metric. (2)

(1) If you have no idea what I'm talking about, please read this post.
(2) And yet, I have the impression that this metric hasn’t fully arrived in the world of financial analysts and accountants yet. There doesn’t yet seem to be a standard way of reporting it – every company defines the metric a little different, and some aren’t reporting it at all.

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