9 Worst Practices in SaaS Metrics

9 Horror Worst Practices in SaaS Metrics

As mentioned in my last post, I recently did a talk about SaaS metrics and I said I'm going to upload the slides. The slides don't contain a lot of text as they were not meant to stand on their own, but I've added a few additional notes to make them a bit more useful. 

You can view the presentation on SlideShare.

PS: Last week I held a session about the same topic at Seedcamp in London – thanks Philip and team for inviting me!

KPIs for VCs

Example for a Geckoboard KPI dashboard

Last week I spent a day in Stockholm to attend a metrics seminar organized by our friends at Creandum. It was a great event with talks from people of some of the best Internet companies from the Nordic region such as Spotify or Wrapp. Thanks Johan, Joel, Daniel, Frederic and everyone at Creandum for setting it up and inviting me!

I did a talk about SaaS metrics (I'll post the slides shortly), and in the Q&A session Andreas Ehn asked a really good question:

"As a VC, what are the most important KPIs for yourself?" 

Ultimately our #1 KPI is the return that we deliver to our LPs. If you're new to the world of venture capital, LP is short for "Limited Partner" and means the people and funds which have invested in our fund. That return is expressed as a return multiple or as the internal rate of return (IRR). As it obviously takes a lot of time to build (and eventually sell or IPO) great companies it will of course take many years until we know our final performance. Like most VCs our fund is set up for a lifetime of ten years.

In the meantime we (and other VCs) track our performance by:

1) Adjusting the value of our portfolio whenever a portfolio company raises a new round of financing from a new investor at a new (hopefully higher) valuation. While there's no guarantee that we will ever sell our shares at these "Fair Market Valuations" (FMVs), the assessment of the portfolio based on current FMVs is usually the best way to measure success. Valuations are usually marked up on an ad hoc basis internally (i.e. when a new round closes) and reported to LPs on a quarterly basis.

2) Monitoring our portfolio companies' key financial data, KPIs and operational performance. This is the best near-time proxy to long-term success, and so we're constantly looking at these things. We usually get either access to live dashboards or monthly reports and I'm hoping that we'll soon find the time to create a beautiful Geckoboard dashboard with the top KPIs across the entire portfolio (requires some work because we get data from portfolio companies in a variety of different forms and shapes).

Besides these pretty obvious ones there are a few other KPIs that we're looking at:

Number of deals that we're evaluating

It's not a KPI in the sense that there's a direct "the higher the number, the better it is" correlation, as quality of deal-flow is of course more important than quantity. But there is a connection between quantity and quality, and since we're using Zendesk to track each potential investment it's easy to monitor this number (for what it's worth, we're currently at deal #3,773 since we started using Zendesk about two years ago, and in the last 30 days 148 new ones have been added). 

Response time for investment inquiries

For founders it's important to get fast responses, even if the answer is "no". Depending on our workload sometimes we're fast and sometimes we're slow. There's still a lot of room for improvement, so this is a KPI that we're going to keep a closer eye on in the future.

"Rating" of our responses

Zendesk allows you to let your end users rate the customer support experience for every support ticket. We're not using this feature yet, but I'm wondering if we should do it in order to keep track of how successful we are in leaving positive impressions with the entrepreneurs that are pitching to us.

How well are we at picking the right investments?

Of all the potential investments that we look at, how well are we at picking the winners and avoiding the losers? And how well are we doing when it comes to allocating follow-on investments among our portfolio companies? We're not yet using a simple set of KPIs to track this, but we're regularly reviewing our past deal flow, trying to understand when we were right and when we were wrong and what we can learn from it.

Finally, there's one other KPI, and while it's again not something you can quantify on a short-term basis, it's just as important or even more important than our fund performance in the long run: It's the concept of Net Promoter Score applied to us. What it means is that when we ask our portfolio founders two simple questions – "Would you raise money from Point Nine in your next startup?" and "Would you recommend Point Nine to other founders?" – we want to hear two wholehearted YESes.

PS: Just like Web startups have their vanity metrics, you can also hear VC talk about vanity metrics – i.e. metrics which sound good but don't mean much. I'll leave that for another post.

Ideas we'd like to invest in: Mobile-first SaaS

Following my posts about electronic signing and vertical SaaS, here's another area that we're very interested in:

SaaS solutions with a mobile-first approach

While my first two posts of this series were fairly specific, this one is pretty fuzzy as I don't have a good sense for what I'm looking for. I just have a feeling that there are huge opportunities ahead for startups which rethink how people will use business applications in the future. This feeling is based on a couple of factors:

• The incredible rise of smartphones and tablet computers, combined with ubiquitous Internet connectivity. Global mobile traffic as a percentage of total Internet traffic has grown from 1% less than three years ago to more than 13% today. In India and other countries, mobile traffic has surpassed desktop Internet usage already, and very very soon there will be more smartphones and tablets than desktop PCs and notebooks. (Taken from Mary Meeker's Internet Trends report – always a good read.)
• In sectors or jobs in which people are on the road almost all the time, people spend much more time with their mobile device than with their desktop computer already. But since the leading SaaS companies have been started before the mobile revolution took off, even if they have developed mobile apps in the meantime their products have not been built with a mobile use case in mind from the ground up. Makes me wonder if there's an opportunity to become to Salesforce.com what Instagram is to Flickr. And field sales people are just one example of course – think about places like hospitals, construction sites or factories where using tablets makes a lot of sense as well.
• The unique capabilities of mobile devices – location-awareness, built-in cameras, touchscreens to name just a few examples – allow the creation of entirely new features, products and user experiences. There are lots of examples for amazingly innovative mobile apps which take advantage of these capabilities in the consumer world, but business apps seem to be lagging behind in this respect.

So...if you're working on a mobile-first SaaS startup, let me know!

Ideas we'd like to invest in: Industry-specific SaaS solutions

Following my post about electronic signing I'd like to describe another area that we'd like to invest in. It's not a specific idea this time, rather a category of startups that we're very interested in:

Industry-specific SaaS solutions

I talked about the topic before when I wrote about "The land of a thousand niches" and touched on it in my "1st DO for SaaS startups". There are several reasons why we're so excited about vertical SaaS solutions. *

• Focusing on a specific vertical simply allows you to build a better product for the industry that you're after. Whereas a generic product needs to be the lowest common denominator for different types of customers, a vertical solution can be tailored exclusively to the needs of your specific target audience.
• By the same token, a vertical focus also allows you to tailor your messaging to one target group. Take our portfolio company Clio as an example. Look at their website and think about how much weaker their proposition would be if they had to keep it generic to address a broader target audience.
• Knowing exactly who your target group is also makes sales and marketing much more straightforward. It means you'll know which publications your target customers read, which conferences they attend, which other products they use, and so on. You can even get their names and addresses from the yellow pages or other directories. And because people in an industry usually talk to each other a lot, it's easier to get a critical mass of mindshare which is so important for organic growth.
• Competition tends to be less intense in verticals. Maybe because building a SaaS solution for field-service businesses like landscapers and snow removers doesn't appear like the sexiest thing on Earth, maybe because opportunities in verticals don't seem large enough for big enterprises. This gives you a chance to dominate a category and achieve extraordinarily high market share.

Boris Wertz, a good friend and co-investor in two vertical SaaS solutions, Clio and Jobber, recently wrote about the topic as well and has some additional points.

I have one caveat regarding vertical SaaS solutions: Make sure that the vertical that you're going after is big enough, i.e. aligned with your ambition with respect to the size of the company that you want to build. Expanding from one vertical into another one isn't easy. Maybe you won't have to start from zero, but the very reasons which make a vertical strategy attractive in the first place can also mean that most of the value that you've built in one category (domain expertise, product/market fit, mindshare,...) can't be easily transferred into another category.

_____________________________

* This doesn't mean that we're not excited about SaaS startups which don't have a vertical approach. If you focus on a specific part of the value chain (e.g. accounting, marketing, sales) it makes perfect sense to go horizontal. It's the "practice management" type product, which encompasses a large part of the value chain, for which I recommend the vertical approach.

A KPI dashboard for early-stage SaaS startups

[Update 12/20/2013: I have extended the dashboard to include multiple pricing tiers and annual subscription plans. Check it out here.]

[Update 01/17/2015: There's a new company called ChartMogul (which we invested in) which makes it easy to get a real-time dashboard similar to the template below. Check it out!]

Over the last few years I've helped quite a lot of SaaS startups to create or fine-tune their KPI dashboards. While every situation is a bit different there's also a lot of overlap, which made me think that it would make sense to publish my template (not without polishing it a bit). I hope other SaaS startups will find it useful, and it will also make it easier for us to communicate what KPIs we're looking for when we talk to SaaS entrepreneurs.

Not surprisingly the dashboard looks quite similar to the financial planning sheet that I've posted some time ago. Below are two Excel screenshots, and 

here is the Google Docs version.

If you prefer the Excel version, which looks a bit nicer, click here to download it. (And if you like it, tweet it!)

The sheet contains some notes on the right side. I was going to note a few additional things here but it's gotten really late here in Europe so I'll leave that for another day. If you find any bugs, let me know and I'll fix them tomorrow morning. :)

One comment, though. Although I've developed this sheet on my own, I've learned a lot about SaaS metrics from David Skok, who I am very thankful for. David created a SaaS dashboard as well, it's a bit more sophisticated and has a slightly different focus, but it's quite similar. Check it out, and if you have not read his brilliant articles about SaaS yet I highly recommend that you do so. They are an absolute must-read for every SaaS entrepreneur.

Like this post? Follow me on Twitter.

Ideas we'd like to invest in

Inspired by Paul Graham’s “Startup Ideas We’d Like to Fund” post of a few years ago I’d like to start a series of posts about ideas that I find exciting and that we at Point Nine would be very interested in investing in. Here's the first one.

Electronic signing

I’m a huge, huge fan of electronic signing. Whenever I have to sign a document and I’m getting a “Please eSign...” email I rejoice because it saves me the hassle of printing, completing, signing, scanning and emailing the signature pages (don’t get me started on snail-mailing paper copies with original signatures!). This is of course especially true if you’re traveling and don’t have access to printers constantly. Apps like SignEasy and SignNow, which target the “signer” and let you e-sign PDF documents from your iPhone, are a pretty good solution and can be a live-safer if you’re sitting in a cab and have to sign an important document. Products like EchoSign, DocuSign, RightSignature and HelloSign, which are geared towards the signature-collecting parties, are even better in that they take care of the entire e-signing process from creating documents to collecting signatures and archiving signed contracts.

There are a couple of reasons why I think e-signing is not just a great product but also a great business:

• The product is inherently viral. Very rare for SaaS solutions. That means low customer acquisition costs which, combined with a good revenue model, are a killer.
• The product is valuable for individual users but becomes even more valuable if it’s used by an entire department or an entire company, which means you can use a Yammer-like land-and-expand strategy to get into bigger accounts. 
• It seems easy to find a good pricing structure which lets you combine an affordable entry-level plan for small customers (or even a free plan) with expensive plans for large customers, since the value delivered to customers (and hence willingness to pay) should correlate strongly with the number of contracts and number of users.

Now – there are a couple of well-funded players already, and EchoSign, following its acquisition by Adobe, has been integrated into Acrobat Reader, giving the product massive distribution as well as an entry product that is geared to the “signer side”. So the big question is if there’s still room for a new entrant.

I don’t have a clear answer, but given that the vast majority of signatures are still done on paper and that the US players seem to have very low penetration in Europe I’m wondering if there could still be an opportunity – maybe for a European champion, maybe with a vertical approach, maybe with a mobile-first strategy or another special twist?

The 6th DO for SaaS startups – Fill the funnel

Here's another post in my series on DOs and DON'Ts for early-stage SaaS startups:

6th DO for SaaS startups

Fill the funnel
Or: Focus on inbound marketing, but
 try lots of things and double-down on what works

In this post I'm going to write about lead generation for SaaS startups. When I edit the series later on I might merge it into my 4th DO (Make your website your best marketing person) to have one post on marketing. Let's see.

To make it clear right away, unfortunately I can't tell you what's going to work for you in terms of getting a large number of potential customers to your site. In fact, my key message is that there is no magic bullet when it comes to lead generation and that you'll have to try lots of things, put in lots of time and effort, double down on what works and execute extremely well. I haven't seen a SaaS company yet which gets more than 50% of its leads from one particular distribution partnership or marketing channel (except maybe word of mouth if you want to count that as a lead source).

Compared to that, marketing for consumer Web startups can be relatively straightforward. If you are a travel startup or an online shop, for example, millions of people search for your products or services online so you can use SEM, affiliate marketing, banner ads and other proven tactics to acquire large numbers of customers. In addition you can do TV advertising as your products are interesting for a relatively large percentage of the population. Getting the economics right and making it work at scale is of course a huge task and a science of its own, don't get me wrong on that.

But the particular challenge in SaaS marketing is that in many cases there isn't a huge amount of demand (a.k.a. search volume on Google), so the number of customers that you can acquire via AdWords is often quite limited. And things like TV advertising obviously don't work because of the huge waste circulation ("waste circulation" was the best translation I could find for the German word "Streuverlust" – does anyone know a better one?).

Just because you have a great solution doesn't mean that people are actively looking for it. That's not to say that you have a solution in search for a problem, but people may not be aware that there is a better way of doing things. What that means is that you need to find – and be found by – the people who your product is geared towards, often at a stage when they are loosely interested but are not yet ready to try (let alone buy) your product. Give them something that is useful to them. Write about the topics that your target group is interested in and provide lots of useful high-quality content and tips and tricks in a variety of formats, e.g. blog posts, white papers, case studies, videos, webinars, infographics or podcasts. Make sure that you don't talk too much about your product and that what you're publishing is really interesting to your target group. Sooner or later, some of these people will try and eventually buy. That's the whole idea of inbound marketing and lead nurturing. If you're not yet familiar with those concepts you should start learning more about them. A good starting point is Hubspot.

Zendesk is of course a great example for excellent inbound marketing. On its site the company provides a wealth of resources that are valuable for anyone who's interested in customer service, everything from tips for hiring customer service reps, to a guide to multi-channel customer support to numerous case studies and much more (including funny videos like this one). All of this helps to establish Zendesk as the go-to site for the help desk industry.

As for other ways to fill the funnel, here are some thoughts on things that you can do (in no particular order and of course by no means exhaustive):

• PR: Very important, and can get you off the ground in the beginning. Build relationships with the important bloggers, journalists and opinion leaders in your space and supply them with news. In the long term try to become an opinion leader yourself. Use Facebook, Twitter, Quora, conferences and events to reach out to the important people in your space.
• Most products are not inherently viral, but think about whether there are (sensible) ways to build virality into the product. If you can't find any you can still launch a referral program and reward users for recommendations to increase referral rates at least a little bit.
• Marketplaces, app stores, API partnerships, integrations, partnerships with hosters and the like: Don't expect huge volumes of leads from them, but they can be a meaningful lead source (and add value to your product).
• SEM & SEO: While you shouldn't bet on it alone, this is a very significant lead source for almost all SaaS startups that I know, so it's worth spending time and money on it.
• Ads on Facebook and LinkedIn: Personally I haven't seen great results with Facebook or LinkedIn ads for SaaS companies, but given the vast targeting options that you have there I think it's worth trying. If you've made it work I'd love to learn more.
• Display ads: Similar story, most of the time it doesn't work very well, but if there are suitable industry sites or blogs you may want to try it. 
• Retargeting: Can work very well. Obviously rather a nice supplement than a real needle-mover since the amount of visitors that you can target is limited by the amount of visitors who you've attracted in the first place.
• Promoted tweets: I don't have a lot of experience with advertising on Twitter, but I think it's worth a try, too.
• Distributors, VARs and similar channels: Tends to work better for traditional software with high license fees, setup and training requirements etc., but I've seen some good success in SaaS as well. Usually better for satisfying existing demand than for generating the demand in the first place, i.e. don't expect your channel partners to create the awareness for you.
• Local meetups: Once you have a number of customers in a region, organize local meetups. Nothing beats putting a bunch of happy customers and prospective customers into one room!
• Telesales/telemarketing: Hard to make it work, but if you can pull it off it can scale extremely well.

Finally...if you have trouble reaching your target group, try to put yourself in the shoes of the persons that you're trying to reach. Imagine how a typical day looks like for them. What websites do they visit, what might they be looking for on the Web? What magazines do they read, which industry associations might they be part of, what other products do they use, which people do they spend time with? Thinking about it this way will hopefully spark your creativity and let you come up with some fresh ideas.

Why I'm happy to be a micro VC

Last week we announced the closing of our new fund, Point Nine Capital II. The most important information about the new fund is included in our official press release, but I wanted to write a brief blog post to give you some additional background and share some personal thoughts.

When we set out to create the new fund last year, the goal was to raise €30 million. Since we're quite new to the VC game and didn't have any relationships with institutional investors, raising the fund took us quite a while. We're all the more happy with the result – not only did we end up raising €40 million, we also managed to get leading private equity fund-of-funds like Horsley Bridge Partners on board. Ironically, while it took us quite some time to raise the first €15 million, in the end we could have raised more than what we did if we had wanted to. I'm sure this will sound very familiar to many startups.

While the fund size means we are a "micro VC", at least by US standards, we feel it's a pretty sizable fund for early-stage Internet investments in Europe. The fund size will allow us to invest in around 40 companies over the course of the next few years, while keeping significant reserves for follow-on investments into our portfolio companies. It will also allow us to hire some people to help us with administrative and other tasks so that Pawel, Nicolas and I (plus the new truffle pig that we're looking for at the moment) can focus most of our time on what we like best – finding new investments and helping our portfolio companies.

The importance of follow-on capacity is one of the things that I've learned as an angel investor. As an angel investor who invests his own money it's hard to keep a lot of reserves. That can be problematic not only for the angel investor (who sees himself getting diluted starting with the A round) but also for the portfolio company if it needs to go back to the market to raise more money from new investors too quickly. I wouldn't say that I've learned this the hard way, but having a fund is definitely a big plus in this respect.

While we have more firepower than private investors, we're still small enough to not have to deal with the challenges faced by large VC funds. If you have a €300-500 million fund it's really hard to find investments which can move the needle or "return the fund", in VC lingo. There just aren't many companies that can put something like €20 million to work and turn it into €200 million. And if you look as the market as a whole, there just aren't enough €1B+ exits to allow a bigger number of large funds to deliver great returns to their LPs. The micro VC fund size also works well with our "angel VC" approach (which means fast decisions, no big committees, founder-friendly terms, simple term sheets, hands-on support and generally a no-bullshit attitude). 

Don't get me wrong, I loved being an angel investor and if I didn't do Point Nine I'd still be one (and needless to say, angel investors fulfill an incredibly important role in the startup ecosystem). As for the other end of the spectrum, I genuinely admire VCs who manage to deliver great returns on large funds. But it's a different game, and not the one I want to play.

That is why I'm happy to be a micro VC.

Do you have what it takes to become a truffle pig?

A few weeks ago, Fabian, who worked as Point Nine's associate from the very beginning, has left to create his own startup, Wunsch Brautkleid. Hence we're now looking for a new Investment Associate to complement our investment team.

Here are all the details.

Please check it out and help us spread the word!

The 5th DO for SaaS startups – Get your pricing right

Following some advice on choosing the right market (here and here), building a team with product/tech DNA and the importance of an awesome product and an awesome marketing website I would now like to turn to the topic of getting your pricing right:

5th DO for SaaS startups

Get your pricing right

If you're following this blog for a little while, a part of this post won't be new for you because I wrote about the topic before and will repost a large part of it here. But I'm going to add a few new thoughts as well, especially about Freemium.

As you're getting close to the launch of your product you'll have to make a number of decisions around pricing:

1. Will there be a free plan?
2. What pricing model am I going to use?
3. How much am I going to charge?

Pros and cons of Freemium

Starting with the first question, there is no general answer on whether you should or should not adopt the Freemium model. Having a free plan can be extremely powerful in getting large numbers of users quickly but there are costs to it. Here are some of the factors that you should consider:

• How much does it cost you to serve a customer? While the marginal costs for hardware and bandwidth to serve an additional customer are of course very low, keep in mind that when you offer a Freemium model you might very well end up with 95% free customers and 5% paying customers. So assuming your CoGS are the same for free and paying customers (which may not be true), the free plan might increase your costs for hardware and bandwidth by a factor of around 20. Also consider the burden on your support team when you think about the costs to serve free customers.
• Is there a natural upgrade path from free to paying? That is, do you think a free plan will allow you to attract users who will eventually upgrade to a paid plan e.g. because their business grows or because they need premium features? Or would a free plan primarily attract users who will never pay for your product and who you might not be interested in acquiring at all?
• How price sensitive is your target group?
• Do you have a good idea for defining the limitations of the free plan? Will you be able to offer compelling reasons for upgrading?
• Is there an opportunity to make money off the non-paying customer base using alternative revenue channels? Or are there network effects in your business that let you benefit from a large user base?
• Is there strong competition? Are you in a "land grab" situation?
• How well are you funded, can you afford to give low priority to short-term revenues?

A good example for a successful Freemium model is MailChimp, the popular email marketing solution. MailChimp offers a free plan that lets you send up to 12,000 emails per month to up to 2,000 subscribers. If you look at the questions above you'll notice that for an email marketing solution there's a strong case for Freemium. Most of the aspects are pretty obvious (costs to serve a free user can be calculated fairly precisely, smooth upgrade path, high price sensitivity due to strong competition). One maybe less obvious aspect is that its large base of free users allows MailChimp to process and analyze hundreds of thousands of email lists and billions of email addresses. This for sure gives MailChimp lots of valuable insights which small competitors don't have. For example, it allows MailChimp to build a database of invalid email addresses which they can use to reduce bounce rates for their customers and thus become a better emailer (from the perspective of spam detection), improving email deliverability rates.

By the way – if your product doesn't lend itself well to a Freemium offer, try to think of something else that you can give away for free to get users and make them aware of your paid product. This could be an add-on to your core product, a mobile app or a small separate product. Hubspot's website grader is a great example.


Using the right model, charging the right amount

Let's move on to the second and the third question from above – what pricing model am I going to use and what should I charge?

It’s obvious that getting pricing right is extremely important: If you’re too cheap you will leave money on the table and reduce your ability to invest in customer acquisition. You may also hinder adoption especially from bigger customers who think that your product can’t be good because it’s so cheap. If you’re too expensive you might be scaring away the majority of your potential customers.

Unless your target customers are all very similar (which is unlikely), the most important thing that your pricing model has to accomplish is to capture different amounts of money from different customers based on their willingness and ability to pay, which correlates with the value that they’re getting from your product. In the old enterprise software world this used to be the job of the sales people – talk to the customer, find out about his needs, get a sense for what he can pay, offer him a solution and negotiate a price. In the world of SaaS, customers (rightly) expect more transparency and will look for a price list on your website before they start a trial.

In many cases a per-user pricing (often also referred to as “per seat”) is an obvious choice, and some of the most successful SaaS companies including Salesforce.com are using that. Other successful examples include pricing based on:

• number of clients managed with the software (e.g. Freshbooks)
• number of newsletter emails sent (e.g. MailChimp)
• number of email recipients in the system (e.g. ConstantContact)
• amount of storage that is used (e.g. Dropbox)
• number of events tracked (e.g. KISSmetrics)

What these companies have in common is that they've found an "axis" that highly correlates with their customers' willingness to pay, which allows them to keep their service affordable (and in some cases free) for small customers while asking bigger customers for much more. It also allows them to benefit from the growth of their customers, since a growing company needs more seats/emails/MBs/events/etc over time. Ideally this can lead to what is known as "negative churn" – the wonderful situation when the MRR growth of some customers of a customer cohort more than offset the effect of terminations from that cohort.

Importantly, most successful SaaS companies differentiate their prices along more than one axis (David Skok wrote about this here). Secondary axes include the level of support, additional features or other usage parameters. For example, Freshbook's pricing is based on a combination of the number of clients that you can manage and the number of seats, plus two additional factors:

So what's the right pricing model for your SaaS startup? The right answer is of course "it depends", and all I can do is offer a few practical tips:

• Try to find one or more axes which correspond with the value that your customers are getting from your product and which correlate with your customers' willingness to pay. Talk to your customers and analyze how your early users are using the system to find out the ways in which larger customers are using your product differently from smaller customers.
• If you don't know how much to charge, take a look at the prices of other products in the market and try to get a sense for the value that customers get from your product. How much time and thus money can a customers save with your product? Does it allow your customer to increase revenues?
• In the beginning, err on the side of being too cheap rather than being too expensive. In the beginning the most important thing is to get customers. You can optimize your margins later.
• Later on, make sure you're not leaving too much money on the table. If not a single customer ever complains that you're too expensive that's a strong sign that you're too cheap. Also keep in mind that a higher ARPU means more money that you can reinvest in customer acquisition and that a higher ARPU can open up completely new ways of acquiring customers, so higher prices can also be a driver of customer growth.
• Accept the fact that it's very unlikely that you will get your pricing right at the first shot. Go out with something that you think makes sense, get feedback from the market and be prepared to make changes quickly.
• If you increase prices, try to do it along with new value-add features that help justify the price increase. And offer your existing customers extremely generous grandfathering terms.
• If your pricing is differentiated based on features, consider giving all users the high-end plan with all features during their trial so that they can play around with the full product.
• Maybe not necessary to mention since these are all known best practices, but just in case: Give users a self-service free trial. Offer monthly pay-as-you-go subscriptions that users can cancel at any time. Provide an option to pay in advance for a year (with a discount). Create a clean, beautiful pricing page. 

Unscalable hacks

Recently I stumbled on the term "unscalable hack", in a blog post by Chris Dixon. This really struck a chord with me because it's a very important concept for many startups but I didn't have a term for it until I read Chris' post.

What exactly is an "unscalable hack"? Google doesn't return a lot of useful results and neither does Quora, so let me try to explain it. In the context of programming, using an unscalable hack means programming something in such a way that it works under very specific, limiting conditions (e.g. with very few concurrent users) but won't work with a larger number of users. The advantage of a solution like this is that it doesn't take a lot of time to develop so it saves you money and time, but the disadvantage is that it, well, doesn't scale and that you're accumulating technical debt.

In a business context, unscalable hacks are actions that you use to dramatically decrease time-to-market, solve chicken-egg-problems or overtake competitors, all the while knowing that you can't operate like this forever. In some cases the success of these hacks can be a make-or-break factor for a startup.

Marketplaces and social networks are particularly prone to these tactics since these types of businesses require you to reach a certain critical mass in order to be successful. Take an auction site as an example: As long as there aren't many buyers on the site, it's not attractive for sellers to list their items on it. And as long as there aren't many sellers, the site is not very useful for buyers. It's a classic chicken-egg-problem, and unscalable hacks can help you solve it.

Here are some examples of unscalable hacks that I'm aware of:

• In the early days of PayPal, PayPal reportedly listed lots of products on eBay and made PayPal the only accepted payment option for these products. I don't know if it's a true story, but either way it's brilliant. :-)
• AirBnB offers people who want to list their apartment on the site professional photo shootings of their apartment for free (maybe this actually isn't unscalable, I don't know).
• Lead generation marketplaces which send free leads to the supply side in the beginning and generally invest a disproportionate amount of money and time into acquiring the first providers.
• Mobile app creators who hope to start a virtuous circle by buying their way into the app store top listings.
• In SaaS, a good unscalable hack is to spend huge amounts of time with your early users to turn them into happy users and evangelists.

Solving the chicken-egg problem that is inherent to marketplace-like models is so mission critical that it sometimes leads to unscalable hacks that are ethically highly questionable, for example dating sites that use faked profiles to attract people to their sites.
The oldest well-known unscalable hack, or maybe a close relative of it, is maybe to give away oil lamps and make money by selling the oil. :-) If you know any good ones from the more recent past I'd love to hear them!

The 4th DO for SaaS startups – Make your website your best marketing person

If you're building a modern SaaS solution for the Fortune 5,000,000, the importance of your marketing website cannot be overstated. In the old world of enterprise software, most software vendors used to have pretty lame websites. Most of them were poorly designed and looked very technical and uninspiring, and the only images they contained were the seemingly obligatory stock photos (suit-wearing business people trying to out-smile each other, handshake close-ups and of course an attractive headset-wearing woman – often the same one on multiple vendors' sites!). Compare that with the website of a modern SaaS solution like Zendesk and I'm sure you'll understand what I mean.

To be fair, those old-school software vendors were probably able to afford having bad websites since the Internet just wasn't their primary sales or marketing channel. By contrast, if you market a SaaS application using a low-touch sales model, most of your customers will have very little interactions with your sales team, which turns your website into the face of your company. Use this as an opportunity to make your website your best marketing person!

The primary objective that your website has to achieve is clear: attract as many visitors as possible (mainly by providing great content, more on that in a later post) and turn as many of them as possible into trial users. There can be a number of secondary goals like collecting email addresses of visitors who aren't ready to start a trial yet, generating interest from and providing information for partners, informing about job openings at your company, transporting your brand image and so on, but getting visitors to try your product is clearly the most important one. As such your site needs to combine a convincing, simple value proposition, which catches the visitor's attention and makes him want to learn more, with a clear and highly visible call-to-action (hello, AIDA).

If you're new to SaaS, probably the best way to get started is to take a look at a number of successful SaaS websites. Great examples include Xero, MailChimp, CampaignMonitor, Harvest and SquareSpace. For some examples from our own portfolio, check out Zendesk, FreeAgent, Clio, Vend or Geckoboard, to name just a few. If you take a look at these and maybe other sites you'll see that they have a number of elements and characteristics in common:

• Beautiful imagery of the software (good screenshots, photos showing the app on Apple hardware) which makes you want to give it a try
• A screenshot tour and/or videos that let you easily learn more
• Brief information about the key value propositions on the homepage, with links to more comprehensive information about the product on sub-pages
• An easy to find link to a clean pricing table so that the visitor doesn't have to search for pricing information
• Quotes from customers and the press and sometimes security certificates or awards to show credibility
• Highly visible buttons for the key calls to action (usually "Sign up" and "Take the tour")
• A simple signup form with as few mandatory fields as possible in order to minimize the barrier to sign up

For an example and some additional notes, here's a wireframe that I created for my portfolio company samedi some time ago and which became a part of the briefing that we gave to the graphical designer:

(click on the thumbnail for a larger version)

Notes and bonus tips:

• Looking at existing SaaS websites and my notes above will give you a good sense for the typical anatomy of a modern SaaS site, and since a lot of thinking and often A/B testing went into them you can deduce some best practices by analyzing these sites in detail. However, this shouldn't stop you from trying your own ideas and from trying something completely new.
• Keep it simple. Just like your product needs to allow for gradual discovery, your marketing website also needs to start with a simple, compelling value proposition and keep the more detailed information for the sub-pages. Interestingly, if you look at the evolution of popular SaaS sites you'll often notice that they got simpler and simpler over time. Example: This is how Basecamp looked like in 2006, and this is how it looks like today.
• I've mentioned secondary conversion options above. It's important that you offer something to visitors who are interested in your product but aren't ready to take a trial yet. It can be a newsletter subscription, a callback button, a whitepaper download, a live chat window or signing up for a webinar, to name some options. Ideally it allows you to get the visitor's email address so that you can reach out to the user later.
• This may not be relevant for you right after the launch, but at some point in time you should try to personalize your homepage based on information that is available about the visitor and see if it has a positive effect on conversion. One simple way to do this is to customize the page based on the user's location A site like Clio, for example, could use geo-targeting to tell a visitor from, say, New York how many lawyers from New York Clio has among its customer base already or show case studies from Clio customers in New York.

Software is eating the world, but the smartphone is pretty hungry too

Last August, Marc Andreessen wrote a great essay titled "Why software is eating the world". In his article, which got a lot of attention in the tech world, Marc explains why and how a variety of industries have been and continue to be disrupted by software. Read it if you haven't read it yet, it's a well-written and inspiring post by one of the most successful and knowledgable people in the Internet industry.

Recently I read about the concept of "dematerialization" (in the book "Abundance – The Future Is Better Than You Think" by Peter H. Diamandis and Steven Kotler). The book quotes Bill Joy saying "We're seeing the tip of the dematerialization wave, like when a phone dematerializes a camera. It just disappears." and goes on to list a number of other goods and services that are now available with the average smartphone.

Software is eating the world, but the smartphone is pretty hungry too.

There's no real contradiction here though, since a large part of the smartphone's appetite for disruption is driven by software as well (although innovations in the hardware used by smartphones play an important role too). Either way, I think it's a fascinating observation. When I look at myself, my iPhone has already replaced my wristwatch, a pocket translator, a GPS running watch, a travel alarm clock, an address book, a calendar and an MP3 player. Most of the time it also replaces my camera, camcorder and calculator.

For other people the smartphone has replaced radios, TVs, GPS navigators, flashlights, mobile game consoles, pocket mirrors and, in case you forgot that you can also use these thingies to make calls, landline phones. Soon the smartphone will dematerialize credit cards, loyalty cards, keys, and this is just what I came up with thinking about it while writing this blog post. I'm sure there are dozens or maybe hundreds of other products or services that are being eaten by the smartphone already or will be in the near future, and I'd love to hear your experiences or predictions in the comments below.

In his now legendary launch presentation of the first iPhone, Steve Jobs said:

Today we’re introducing three revolutionary products of this class. The first one is a widescreen iPod with touch controls. The second is a revolutionary mobile phone. And the third is a breakthrough internet communications device.

So, three things. A widescreen iPod with touch controls. A revolutionary mobile phone. And a breakthrough internet communications device. An iPod. A phone. And an internet communicator. An iPod. A phone. Are you getting it?

These are not three separate devices. This is one device.

It probably took most of us some time to really get it. But now we're getting it. And it's not just three separate devices which the iPhone is replacing, it's dozens of devices.

Bon appétit.

The 3rd DO for SaaS startups – Create an awesome product

With some delay I'd like to continue my little series:

3rd DO for SaaS startups

Create an awesome product

This one is a little tricky. Firstly because it feels like I'm just stating the obvious – who doesn't want to create an awesome product? Secondly because it's hard to offer a lot of useful advice in a blog post on a topic which shelves of books have been written about. But a series on the DOs for SaaS startups would be incomplete without at least one DO about the product I and will focus on a few aspects that I personally feel strongly about.

As mentioned before, I'm going to assume that you want to build a modern SaaS solution for the "Fortune 5,000,000". This most likely means that you won't have a field sales force and that you're going to use a low-touch online sales model instead. What implications does this have for your product?

The entire user experience – from the first time the user visits your site to the moment he signs up for a free trial, through the onboarding and the exploration of the product and further on – needs to be completely frictionless. It should be designed with the same mindset that designers of online shops have, e.g. when they design a checkout process: Any little thing that doesn't work flawlessly, anything that may make the user doubt can kill a few conversion percentage points.

If your product is complex, and chances are that your product will have significant complexity at least from a new user's point of view, hide a big part of the complexity from the new user and give him or her a way to gradually discover it. When you have the user's attention, you have to fight to keep it against a million possible distractions. Make the learning curve as smooth as possible and give the user as much gratification along the way as possible. The masters of this discipline are designers of games that teach the game to new users in many small steps, meticulously making sure that it never gets too difficult nor boring, giving the user lots of little gratifications along the way.

Speaking about games, I think this is how product discovery looked like in the old enterprise software world:



Poor Mario is faced with an insurmountable barrier, and it takes the vendor's sales and support team (those little guys on the right) to pull him up that mountain, which means lots of money and time spent on sales, setup and training – and a lot of time and reasons for Mario to give up before reaching the flag.

Contrast that with new world of self-service, low-touch sales SaaS:



The big barrier has been torn down, and the way to the required understanding of the product is paved with several "aha" moments (those little trampolines which help Mario jump to the next step). *

Online shops, games, instant gratification, gradual discovery – by now you can probably guess the bigger theme that I'm heading at: The consumerization of enterprise software. The consumerization of enterprise software means that the way enterprises buy software is changing. Keep that in mind – you're not developing a product for IT professionals (unless you are offering a product to the IT team) who are super tech savvy and will make a choice based on a feature matrix. Your product will be used by marketing, sales, HR, support or finance people or founders or managers of small businesses – whatever the case may be – and your product must be easy enough to use so that a typical member of your target group can come to your site, start a trial and see the value of your product with little to no intervention from your company.


_________________________
* Thanks to Roan Lavery of FreeAgent, whose presentation at out recent SaaS Founder Meetup was the inspiration for the images above.

Yummy, dog food! Or: Running a VC fund in the Cloud

Point Nine not only loves animals, we also love dog food. After all, some months ago we invested in ePetWorld, which runs hundeland.de, a fast-growing online shop for dog food and supplies. Today I'm going to talk about a different type of dog food though.

If you know us a bit you'll know that we talk a lot about the Cloud. In our opinion, the move of software from the desktop or local servers to the Cloud, along with the consumerization of enterprise software and other developments that go hand in hand with it, truly is a revolution. Like in any revolution there will be casualties, in this case incumbents that aren't fast enough to adapt to the new realities, but fortunately it'a a peaceful revolution which only puts bad UIs, overpriced software maintenance contracts and "call us for a demo" websites under the guillotine. And like in any revolution there will be new rulers – startups that drive the Cloud revolution and attract tens of thousands of customers within few years. Our goal at Point Nine is to find some of these revolutionaries at an early stage and back them on their way from the bottom to the top.

Back to the dog food. We run Point Nine mostly using Cloud apps, and it tastes pretty darn good. I wrote about the idea of going "Office free" about seven years ago. Today we're using Google Drive (plus Basecamp) for 90% of our documents and spreadsheets, and ironically that's not because Google Documents and Google Spreadsheets are particularly good products. In fact I think they are pretty bad, and I'm amazed how slowly Google has been developing them if you consider that they were launched many years ago already. But the fact that Google makes it dead simple to collaborate on documents and spreadsheets, this one USP over desktop software, is such a compelling argument that we happily accept all of the products' shortcomings (makes me wonder, by the way, if there could be an interesting opportunity in building a better online version of Word and Excel).

While we're heavy users of Google Docs, Google Spreadsheets and Basecamp, by far the most important application for us is Zendesk ¹, which we use for deal-tracking ². It's our life blood, and I don't know how we'd survive without it. While Zendesk has of course been built for a different use case – customer service –, and Mikkel might kill me if he sees how we're using Zendesk, it turned out that because of its adaptability it works perfectly well for our needs. For us, every new potential investment becomes a "ticket", and we use Zendesk from our first encounter with a new company through the entire assessment of the deal up until we either decide to pass (about 99% of the time) or to invest (about 1% of the time, in which case Basecamp takes over, since we set up a Basecamp project for every investment to collect updates, notes, etc).

Here are some of the great things that Zendesk allows us to do:

• Every email that we receive at submit@pointninecap.com is automatically turned into a Zendesk ticket and gets assigned to Fabian, with the stage automatically being set to "evaluating". Fabian and Nicolas then do some initial research and add things like slides, spreadsheets (ouch, you got me) or call notes to the ticket. Once Fabian and Nicolas have made up their minds they assign the ticket to Pawel or me and set the stage to "Recommendation: Evaluate further" or "Recommendation: Pass". This makes the ticket appear in the respective view/filter for Pawel and me.
• It happens very often that we talk to a startup which looks interesting but isn't ready for an investment yet. Zendesk makes it easy to keep track of these opportunities. We simply set the stage to "Follow-up in 3 months" or "Follow-up in 6 months". After three or six months, Zendesk automatically sets the stage to "Take another look" and sends us an email notification.
• Zendesk makes it easy to stay up-to-date on everything since you'll get an email notification whenever a ticket is updated. You can reply directly to those emails to add comments to the ticket (as well as create new tickets by emailing them in), plus there are great apps for the iPad and the iPhone, so it's convenient to work on tickets on the go.
• Finally, you can use tags or custom fields to collect additional information about tickets. We are, for example, tracking deal sources and company locations, which is helpful for analyses that we're going to do in the future.

Bye now. I still have a bunch of open tickets in my queue. :)


¹ In case you don't know yet: Disclosure, I'm an investor in Zendesk.
² Dear founders, sorry to call your startup a "deal". That's VC speak and I hope it doesn't sound too disrespectful.

The 2nd DO for SaaS startups – Build the right team

Continuing my little series using the "minimum viable" approach, here is my

2nd DO for SaaS startups:

Build the right team

I've written about the topic before, so if you've read this post from early this year most of what I'm going to write now won't be new for you and you may want to skip this article.

I'm going to assume that you want to build a modern SaaS solution for the "Fortune 5,000,000" – a great product that's easy to understand and so useful that it will almost sell itself. If your plan is to create a bloated piece of enterprise software with an ugly interface and make it up by hiring a large field sales force from the get-go you might succeed as well, but in that case please don't ask me for advice. :)

Let's start with the founder team. If you want to build a great SaaS product that's (relatively speaking) easy to market and sell you will need

• domain expertise, 
• UX/UI talent, and 
• a great engineer who can code the application. 

The reason is obvious, you need to understand the problem that you are solving for your target customers, you need a product that looks good and feels good and can be sold online and last but not least, to say it how Dave McClure would probably say it, you need someone to get sh*t done. :) If you're a genius you might combine all of these threes qualities in one person, but it's more likely that you'll need a founder team of two or three persons to cover all three areas.

What if you don't have that SaaS founder dream team – a CEO with domain expertise, a great CPO and a rock-star CTO? If you're only missing the domain expertise that may be comparably easy to acquire. In many (but certainly not all) markets you can probably learn a lot of what you need to know within a couple of months. If you don't have product and engineering knowledge that's tough. In my opinion you absolutely have to have this in the DNA of your company. Don't even think about outsourcing product design or engineering to an agency, I can almost guarantee you that it ain't gonna work. So if your founding team consists of five MBAs who've never built a product before, don't start a SaaS company, build an eCommerce business instead (there's nothing wrong with that either).

What comes next? The first hires after the founder team usually are, in this order:

• Developers (get even more sh*t done)
• Someone for customer support (in the beginning the founders should do customer support themselves in order to stay as close to the customer as possible, but at some point you'll need more manpower to deal with customer questions and support issues. Your customer support person will also likely act as your first inside sales person who helps converts trial users into paying customers.)
• One or more inside sales people (to maximize the conversion of your inbound leads)
• A marketing person (depending on a variety of factors, this person can also come in before the first sales person)

With the exception of the developers (arguably), these hires can all be pretty junior people – young, smart, hungry people that learn fast. Later in the game you'll need people with a lot of experience, for example for the VP Sales role. But for most positions, most of the SaaS CEOs that I've talked to have a strong preference for "raw talent" and people with the right attitude.

PS: As you know, this whole series is, and will continue to be for some time, a work-in-progress. Any comments or feedback is very welcome!

1st DO for SaaS startups, continued

Further to my post about my "1st DO for SaaS startups" (and again, in the spirit of releasing early and iterating fast) I'd like to touch on a few additional points with respect to the right market.

Market size

• If you want to go big and build a large, successful company it's obviously important that your market is big enough. How big is big enough? Most large VCs would answer that the TAM of a SaaS company should be at least $1B. The thinking is, if it's a $1B market and you grab 5-10% of it and get a revenue multiple of 5-8x, the company will be worth $250-800M at exit. This is where large VCs start to get excited. 
• We as a small early-stage fund are a little more modest but we also want to see a clear potential for a $100M+ exit, which means there needs to be a clear potential to get to at least $10-20M in revenues. If you assume 5-10% market share, that means the TAM should be $100-400M at the minimum.
• Note that by TAM I mean your primary market. If there's potential to expand into new products or geographies that's great and can be a big plus, but given the uncertainty of these expansions it's important that your primary TAM alone is big enough.
• Can't you target a smaller market but aim for much bigger market share? The general thinking is that it's much easier to get to, say, $50M in revenues in a $1B market than in a $200M market. My gut tells me that's right, but it would be interesting to see some real data on this question.
• Note that I'm answering the question from my biased VC perspective. There are plenty of opportunities to build very respectable companies in smaller markets or niches. They just may not be VC-fundable – which can be completely fine if you don't need that much capital and if your competitors don't get VC funding either.

Fortune 500 vs. Fortune 5,000,000
Should you go after the Fortune 500 or the Fortune 5,000,000? At Point Nine we're big fans of the latter. To some degree that's just a personal preference. We don't have expertise in enterprise sales and we just love consumerized, low-touch sales SaaS businesses. Some of the most valuable software companies have been built based on the enterprise sales model (including SAP, probably the most successful high-tech company coming out of Germany in the last 40 years) and maybe that's still possible. It's just not our thing.

Here are a few of the reasons why we like targeting SMBs:

• You need less time and money to get a first version to the market. The lean startup approach doesn't work well for enterprise software as you need to invest much more money into product development and sales.
• When you develop for enterprise clients there's a risk that you become a victim of the law of small numbers: You develop your product based on the requirements of a handful of pilot customers but you don't know if the rest of the market has the same needs. When you target SMBs you'll develop and iterate your product based on the needs of a much bigger sample size.
• The same goes for the sales side: Because you're dealing with small numbers it's easy to draw wrong conclusions. For example, you may think that you have a great CAC/CLTV ratio and all you have to do is hire more salespeople whereas in reality you just had luck with a few good customer wins.
• Customer acquisition is much less sales-driven, which means that you need less capital and that you can grow faster.
• And finally, starting with SMBs doesn't prevent you from going upstream over time. As your product becomes more and more robust and you understand the needs of bigger clients better and better you can target increasingly bigger customers. Much better than doing it the other way round since it's very hard to take an enterprise product and strip down features to make it usable for SMBs.

Horizontal vs. vertical

• The advantage of a vertical product, i.e. a product made for a particular industry, is that you know exactly who your target customers are. That makes it much easier to find out the precise needs of your target customers and also makes your marketing efforts easier. The downside of a vertical product is that your niche might not be very large and you might struggle to expand into other verticals.
• For horizontal products it's usually the other way round: Bigger TAMs, but it may not be obvious who the first adopters of your product are and it's harder to reach potential customers in a targeted way.

DOs and DON'Ts for SaaS entrepreneurs – #1

I've been thinking about a "DOs and DON'Ts" article geared towards early-stage SaaS founders and upcoming SaaS founders for a little while now. I thought it would be a good idea to summarize what I've learned about SaaS in the last few years and put it into a format like this. Problem is, it's a very large topic, and if I try to make it as broad, deep and well-written as I'd like it to be I'll never do it. I don't have sixkidsandafulltimejob.blogspot.de like Benchmark's Michael Eisenberg, but three little kids, about 25 angel investments and Point Nine keep me pretty busy too.

So what I'm going to do now, I'll apply Eric Ries to blogging, and in the spirit of release-early-and-iterate-fast I'll just get started with something. It's an experiment and I don't know yet what the result will be – how many DOs I'll end up with and if I have enough time to work on the series in a timely manner at all. But Reid Hoffman said that if you're not embarrassed by the first version of your product you've launched too late, and hey, no one is forcing you to read this crap. :-)

So...my first MVP are some thoughts on what I'll call...

The 1st DO for SaaS startups

Choose the right market

Some entrepreneurs will find this statement awkward because they don't feel like they've chosen a market. Some founders use a very systematic and analytical approach and evaluate a number of ideas first, but others just have an idea (or just happen to have domain expertise in a specific area) and get started without too much analysis and without ranking the idea against other ideas. There's nothing wrong with pursuing the first idea if you're really convinced of it and I'm sure that some of the biggest success stories began that way. But I do think that generally it makes sense for founders to do some due diligence on their idea, at least before committing the next years of your life and maybe your savings to it.

So how does an attractive SaaS market look like? Simply put, an attractive market allows you to provide:

• a painkiller solution
• to a large number of companies
• whose needs aren't adequately served by the incumbents

Additional aspects which make your market even more attractive:

• Plenty of opportunities to increase your TAM (total addressable market) by broadening the product offering, moving upstream or going into adjacent markets.
• Chance to realize network effects, to become a platform or to create a data asset.
• Most of your target customers are still using old-school desktop solutions or make do with a combination of generic applications like Outlook, Word and Excel.

A great example are web-based accounting apps: Every company must do their accounts and desktop solutions suck. Voilà, a painkiller solution for a large number of companies whose needs aren't adequately served by existing products. The category also scores well on the bonus points above:

• Let's say you start with an invoicing app for small businesses. That alone is a sizable market, but it's also a great starting point to move into accounting and payroll, as well as to gradually target bigger customers over time.
• There's also potential for network effects (think e-invoicing between your customers), to become a platform (for a variety of adjacent apps) and to create a data asset (e.g. benchmarking data), which all helps to make your position more defensible and gives you pricing power in the long-term.

To be continued!

A PS on grandfathering

If you've read my last blog post I still owe you a small PS. I mentioned that while I was writing the post I've learned two surprising things, so here goes. (Caveat: I usually try to provide some useful advice in my blog. What I'm going to write now doesn't have any practical value so feel free to skip it.)

Number 1: 

Do you know where the term "grandfathering" comes from? Maybe it's just my illiterateness and you're yawning but I had no idea that the term, which describes such a nice thing in the context of business and politics today, goes back to such a horrible concept:

The concept originated in late nineteenth-century legislation [...], which created new literacy and property restrictions on voting, but exempted those whose ancestors (grandfathers) had the right to vote before the Civil War. The intent and effect of such rules was to prevent poor and illiterate African American former slaves and their descendants from voting, but without denying poor and illiterate whites the right to vote.

(Source: Wikipedia)

Number 2:

I initially thought that the lower your churn rate is, the tougher it will feel for you to offer generous grandfathering. My thinking was: If you have a low churn rate and therefore a long customer lifetime, you're giving up a lot of incremental revenues by not increasing your prices for existing customers. If on the other hand you have a high churn rate you can more easily do without the price increase because you're existing customers won't stick around for a long time anyway.

Turns out this isn't true, at least if you expect churn to be constant – and if you're interested in the relative importance of the aforementioned incremental revenues as part of your total revenues (if you only care about the absolute dollars that you might be giving up, my original assumption is of course correct). If you take a look at this Google spreadsheet (let me know if you'd like to get the Excel version) you'll notice that the  relevant revenue portion that we're talking about (revenues from Group A customers due to pricing increase, cells E22-G22) is almost completely insensitive to changes in churn rate (cell B10)!

Look at cell G22 in the spreadsheet, which shows the revenue portion that you give up by offering grandfathering for year 3. If your churn rate is 1% p.m. that percentage is 7.35%. If it's 3% p.m., the percentage goes down to 7.22%, almost no change. And if your churn rate is 5% p.m., again almost no change to that percentage (7.08%). The reason is that revenues from your new customers ("Group B customers" in the model) are affected by your churn rate as well, and that effect almost completely offsets the effect of your churn rate on your existing customers with respect to the question that I was talking about. If you think about it, it's logical, but my original intuition was wrong.

The Case for Grandfathering

If you're running a SaaS startup it's likely that sooner or later you'll want to increase your prices. The reason is simple: It's impossible to find the perfect pricing right off the bat, so most startups launch with a pricing scheme that's on the low end to make sure that they don't scare away potential customers. "In the beginning, err on the side of being too cheap", was also one of the tips that I gave in my previous blog post about SaaS pricing.

Now let's say 12 or 18 months have gone by, you've acquired your first couple of hundreds of customers, you've added lots of features and made your product better and better. By now you also have a better feel for what your customers are willing to pay, maybe supported by A/B tests with different prices or customer interviews, and you want to increase your prices. 

There are a number of questions that you'll have to answer: Do you want to keep the pricing model and just increase the amounts or do you want to change the structure of the pricing – axes, plans, limitations – as well? How much do you want to increase prices by? Are you introducing new features or editions that justify a pricing increase or are you going to increase prices for the existing offering?

In this post I want to focus on just one question: Should the new, higher prices be applied to your existing customers as well or should their plans get grandfathered?

At first you might be tempted to increase prices for your existing customers. They like your product and are used to it (and will incur "switching costs" if they switch to a different product), so most of them probably won't leave even if they are not thrilled about the price increase. The additional revenue from the higher prices will probably more than offset the revenue that gets lost due to some customers who leave. So increasing prices for your existing customers promises to give you an immediate, maybe very significant revenue bump.

In spite of this I want to argue that if you take a long-term view grandfathering your existing customers is almost certainly the better choice. (At least if you're a fast-growing early-stage startup. If you're a big company in a saturated market things may be different, but then you're most likely not reading this post anyway!)

The main reason for grandfathering existing pricing plans is that it just doesn't feel right to attract customers, get them used to and maybe even locked into your product and then demand more. Unless the pricing increase is very modest or your customers all agree that the old price was way too low relative to the value of your product, this will almost certainly upset a significant percentage of your customers.

However, the reason I want to focus on is mainly a mathematical one and is related to the effect of fast growth. It also doesn't require you to think much about business ethics as I will argue that grandfathering is also better for you, not just for your customers. :-)

Take a look at this Google Spreadsheet. 

Let's say your customer churn rate is 2.5% per month, your customer growth rate is 5% per month and you're planning a price increase of 50%. Based on these assumptions, by year 3 after the pricing increase the additional revenue that you get from not grandfathering your pre-price-change customers (named "Group A" in the spreadsheet) will – maybe surprisingly – account for a mere 7% of your total revenues. Here's how it looks like on a chart:

This does not yet include the effect of cancelations due to the price increase! If you assume that you will lose 5% of your existing customers due to the price increase (see the second scenario in the spreadsheet), the net revenue gain of not grandfathering has shrunk down to less than 2.5% by year 3, and by year 4 the gain will have turned into a net revenue loss:

If you're assuming a higher cancelation rate that will obviously happen even earlier.

You can download the Google Spreadsheet to play around with the assumptions (or let me know if you want the Excel file via email, in that case you'll also get the charts which didn't survive the Excel => Google conversion). It depends on your assumptions if and when the positive effect of not grandfathering will reverse itself, but unless you're not predicting much growth it won't take very long until the additional revenue will have become a pretty insignificant factor.

Importantly, I have not even taken into account the potential negative effect which not-grandfathering might have on your future growth rate by reducing referrals from your existing customers and generally by losing goodwill in your target audience (whereas generous grandfathering could motivate your loyal customers to give you even more referrals than before). These effects are hard to measure but I'm sure they exist and if you keep them in mind the decision will be even clearer.

Finally, if you agree with the above, consider creating a "Customer Bill of Rights" which, upon signup, explains to customers how you're going to deal with pricing increases in the future. I think I've never seen this on a signup page but I'd be curious to find out whether this would have a positive effect on conversion rates.

PS: While writing this blog post I learned two surprising things (surprising for me, at least). More on that soon. :)