Xero visits Dr SaaS

A few weeks ago Xero released their latest interim report for the six months ended 30-Sept.

I thought it would be interesting to plug these results into Dr SaaS, to see what the diagnosis shows us about how they are tracking.

Most of the details we need are in the report which is available on the investor centre section of the Xero website.

Revenue

There were 371,000 subscribers at 30-Sept, and total operating revenue of $54.295m. They report average monthly customer churn of 1.3%.

Starting with 284,000 subscribers at 31-Mar (from the previous annual report) they added 87,000 new subscribers net. So, if we assume a churn rate of 1.3% that works out to be ~109,200 new acquisitions offset by churn of ~22,200 subscribers.

xero-revenue

Based on these values Dr SaaS calculates growth of 3.91% per month, and and ARPU of just over $27 per subscriber per month (which is slightly less than the $29 value they include in the report).

Dr SaaS also estimates the average tenure of a new subscriber to be approximately 53 months, or nearly 4.5 years, which is pretty sticky! If you’re interested there is more information available about how Dr SaaS estimates tenure.

Profit

Next, we split out the acquisition and service costs. This is all done for us in the report – the total “cost of revenue” was $18.016m and “sales and marketing” was $38.329m.

xero-profit

Based on these values Dr SaaS breaks that down as $165 per new subscriber and just over $19 per month to service each subscriber. The profit margin is calculated to be 17.86%, which is to be expected given the focus on investing in growth.

Runway

To calculate the runway we need to also include the other revenue and expenses that don’t relate directly to subscribers.

Again the report includes all of the details we need – “other income” was $1.48m (this is a combination of government grants and rent received), “interest” was $4.128m and “other expenses” were $27.35m (mostly the cost of software development etc). The cash balance at 30-Sept was $170.8m.

xero-runway

Based on these values Dr SaaS calculates the break-even point (based on the current burn rate) to be around 944,000 subscribers. The runway is just over 43 months (again, based on the current burn rate).

Diagnosis

Based on all of this Dr SaaS gives Xero a pretty good diagnosis:  “you’re bleeding a little, but you’ll survive”.

Overall the lifetime value per subscriber is positive – total revenue per subscriber of $1428 offset by acquisition costs of $165 and service costs of $1008, leaving a gross profit of $255 per subscriber.

xero-diagnosis

You can see the full summary here:

https://drsaas.md/businesses/32ab60cf19806530ac33/diagnosis

This is obviously a pretty rough and inaccurate analysis. To do this properly you’d want to understand a lot more detail about growth and performance in each of the different markets where Xero operates, as well as the trends in terms of ARPU, churn, and acquisition costs for different channels etc. However, as a quick exercise it’s useful to give a high level overview.

You can try Dr SaaS for yourself, using either your own numbers, or (if you just want to have a play) using the public details from one of many listed SaaS companies. Hopefully going through the process will teach you a little about the SaaS business model.

http://drsaas.md

We’d love to hear what you think.

The Goat

This weekend I raced The Goat, which is a ~20km mountain run from Whakapapa to Turoa, along the western slopes of Mount Ruapehu.

It’s a beautiful but brutal course – a lot more scrambling, scree, and rock climbing and a lot less packed trail than I had mentally prepared for. I managed to get around with only one face plant and tagged knee. The last 5km climbs from 1233m at Mangaturuturu Hut to 1624m at the ski field finish, including the final 2km “mamas mile” up the road, by which point everybody was looking pretty broken.

I was stoked to finish in 3h 11m, in 135th place overall. The data file from my watch recorded 1163m of vertical ascent (and 2402 calories burnt, yo!)

I don’t normally bother with official race photos, but this one taken half way up the famous “Waterfall” was just too good to pass up:

The Goat 2014

If you look closely you can see there is one small spot on my shirt which isn’t soaked in sweat. It took me a while to work out this is just the thick part of my heart rate monitor strap.

More photos:

It’s a great event, and I throughly recommend it to you.

There are only 600 places available each year, so keep an eye out for registration for the 2015 race soon!

 

The Quiet Ones

In 1997 Apple launched a new advertising slogan: Think Different, celebrating the crazy ones like Picasso, Gandhi, Einstein and others. In hindsight this may have been the turning point, as they recovered from being lost and near bankruptcy to become one of the largest and most iconic companies in the world.

In 2010 Derek Sivers gave a great short TED talk, called How To Start A Movement, about the importance of first followers. As somebody who has never really started anything of note, but has been lucky enough to be an early follower a few times now, I was encouraged and inspired.

This is my juxtaposition of the two: Here’s To The Quiet Ones

Please share this, using the hashtag: #QuietOnes

These are the people featured in the video, many of whom are my heroes:

This is the text of the voiceover:

Here’s to the quiet ones.

The co-founders, the assistants, the collaborators.

The round pegs in the round holes.

The ones who see things as they are.

They work behind the scenes, helping the crazy ones with their rough edges.

You can overlook them, disregard them, trivialise or underestimate them.

But as you ignore them they quietly get on and change things.

They push the human race forward.

And while some may see them as the quiet ones,

We see genius.

Because they are the people that know that what matters most is what you achieve,

Not who gets the credit.

Enjoy!

Estimating Tenure

The key number that Dr SaaS needs to calculate in order to diagnose your SaaS business model is average tenure, or, if you prefer, the life expectancy of a new customer when they subscribe to your service.

To calculate the lifetime value of a customer (LTV) you just need to know how much you earn on average from them each month (ARPU), how much it costs you on average to acquire a new customer (CAC), how much it costs you on average to service a new customer (CTS) and how long you can expect them to remain a customer (Tenure). ARPU, CAC and CTS are all easily derived from your financial statements. But, tenure is not so straight forward.

The way this is typically calculated is using the current churn level, which is the rate at which existing customers currently cancel:

Churn = Cancelled Subscriptions / Total Subscribers

For example, if you have 500 subscribers and 12 cancel during the month, then your churn rate is 2.4% per month.

Then:

Tenure = 1 / Churn

For example, if your churn rate is 2.4% then your average tenure using this formula is just under 42 months (or 3.5 years).

This sort of makes sense: if you have 12 cancellations every month then after 42 months all 500 subscribers will have cancelled.

However, in practice this approach often ends up over estimating the actual tenure, as Jason Cohen (aka A Smart Bear) explains in his great blog post on this topic:

“It’s impossible to see ahead to timeframes beyond a few years for a young company and perhaps 4-6 years for a mature one. In those timescales you expect drastic changes in market conditions — a strong new competitor appears or dies, the economy slumps or soars, a disruptive technology changes the landscape, etc.

That in turn will cause material changes in pricing, retention rates, reorganized customer segmentation, usage levels, service levels, and so forth.

Computing expected months with the ad infinitum approach leads you to over-estimate the total revenue you can depend on.”

This skew is especially evident if your churn rate is low as the inverse value increases rapidly at this point:

Alternative Tenure Calculations

So, what to do about this? Jason suggests two alternative approaches – either capping the number of months or using a discount rate.

Tenure = 1 / (Churn + Discount)

This option does product lower estimates of churn when the churn rate is low (and as he points out who cares about what it does if the churn rate is very high, as in that case you likely have much greater problems to deal with than what tenure formula to use!)

Alternative Tenure Calculations

In Dr SaaS we use a third option which gives values somewhere between these two extremes when the churn rate is less than 2%, but lower values when the churn rate is higher.

Tenure = ln(0.5) / ln(1 – Churn)

While this looks complicated, it’s just using the churn rate to work out how many months it takes before half of the new customers in a given cohort have cancelled.

Consider the example above, where tenure is estimated to be 29 months (compared to 42 months for the simple formula):

Month 0: We start with 500 subscribers
Month 1: 500 * 2.4% = 12 cancellations, leaving 488 subscribers
Month 2: 488 * 2.4% = 12 cancellations, leaving 476 subscribers
Month 3: 476 * 2.4% = 11 cancellations, leaving 465 subscribers
Month 4: 465 * 2.4% = 11 cancellations, leaving 454 subscribers

Month 28: 259 * 2.4% = 6 cancellations, leaving 253 subscribers
Month 29: 253 * 2.4% = 6 cancellations, leaving 247 subscribers

At this point, 50% of our original 500 subscribers remain, so we take this as our average tenure.

You can see how this looks on the graph:

Alternative Tenure Calculations

If you want to try this out with your own subscriber numbers, check out Dr SaaS:

http://drsaas.md

What do you think?

How are you currently calculating tenure? How does it change your results if you use this formula instead?

We’re interested to hear any suggestions.

Dr SaaS Demo

I want to walk through an example of getting a diagnosis for Dr SaaS, to show how easily you can do this for your SaaS business, and what sort of analysis you can expect to get out of it.

To get some numbers to use for this, I’m using the Demo Company which is available in Xero (if you’d like to play along at home, log into Xero and look at the bottom of your My Xero page for a link to your own copy of the Demo Company).

For the purposes of this demo I’ve changed two of the accounts to better match the sort of expenses you might have in a small SaaS business: “Subscriptions” is now “Staff Costs” and “Rent” is now “Hosting”, otherwise the data is straight out of the box.

Step 0: Getting Started

Visit http://drsaas.md and click the big orange button on the homepage:

step0a

Enter your name and email address, and you’re underway:

step0b

Enter your company name and select the period you wish to analyse. In this case I’m going to use the details for the last quarter ending Sept ’14:

step0c

Step 1: Revenue

This step collects details about subscribers and revenue, and calculates growth, churn and average revenue values.

We will need to make up the subscriber numbers, as there are no details about this in Xero. When you’re doing this yourself, you can get your subscriber numbers from your customer database or billing system.

Firstly, enter the number of subscribers you have at the end of the period. This should include both free and paid subscribers, if you have both. We will say 598 subscribers at 30 Sept.

Secondly, enter the number of new subscriber you acquired during the period. This should count every new subscriber who joined during this time, even if they have already cancelled. We will say 186 new subscribers between 1 July and 30 Sept.

Thirdly, enter the number of cancellations during the period. We will say 98 cancellations between 1 July and 30 Sept.

At this point we already have our first metrics calculated, showing the growth rate, churn rate and average tenure:

step1a

Finally, enter the amount of revenue received during the period. To get this you need to open Xero and run the Profit & Loss report:

step1b

The revenue number is shown at the top. If you have other revenue you should only count recurring revenue from subscribers at this stage (other revenue will be entered separately in Step 3 below).

In our example, there are sales of $13,733 showing in the P&L, so we enter that value here.

This then calculates the fourth metric on this page, the ARPU or average revenue per user. This is the amount you earn on average from each subscriber each month:

step1c

Already we have some useful information – the growth rate is 4.91% per month, which is okay, but churn is 6.41% which is very high and means that on average each new subscriber only sticks around for just under 10.5 months, on average we earn $8.05 per subscriber per month, which doesn’t leave a lot to play with.

Step 2: Profit

This step collects details about how much we spend acquiring and servicing subscribers, and calculates our cost of acquisition, cost to serve and also profit margin.

Before you can complete these inputs you need to split the various costs showing on the P&L report into three categories:

  1. Acquisition costs – i.e. all sales and marketing costs, commissions, discounts and related staff costs.
  2. Service costs – i.e. all support and hosting costs, payment processing and related staff costs.
  3. Operating costs – i.e. everything else! (note: we will enter these costs in Step 3 below)

In our example, we will treat “Advertising”, “Entertainment” and “Printing & Stationary” as acquisition costs, and “Hosting” and “Telephone & Internet” as service costs. We will also split the “Staff Costs” into thirds and say one third of this amount is spent on acquisition and one third on servicing subscribers. It can help to get out your highlighter at this point, to keep track of which expenses you have entered:

step2a

Those add up to $2209 and $1531 respectively, so we enter those values here:

step2b

You can see from the bubbles at the bottom that we’re currently spending $11.88 to acquire each new customer and 90c per month to service them, which leaves a profit margin of 74%, which isn’t bad. But, again, the problematic value which is highlighted is the cost of churn, which is the effective amount spent each month to overcome churn – i.e. we currently spend 9.45% of all of the revenue we earn each month to acquire new subscribers to replace those subscribers who churned.

Step 3: Runway

This final step collects the remaining details about expenses, and also how much cash is available to cover these expenses, to calculate a burn rate, breakeven target and cash runway.

Firstly, we enter the details of other revenue and other expenses not already included above:

step3a

From this we can see that the calculated breakeven target is 118. This shows how many subscribers are required in order to cover all of the operating costs and other costs, given the current business model. In our example, this is good news as we already have more subscribers than this.

However, we have not yet considered the other costs which are not included in the P&L, such as capital expenses, capital raising costs, and tax as well as foreign exchange movements. To get these we will need to look at the Cash Summary report in Xero, which shows that during the period we spend $1652 on computer equipment, so we enter that here.

Finally, we need to look at the cash on hand in the Balance Sheet report in Xero.

In our example, the bank account has $16,666 at 30 Sept:

step3b

At this point we get the calculated burn rate and runway. In our example the burn is negative, so the runway is effectively infinite, but assuming you’re not yet making a profit these values will show how much cash you burn each month and how many months you have left assuming current burn rates.

Step 4: Diagnosis

That’s it. We’re done!

The final page shows the summary diagnosis:

step4a

This graph can be a bit confusing at first, but is actually simple. It shows the lifetime value per subscriber.

The green revenue bar, on the left, shows the total amount of revenue you can expect to earn from a new subscriber on average. In our example, this is $84.29. The value is based on the average tenure of a new subscriber (derived from churn rates) and the average revenue per subscriber.

The two red bars in the middle show the cost to acquire and cost to serve, again over the lifetime of the subscriber. In our example these are $11.88 and $9.40 respectively.

The bar on the right shows the remaining gross profit – i.e. revenue less costs. If you have a profitable business model then this bar will be green, as in the example above. Otherwise this will be red, meaning you are effectively losing money on every new subscriber!

Below this is a brief description of your unit economics. This will be customised to the values you have entered:

step4b

The second part of the diagnosis highlights specific metrics which are relevant to your situation. In our example, it shows the gross profit value of $63.02 and growth rate of 4.91%, which are both positive, and also highlights the high churn rate of 6.41%. Again, the metrics that are displayed are different for each company, depending on the values that have been entered and the things you should be focussing on.

From this page you can choose to save the diagnosis, which allows you to share details with others on your team, enter multiple months to keep track of the full history, and setup a goal for one of your metrics that needs focus. You can also enter values for multiple businesses and switch between them easily – great for people like me who spread their time across multiple companies.

Please, try it out for yourself now: http://drsaas.md

We’d love to hear how you get on.

Enjoy!

 

Dr SaaS

Make your appointment now

How do you know if your SaaS business is healthy?

You need to start with the unit economics, which are the key to understanding how you will (or won’t!) make money.

At Southgate Labs we’ve had the opportunity to work with a number of growing ventures, and one thing they all have in common is that keeping on top of the maths is hard work – the calculations are confusing, it’s hard to even find a consistent formula, and a lot of what is written about this stuff is pretty dense and academic, plus there is a long list of different metrics to calculate.

All of this makes it hard to know if the business is growing well or not. So, we decided to build a tool to try and make this all easier. It’s called Dr. SaaS, and you can find it here:

http://drsaas.md

It asks you to enter some information about your subscribers, revenues and expenses, and then does all of the maths for you. All of the details are explained in plain English, so you can get started quickly and easily. And, once you’re done, a diagnosis is generated based on the information you enter, highlighting healthy areas, and also areas where there’s room for improvement. It gives you an honest assessment – if things are not healthy this will help you identify the problems early and make the changes that are needed. And, once done, you can also share the details online and invite others to view the diagnosis – it’s a good way to quickly share a snapshot of your progress with your team, your advisors and your investors.

For example, check out this diagnosis of the mythical Dobalina Inc, as an example.

We’ve been using Dr. SaaS ourselves, in various forms, for a while now, so it’s good to finally launch it for you to start to use today.

Please try it out, recommend it to others, and let us know what you think so we can make it better.

How does this work?

To understand your unit economics you need to answer three questions about your venture:

1. How much does each customer pay?
2. What does it cost to get a new customer?
3. What does it cost to provide your product or service?

Then, once you know those values, you can think about what it would take to have a profitable venture:

4. How many customers are needed to cover your fixed costs? (the break-even point)
5. How much cash do you need to get to that point?

In a traditional business model this is all reasonably straight forward – when you make a sale the revenue and the costs of goods sold are normally obvious, so all you are left to do is divide the amount spent on sales and marketing by the number of sales made to get an average cost of acquiring a customer, and you already have a pretty good picture of the health of the business.

However, with a software-as-a-service business model, where customers are paying a monthly or annual subscription, it quickly gets much more complicated. In order to calculate the revenue from a new customer, you need to know not only how much they pay, but also how long they are likely to remain a customer. Likewise, to determine what it costs to provide the service, you need to consider the total cost over the whole time they are a customer.

To complicate this even more, there is a long and confusing list of metrics used:

ARPU = average revenue per user (or customer!), normally per month or per annum
Churn = the rate at which your existing customers cancel their subscription (sometimes also expressed in terms of tenure, or life expectancy of a customer)
CAC = average cost of acquiring a new customer, ideally including all sales and marketing staff costs
CTS = average cost to serve, again ideally including all customer support staff costs (sometimes also called COGS or cost of goods sold), normally per month or per annum
LTV = expected lifetime value of a customer
Burn = the amount of cash you spend each month
Runway = the amount of time you have left before you run out of cash, given your current burn rate

Dr SaaS has been designed to cut through all of this. You only need to enter your subscriber numbers (i.e. how many subscribers you have, how many new subscribers you added in the last month and how many subscribers cancelled?) and some details from your accounts about how much you earned and how much you spent (i.e. how much did you spend acquiring new customers, how much did you spend supporting existing customers and how much did you receive from them in subscription revenue?) We even help with suggestions about where you look to find these numbers.

With those details we can calculate the amount of money you can expect to earn from each new subscriber. The graph will look something like this:

Average Lifetime Value per Subscriber

This shows the total revenue you will earn from the subscriber over their lifetime as a customer (the big green bar on the left), less the amount you spent acquiring them as a customer (your sales and marketing costs, including staff costs) and the amount you will spend supporting them while they are a customer (your operations and support costs, including staff costs). What’s left is your gross profit per customer the (hopefully!) green bar on the right. If you spend more to acquire and service customers than you earn from them then the gross profit will be a red bar.

Every SaaS company is different, and there is not one right answer with this stuff, but it is important that you know your numbers and then think about what you need to do to improve those as you grow.

Good luck!

Magic Dust

Realising that nobody else knows the secret formula for your venture is an important and valuable thing to learn.

Sadly, I don’t have any magic dust that I can sprinkle on any given start-up to make it successful. Nor does any potential advisor, mentor or investor, even if they promise otherwise. Not even if they have worked on something successful in the past – indeed, this often seems to create a bias, where we incorrectly assume the things we did will also be relevant to your situation.

To have any chance of contributing much of value, I would need to dig-in for a long period of time, and really get to know you and your business, and to understand your current circumstances and constraints.

This will take longer than one coffee meeting (but, thank you for the invitation).

If you think you need some help with the thing you’re starting, but don’t even know what that is, look for somebody who knows you, believes in what you’re doing and is prepared to work with you for years to make it happen. And, before you even ask them, make sure that’s true for you too.

Or, if you think there is something specific I can do to help you, please ask.