Sector Spotlight: SaaS
The performance of the software-as-a-service (SaaS) industry over recent years has made it worthy of close examination. Alongside its value growth, the sector has hit saturation points bringing an added challenge of competition to new entrants. Statistica demonstrated the sector’s impressive performance—noting its estimated worth of 145.5 billion U.S. dollars in just 2021 alone. This existing and growing mass market of providers has led to a renewed focus on differentiation and the competitive edges needed to survive.
In order to give our readership a useful glimpse into the industry, we wanted to provide two top three lists; one centered around the top 3 metrics investors are now focused on, and the second, the top 3 trends in industry best practice/innovations.
The 3 Investor Metrics That Matter Most
Investors are forever interested in the ability a company has to retain clients beyond their subscription term. Churn rates determine exactly that, a calculation revealing how many clients are not renewing upon expiry.
SaaS is an industry, which is almost entirely reliant on subscriptions, meaning that monitoring the number of clients that drop off (customer churn) as a percentage of total clients is crucial. The more important churn rate though is revenue churn, which measures the amount of revenue drop off due to customers leaving as a percentage of overall revenue.
SaaS companies sometimes make the mistake of striving for customer growth in a way to offset churn, however, this is unsustainable. When you have 100,000 clients paying $1000/year and a customer churn rate of 7%, we are dealing with $7,000,000 in revenue lost. If instead of analysing to bring down that churn, you strive to grow that client base to make up for the churn, that customer churn won’t change and the revenue loss will just continue to grow as more clients sign up.
According to Recurly, who analysed hundreds of subscription based businesses amongst multiple industries the average churn rate is roughly 5%, with the upper and lower quartiles being 8.5% and 2.9%, respectively.
Screenshot from Recurly Research
Having a clear and compelling sales cycle is important in every business. Founders should be able to establish a sales process that has an objective to potentially yield high revenues and customer satisfaction. From product pitching to retained subscription, a sales cycle will indicate and forecast a company’s success—thus helping investors gauge the best ones to be involved with.
One key success that larger industry players have displayed is the ability to have multiple pathways when it comes to sales, that is, building a SaaS offering that is attractive to a CEO, CMO, CIO, and CTO as well as other key decision makers – thereby expanding the opportunities for a sale.
When it comes to metrics, the time and conversion rate of the sales cycle in practice will be of most importance.
Annual Recurring Rate (ARR)
A good-looking ARR holistically captures the skills of those founders who are able to keep an impressive number of customers, both new and existing, engaged in their offered products or services. A well established ARR is a strong sign of self-sustenance, as well as an indication of the market demand for your product. Two things investors will need to see when it comes to any SaaS business.
Investors look at ARRs to identify if the start-up is displaying an attractive projection, this attractive projection in-turn leads to a growing valuation, and ultimately a return on investment. With SaaS valuation multiples now sitting at an average of 12X revenue, you will want to show investors projections that demonstrate the valuation growth.
Graph by Sammy Abdullah – Image source: (Abdullah, 2020)
Top 3 Market Trends in the SaaS Industry
Smart SaaS – Artificial Intelligence (AI)
The innovations linked to AI have always been phenomenal, disrupting an array of sectors worldwide. In SaaS, the role of artificial intelligence remains vital as it has been tagged as a fundamental element in the industry since being introduced and established in mainstream areas of business. AI is a consistent trend in the SaaS market that has been actively delivering grand results ever since.
According to research by Salesforce, we are in an era whereby 75% of B2B customers expect providers to predict and pre-empt their needs proactively. It is the power of pattern recognition and predictive analytics that will pave the way to this desired outcome – it is AI that holds the power to make this happen.
Specialist Mindset with Vertical SaaS
According to a Forrester research report Liz Hubert, principal analyst, writes of the growing customer demand for vertical SaaS/SaaS apps. Meaning software that is made for a particular vertical/industry. It is designed to cater to a particular niche so as to provide a more fitting set of functions to the intended industry. Vertical SaaS exhibits the characteristics of a highly flexible software because its solutions are targeted toward a customer base of shared perceived value, meaning one change would most likely fit the needs/wants of the majority of said users.
Because of its customizable feature, the vertical SaaS is expected to be a continual trend in the field of business. We saw Salesforce take this approach with their customisable software which has spurred the expansive range of industry-specific CRM apps on their app exchange.
An Appeal for Analytics
Analytics delivered to users of SaaS have been a cornerstone of the industry and a constant area of focused innovation. Again, industry darling Salesforce has made this a focus with their einstein analytics, as well as Workday in the HR space constantly serving up relevant information to users based on activity. When it comes to analytics it is important that they are provided with actionable insights to ensure they are of value to your client and help drive/inform key business decisions.
It will be the metrics and trends above that determine the commercial success and viability of newer players on the market. To keep in mind, what is of importance to both investors and prospective clients, is to act with prudence in the face of growing competition.
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