Increasing SaaS Recurring Revenues via Incremental Improvements
Every business is always on the lookout for ways to increase performance and drive growth. In most cases, entrepreneurs hope to grow revenue by substantial margins so as to achieve this.
One of the most effective strategies to SaaS (Software-as-a-Service) business growth is through incremental improvements. By enhancing every step in the customer lifecycle by a small margin, the overall effect is outstanding. Small compounded improvements exert a compound effect on the whole leading to exponential growth.
Loopholes in Conventional Approaches
SaaS business models differ from all others in that they get revenues over an extended period of time. For as long as customers are happy, they stay and keep the revenue stream going. As such, most entrepreneurs focus all their energies on customer retention. They mistakenly believe thatfocusing on the final stage of a customer lifecycle will yield growth. Theyimplement relatively big changes at this stage in a bid to improve the “negative churn”. With all other steps in the business cycle remaining constant, implementing a massive change in the final step accomplishes little.
On the other hand, some use spreadsheet approaches that simply add up the numbers. Under such models, achieving double revenue requires doubling the number of prospects. In turn, this means hiring twice the number of salespeople, thus doubling costs.Consequently, the approach leads them down the wrong track.
Taking Advantage of Multiplicative Effects
Customer lifecycle models do not concentrate on creating an additive impact or massively enhancing just one step of the process. Rather, they seek to gain leverage by exploiting the multiplicative properties of the customer lifecycle. They address multiple areas concurrently, implementing marginal improvements on each one. By doing so, they compound the effect, leading to parabolic rather than linear expansion. Consequently, though they make small changes, the results are massive.
The key to this approach is thinking of ways to optimize the system holistically, rather than in individual parts. Effectively implementing the model requires an analysis of the customer lifecycle taking into consideration various metrics.
Putting Theory into Practice
Based on Jacco Van Der Kooij’s book The SaaS Sales Method: Sales As a Science, Lean-Case enhanced its metric model and put this method a SaaS business model – how to double revenues with incremental stepsinto practice.It breaks down the typical customer lifecycle into two main stages, both of which have a number of sub-stages. It then applies four metrics to assess the impact of every step on performance. Take a look at how the model works:
1. Getting Customers
The first step involves awareness creation, customer education and customer selection support. In terms of creating revenue, this step has a one-time impact.
2. Keeping and Growing Customers
Unlike the previous step, this one has a compound effect on generating recurring revenues. As such, every contract renewal could possibly result in revenue expansion.
Breaking down the Stages
Getting Customers, according to the above model involves six key steps:
- Prospects acquisition (S1 – Prospect)
- Turning prospects into Market Qualified Leads (S2 – MQL)
- Creating Sales Qualified Leads and handing them over to the sales team (S3 – SQL)
- Sales team accepts them as Sales Accepted Leads (S4 – SAL)
- Conversion into Committed Accounts (S5 – Commit)
- Solution deployment and onboarding them as Live Clients (S6 – Live)
On the other hand, keeping and growing them takes two main steps:
- Securing the initial recurring revenue stream (S7 – MRR)
- Addressing expansion and churn to maximize the recurring revenue stream over the duration the account exists (S8 – LTV)
Here are the four metrics the model uses to assess the impact of each step on the overall performance:
- Volume – Each stage takes in a specific input and gives an output. For instance, the total number of prospects will turn into a lower number of MQLs. This process will continue throughout the cycle.
- Conversion – These metric measures the conversion rate. Using this value, one can determine the input they need to generate a specific output.
- Time – This metric measures the amount of time it takes for an input to generate the output.
- Finances – Each step requires financial input (cost) and can generate revenue. Financial metrics measure these aspects in every step.
The Model at Work
For illustration purposes, we will create a sample SaaS business model using assumptions for the different metrics. With regards to time, the conversion of a single prospect to live customer status takes 6 months on the model. We will assume that the total number of prospects at the start was 1,000.
The total conversion rate is 1%, meaning that at the end of 6 months, we will have 10 live customers.
1,000 prospects*1%=10 Live Customers
What would be the impact of improving the conversion rate of each stage by 15%?
The overall result on the number of live customers is a 2% conversion rate, which is actually a 100% increment on the initial 1%. This means that from 1,000 prospects, one would get 20 customers. Note that this is double the initial number of customers which was 10. Essentially, the model has achieved a doubling effect from a marginal 15% improvement.
This obviously doubles the Monthly Recurring Revenue (MRR). Assuming that the New MRR per customer is $1,000, 10 customers will yield $10,000. Therefore, 20 customers will mean $20,000.
Unit Economics and CAC
Financial metrics will take into consideration the Unit Economics to check the viability of the business model.For the first phase (Getting Customers), this includes the Customer Acquisition Cost (CAC). For the Keep-and-Grow Customer phase, we will consider revenues and Cost of Goods Sold (CoGS).Expenses in CAC include marketing costs such as the cost to create prospects and selling cost, in particular the expenses for your sales teams pushing prospects through the pipeline..We are assuming a cost per prospect of $100 and a selling cost of $250 for every conversion at all subsequent stages. These include MQL, SQL, SAL, Commit and Live.
Taking the total CAC and dividing it by the total number of live customers, the CAC for every customer is $19.625.
To understand this in more detail, pleaserefer to this video made by Lean-Case.
Optimizing Your SaaS Business Model using Incremental Improvements
Using incremental improvements on a SaaS business model creates an opportunity to implement realistic and achievable growth targets. By making small changes to every part of the business cycle, it facilitates a significant enhancement on overall performance. Over an extended period, this allows for consistent growth and higher profitability.
Image Credits: revenue from Fabrik Bilder /Shutterstock