Measuring sales and marketing effectiveness of SaaS companies

The CAC Ratio

I read an interesting blog post from Will Price, a fellow VC from Hummer Windblad on how to measure the sales and marketing effectiveness of SaaS companies with a magic number defined approximately as the ratio of the incremental sales in a quarter (annualized) divided by the sales and marketing expenses of the previous quarter (this assumes that sales are recognized from a gap standpoint the quarter following the sales and marketing investment).

I found this approach interesting, but it seems to me that gross margin is a more relevant benchmark than revenues, given that the GM of saas companies varies by type of application and size of the company (for example NetSuite went from about 50% GM three years ago to close to 70% today). A more accurate benchmark would then be to divide the incremental GM (annualized) in a given quarter by the S&M expenses of the previous quarter. Let's call this ratio the Customer Acquisition Cost ratio or CAC ratio. The definition becomes for the last quarter of 2007:

CAC Ratio = (GM (Q4 07) - GM (Q307)) x 4 / S&M costs (Q307)

A CAC ratio of one would be equivalent to breakeven marginally on a new customer in one year. A ratio of 0,5, would mean breaking even in two years.

The next question is then: what is the right benchmark for this ratio? From our private investor experience, a breakeven in 1-2 year seems reasonable and if we look at Salesforce.com CAC ratio since its IPO, it is indeed within this 0.5-1 range:

The implications for a private saas companies are straightforward:

• If your CAC ratio is above 1, invest more to accelerate growth (and send me an e-mail at saasvc@bvp.com)


• If your CAC ratio is lower than 0.5, you need to think through your sales and marketing model and ramp up the sales learning curve before investing more


• If you are in between, stay on your course, your are doing fine
  

Refining the CAC Ratio

This CAC ratio can be refined by looking at the variation in Monthly Recurring Gross Margin defined as the Montly Recurring Revenue (MRR or CMRR) less the COGS run rate for the month (See my previous post on saas metrics for the definitions of MRR and CMRR). If you use the MRR, then the formula above is correct (just multiply by 12 instead of 4 to annualize the gross margin increase), but if you use the CMRR, then you need to divide the increase in gross margin by the S&M costs of the current quarter not the previous quarter.

The assumption here is that for most SaaS companies, the service takes a few months to get implemented, so from a GAAP standpoint, the revenue recognized in quarter N has been acquired in quarter (N-1) and therefore it is natural to use the S&M costs from the quarter (N-1) in the CAC ratio. If you use the gross margin derived from CMRR, the situation is different. The CMRR represents the revenue contracted during quarter N and not recognized yet on a GAAP basis because the service has not been implemented. Therefore it is legitimate to say that the increase in CMRR from quarter N vs. quarter (N-1) has been acquired with S&M cost of the quarter N, not (N-1), hence the need to adjust the formula.

For companies with short implementation cycle (like e-mail marketing), then the revenue can be recognized in the same quarter and therefore the formula should be calculated with the S&M cost from the quarter N, not (N-1) for the same reason.

CAC Ratio benchmarking for public SaaS companies

I also looked at all the 13 saas companies listed in my SaaS 13 Index to see how they were performing. The results for Q4 2007 are exposed in the chart below where the CAC ratio is plotted against the EV/TTM revenue mutliple (Enterprise Value divided by Trailing Twelve Month revenues):

Note: Negative numbers indicate that companies actually decreased their gross margin over the quarter.

As a SaaS VC, I tend to focus on Private companies, so I leave it up to you to design you short and long strategies on this peer group - of course a lot of other factors need to be taken into account (like growth rate and churn as $1 of recurring revenue is worth more for companies with lower churn) - but it is interesting to note that SuccessFactors is valued at more than 7x EV/TTM while it lost GM in Q4 07 and that Constant Contact is valued at the same multiple than Concur (both expecting to grow 60% 2007 vs. 2008) but with very different CAC ratios.