Whether we sit on the investor’s side of the table, or the founders’, we all know that running a successful SaaS company in a competitive market requires careful tracking of KPIs.
Until (what feels fairly) recently, the main focus for startups - and likewise, their investors - was on growth, growth, and even more growth. But as we all have no doubt felt, our world has changed significantly in the last couple years, and the market downturn caused a necessary shift in how we prioritize startup KPIs. Today, efficiency and runway are much more critical and desired indicators of success.
Let’s explore this changing landscape of startup KPIs, what companies should be tracking, and why these KPIs are crucial for their success.
Market Conditions: What’s happening in the private market
In 2022, to combat soaring inflation, the US Federal Reserve raised interest rates, resulting in a downturn in public markets. While private market valuations have also declined and companies are finding it more challenging to raise their next round, the adjustments for the private market have been slower and more modest compared to the public markets.
In light of that, it’s crucial that startups also adapt by shifting their own KPIs to better reflect this reality.
Shifting KPIs: What startups need to track
Before the 2022 market downturn, KPIs were mostly focused on growth, with valuations highly correlated with 12-month growth rates. During that time, cash was relatively cheap, and public investors placed a high premium on future returns and growth. The most important startup KPIs included annual recurring revenue (ARR) growth, which encompassed both organic ARR growth (expansion of existing customers) and new sales ARR growth (acquiring new customers). Other crucial metrics included new and expansion growth rate, net dollar retention (top-line revenue without new customers), gross dollar retention (customer retention rate), and churn rate (rate of customer cancellations or subscription cancellations).
ARR was a key startup KPI for valuing SaaS companies because it was based on the assumption that most licenses renew automatically each year, allowing companies to predict their future revenues and growth. However, with the current state of the market, many SaaS companies are setting inflated growth projections that are not being realized quickly enough. As a result, it is no longer feasible to rely solely on ARR as the most important startup KPI.
Instead, a new set of KPIs - focused on efficiency - has emerged. Here are some essential metrics to consider:
- Customer acquisition cost (CAC) payback months: This metric evaluates how long it takes to recover the cost of acquiring a customer, measuring the number of months of gross margin from paid subscriptions. It provides insights into the sales motion of a company, helping to determine the cost of acquiring new customers and how long it will take to recover those costs.
- Burn multiple: This measures how much capital a company is burning to generate each incremental dollar of ARR, indicating the company's efficiency in managing its expenses.
- Rule of 40: This principle states that the combined revenue growth rate and profit margin of a SaaS company should equal or exceed 40%. It serves as a benchmark for evaluating the health of the business and the balance between growth and efficient operation spend.
All of these KPIs speak to how efficiently a SaaS company is using their money. The CAC payback metric, for example, is very important because it gives companies a good understanding of the sales motion. With it, they know the cost of acquiring new customers and how long it will take to recover those costs.
The Rule of 40 is also an important metric and benchmark for SaaS companies. To hit goal growth rates, companies need to readjust their cost structures; they cannot continue to spend based on previous years and inflated projections.
Management Considerations: What to do next
So, what does this all mean? As mentioned, one key takeaway is to stop spending based on previous year’s growth rates. We see many companies keeping relatively aggressive growth projections on which they plan their expenditure.
While using this approach, the chances of keeping within the Rule of 40 or other efficiency KPIs are slim to zero. Therefore, companies should identify at least three growth scenarios - low, base, high - and plan their expenses based on the low end, with the ability to scale fast as the market changes.
Five ways to approach the process while keeping the company’s strategy and KPIs aligned:
1. Confirm whether company strategy is already aligned with desired growth.
First, startup founders must ask themselves if there is even a need to change what they’re already doing for the level of growth they are aiming for. They should take into account the wider industry in which they operate. For example, how is their market changing? Is their industry due for a technological upgrade or a change in models? Maybe the structure of their industry is more resistant to the level of growth they seek.
For example, take a midsize organization where the technology is lean and easier to adopt. There may be less scale and infrastructure, and the sales motion is faster and much simpler. While this may work well, the same strategy won’t work for accessing bigger, corporate customers, which will require a different play.
2. Do a deep analysis of your own company’s standing.
Founders should analyze their market, any inherent advantages, regional implications, its line of products, potential add-ons, trends in their competitive landscape, new available technology, its sales motion and value adjustments, and the efficiency of their team.
For example, it may be much easier for a particular startup to penetrate the European market, in terms of adoption, willingness to pay, etc. However, the market may be very limited - certainly compared to the US. That’s a trade-off that may be worth making, knowing that while the US is a bigger market, it will take much longer to break through the market there and show results - and have potentially way larger gains down the line. Depending on how much time and runway that particular company has will help to determine the right move to make.
3. Take short term actions towards efficiency.
Existing Customers: In most cases, the low hanging fruits are your existing core customers. Don’t underinvest in customer success and professional services to only focus on gaining new customers; on the contrary, consider the cost of ‘losing a customer’ and the lower costs of up-sale and cross sale. This will have a tremendous impact on your CaC payback and retention rates.
Product Support: Keeping up with product support can positively impact retention rates and add further revenue growth streams. For example, this could be product-led motions for small-to-midsize customers or marketplace-enabled models as well as value based sales.
Investment in Sales and Marketing: Notoriously, sales and marketing are known as two of the biggest expenses for a company, reaching up to 50% of revenue in high-growth businesses. The high ratio is partly a result of the business model, in which revenue lags behind investment. But if these are a core part of the company’s strategy, optimize for them. Resilient companies don’t only focus on reducing expenses; they also invest wisely in activities that position themselves ahead of their competition.
M&A and Collaboration: Consider the potential of new M&A and strategic collaboration opportunities with complementary products or companies. The idea is to gain (and help reach KPIs) for your own startup, and see benefits for your partner as well, impacting both short and long term goals and outcomes.
4. Plan for the long term.
In order to become more efficient, many companies spend a lot more time focused on short term actions rather than investing in long term strategy. While we just reviewed ways to invest in the short term, founders should be careful not to abandon long term planning. Startups can benefit from the macroeconomics and adjust for lower expectations of growth in order to invest in longer term projects like new products, capabilities and technologies or new markets which might be more challenging and take longer to penetrate. Unlike in the past, when startups were expected to pour enormous amounts of money to accelerate growth, now it’s easier and more expected to do it consciously and efficiently.
5. Explore multiple scenarios with the ‘what ifs’ playbook.
In order for a startup to move fast - and wisely - in this turmoil-riddled market, founders should come up with different potential scenarios which assume both internal and external factors, and explore the lines of thinking these scenarios would require. It’s something many companies avoid doing, with good reason - it feels not urgent or unnecessary. But being prepared and aware of potential ‘what ifs’ could save time (and shock) down the line, and open up founders to other areas to explore in the meantime.
To do this, management needs to anticipate different potential events and their implications on the business. They should try to attach milestones, parameters, and KPIs which will trigger management to take action in the case that a scenario arises. Having a known playbook for each scenario enables founders to make faster, yet well-planned, decisions in the face of the (semi) unexpected.
Ultimately, KPIs are a guideline - a ‘north star’ - for a startup, including its founders, and yes, its investors, too. They cover both what a company should be focused on, as well as outlining where the ‘do not cross’ lines are - keeping everyone on track for success.
Anat Eitan is CFO and Partner at Hetz Ventures.