Friday, October 17, 2008

Bessemer SaaS Law #3

Bessemer SaaS Law #3. Tune before you scale: the Sales Learning Curve is even more
critical for SaaS and it takes at least $300k MRR to climb it. Stop at three sales reps until at least two of them are making $100K MRR quotas.

Years ago Bessemer was fortunate to invest behind Mark Leslie at Veritas, and as a result our firm became big believers in a concept Mark helped pioneer around the Sales Learning Curve (SLC). The core concept is that software organizations often fail because they staff up their sales efforts too quickly and make them too large before the sales model has been refined. This concept is even more critical for SaaS businesses given the large upfront investment required to acquire customers. Ramping up too quickly will burn precious cash reserve and could sink the business.

While the CAC ratio helps SaaS businesses at scale to manage their Sales and Marketing spend,the SLC is a helpful framework for early stage businesses before you have meaningful data. To understand when the business has started to climb the sales learning curve and is in a position to hire more reps profitably, you have to think in terms of CMRR instead of bookings. You know you can profitably scale sales when a couple of sales reps are at an annualized run rate to sign annual contract values (CMRR x 12 months) equal to twice their fully-burdened cost of sales. In
this case, fully-burdened is not just the salary, bonus, and benefits of the sales rep, but also allocations for sales engineering support, executive support, marketing expense, and professional service expenses associate with securing the customer.

For a direct, enterprise sales business model, these thresholds are likely to be around $80,000-100,000 CMRR (approx. $1-1.2M annualized), and for tele-sales models, this may scale down to $60,000-75,000 MRR ($720,000-900,000 annualized). It is usually time to accelerate sales hiring when at least two out of three sales reps are hitting quotas at these numbers, and the business has achieved some scale to suggest that the processes are repeatable- at least $300,000 of CMRR. The “repeatable” aspect is critical: too often companies scale their sales force aggressively after their first senior rep is getting traction in the market and then quickly realize that the new hires struggle to sign their first deal because they don’t have three VP’s and the CEO alongside them. To then quickly quantify the total business impact from productive sales executives, you can use the “Rule of 78’s”. To use round numbers, let’s assume a salesperson sells $10K of new CMRR every month for twelve months. The new customer closed in January will then generate $120k of revenue that year (12 months x $10,000), the February deal generates $110,000, the March deal $100,000 and so on. Consistently delivering a deal per month in this progression gives you a total of 78 months of cumulative recognized revenue. The Rule of 78’s shows the first year revenue amount for such an effort (78 X $10K = $780,000). It is critical to note that unlike a traditional software company model where missed periods can be made up with a few large transactions at the end of the quarter, SaaS revenue can not be recaptured. If the salesperson delivered every month as outlined but missed just his or her January deal, $120,000 of revenue is lost forever. A lost subscription month is lost forever, and no amount of year-end heroics can recapture it. This means that revenue closed earlier in the year (or even quarter) is far more valuable than the same size deal later in the year. It is therefore critical to establish a sales compensation plan that rewards early and consistent performance. The power of SaaS is further illustrated when you realize the same 12 logos that generated $780,000 the first year will generate $1,440,000 in year two – the “Rule of 144” - assuming net neutral churn and up-sells.

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