measuring the performance of your subscription business: the three metrics that matter
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Why Zuora : Zuora Provides a BluePrint to Succeed inthe Subscription Economy!
Measuring the Performance of Your Subscription Business:The Three Metrics that Matter
The Problem of Assessing Subscription Companies
High growth subscription companies are often “unprofitable”
Yet the markets value subscription revenue at twice product revenue
Fast Growing, Money Losing, Highly Valued SaaS Vendors
4
-25% 0% 25% 50% 75% 100%
-80.0%
-60.0%
-40.0%
-20.0%
0.0%
20.0%
40.0%
FireEye
Workday
Tableau
NetSuite
Marketo
Salesforce
0.0x
Intuit
Microsoft
Oracle
SAP
Splunk
Adobe
Revenue Growth
% N
et In
com
e
Companies moving to SaaS have high valuations even with negative
growth.Legends:Size of Bubble = Valuation/Revenue
SaaS
Mixed
Software
Only 30% of public SaaS companies make a profit!
Financial Differences
Sale Subscription Annuity
Revenue Acquisition Costs
Prior to Purchase Prior to Contract
Profit from Sale At Delivery Over Life of Customer
Revenue and Profit
Predictability
Large Profits, then nothing until next sale
Greater Profits, but over the Life of the
Customer
Comparing financial results requires a different analysis
Revenue comes later with Subscription Companies;Much later with High Growth Subscription Companies
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8$K
$20K$40K$60K$80K
$100K$120K$140K$160K$180K$200K
Purchase versus Subscription Annual Revenue – No Growth
Purchase
Subscription
Ann
ual R
even
ue
100 New Deals/Year$3K Purchase versus$1K Annual Subscription10% Annual Churn
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8$K
$100K
$200K
$300K
$400K
$500K
$600K
$700K
Purchase versus Subscription Annual Revenue – 30% Growth
Purchase
Subscription
Ann
ual R
even
ue
100 New Deals/Year$3K Purchase or$1K Annual Subscrip-tion10% Annual Churn
We need financial analysis methods to value long term profitability of the growing Subscription Annuity stream, not just short term profit.
The Limitations of GAAP Financials
GAAP is backward looking not showing the value of the recurring revenue stream
GAAP Income Statements do not give insights into the health of a rapidly growing subscription business
Subscription Financials Analysis Requirements
Build on GAAP standards
Recognize the future value of the Subscription Recurring Revenue stream
Measure the Revenue Acquisition Costs against the Recurring Revenue stream
Segregate the costs of Running the Business from Acquiring New Business
*at a sustainable cost
Subscription Businesses are all about Efficiently Building the Recurring Revenue Stream*
3 Metrics Measure Subscription Business Efficiency
Churn
The revenue that is lost and must be replaced
Growth Efficiency
= Revenue Acquisition Costs/ New Annual Recurring Revenue
The cost to obtain a dollar of new subscription revenue
Recurring Profit Margin
= Subscription Revenue – (Cost of Subscription Services
+ R&D Expense +
Administrative Expense + Acquisition Cost of Replacing Churn)Profit excluding Costs of Incremental Revenue
Key Metric: Churn
Churn destroys the value of the subscription revenue stream
Churn must be replaced raising the total cost of Customer Acquisition
Churn should decline over time
Ch
urn
Ra
te
Time as Customer
Churn Targets
More Customer Commitment Lower Churn
Customer Engagement (Use) predicts churn
0%
5%
10%
15%
20%
25%
Churn
Target Churn<10%<20% <25%
B2B EnterpriseB2C SMBB2C
Key Metric: Growth Efficiency Index (GEI)
The company’s ability to grow is constrained by the cost of growth
The acceptable GEI is a function of churn
The GEI should decline with company maturity
Salesfo
rce
Workd
ay
NetSuite
Box*
Zendesk*
0%
50%
100%
150%
200%
250%
300%
35%
104%
31%
111%88%
152%
75%
154%
262%
111%
Growth Efficiency of Public Companies
% Growth Growth Efficiency* Pre IPO
Growth Efficiency Index Targets
GEI will be high during the early company life
New Customer Acquisition is Expensive
Customer Expansion is much less expensive
Later Stage subscription companies have lower GEI
Target GEI
~.5~1.0~1.5+~2.0
B2C, High ChurnB2B, Later StageB2B, Growth StageB2B, Launch Stage
Key Metric: Recurring Profit Margin
Recurring Profit Margin is the estimated profit with no growth
Additional Sales & Marketing expenses will fund growth
0% 10% 20% 30% 40%
-40.0%
-20.0%
0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
120.0%
140.0%
26%16%
6%-4%
-14%
COGS Sales & MarketingR&D G&AProfit
Growth Rate
Exp
en
ses
Recurring Profit Margin with no growth
Sales Efficiency 1.0x
Subscription Businesses trade-off Profitability and Growth
Recurring Profit Margin Targets
Recurring Profit Margins should reach 30%+ with company scale NetSuite Workday SalesForce Box
-150%
-125%
-100%
-75%
-50%
-25%
0%
25%
50%
75%
-15%
-33%
-6%
-128%
55%
28%
57%
20%
% Operating Margin % Recurring Profit Margin
3 Direct Measures of Growth
• Increase in ARR– Value of all Subscriptions contracts at a point in
time
• Increase in Revenue– Includes all revenue from the business
• Increase in Cash Flow– Focuses on the cash generated from operations– Should exceed the income from operations
The median growth of public and private SaaS companies is 30%
Customer Lifetime Value Predicts the Value of Subscriptions
• Customer Lifetime Value (CLV) is the Predictive Measure of the Net Present Value of the future Subscriptions Gross Profits
• Customer Equity is the sum of Customer Lifetime Values
When Customer Equity is growing rapidly, loses are defensible
Customer Equity
Annual Recurring Revenue
Cost of ServiceChurn
Cost of Capital
Customer Equity = Total Recurring Revenue – Cost of
Service %Revenue Churn
+ %WACC
Target Revenue Acquisition Cost from CLV
• Revenue Acquisition Cost < 25% CLV– Comparable to Product Sales
• Growth Efficiency Index < 25% CLV/ARR – Equivalent measure based on GEI
Contrasting Public Software & Subscription ProfitsSubscripti
on Companies
Software Companies
Revenue 100% 100% Cost of Service* (30%) (33%)Gross Profit 70% 67%
Operating Expenses S&M (39%) (23%) G&A (17%) (10%) R&D (18%) (15%)Total Op Ex (73%) (49%)EBITDA (.3%) 19%* Includes low margin professional servicesMedian Growth
26.0% 9.9%
Economic Value/Revenue 8.0x 3.2x
Source: SEC Software Equity Group, Q1 2014 Software Industry Financial Report
Public Subscription companies have over twice the valuation ratios of Public Software companies
Alternative Income Statement Presentation
Revenue 100% Cost of Service -20%Gross Profit 80%
Operating Expenses S&M -40% G&A -15% R&D -20%
Total Operating Expenses -75%
EBITDA 5%
Revenue 100%Cost of Ongoing Operations Cost of Service -20% S&M - Churn Replacement -10% G&A -15% R&D -20%Cost of Ongoing Operations -65%Recurring Profit Margin 35%S&M - Incremental Revenue -30%EBITDA 5%
Traditional Income Statement
Subscription Income Statement
Yearly Metrics: Prior Current GrowthRevenue 100 130 30%Ending ARR 115 150 30%Revenue Churn 10% 10% 0%Cost of Capital 10% 10% 0%Customer Equity 576 749 30%
Growth Efficiency 1:1 1:1 0%
Yearly Metrics:Prior Current GrowthRevenue 100 130 30%
Summary
GAAP financials show the historical company results.
Growth in Customer Equity and Recurring Revenue measure the company’s growth and future revenue.
Recurring Profit Margin of existing subscriptions should be separated from the costs of new revenue.
Subscription Metrics of Growth Efficiency and Churn are the Key Performance Indicators of cost effective growth.
The growth in the company’s Customer Equity measures the increase in company value.
Contacts
26
Iain Hassall, VP Finance & Corporate Controller, Zuora
Twitter: @iainhassallEmail: [email protected]: +1 650-241-0658
Dave Key, Managing Director, CloudStrategies.biz
Twitter: @DaveKey0Email: [email protected]: +1 949/887-4401