Early stage B2B SaaS companies, and tech companies more broadly speaking, are typically very focused on adding new accounts, growing existing accounts (up-sell and cross-sell) and serving their account base as best they can (customer success). These activities drive revenue growth, which in turn drives valuation, market credibility, ability to hire talent and a whole host of other important things.
While this focus is certainly well placed, in the process of focusing on revenue generating activities, many B2B SaaS companies forget to periodically assess their accounts from a profitability perspective and ensure that their sales coverage models are appropriately positioned given the varying profitability of the underlying accounts being served. The result is that many of these B2B companies end up relying too heavily on large direct sales forces when:
- The profitability of the underlying customer accounts doesn’t justify the use of direct sales reps in all situations
- There are often lower cost to serve models that are not only cheaper but also more effective with many types of customers.
As such, if you rely heavily on a large direct sales team, it can often be helpful to do a quick coverage alignment exercise to determine whether it is worth re-assessing your account coverage model. While this is primarily a cost-saving activity (e.g. moving some accounts from a higher cost direct model to a lower cost indirect model) there can many times also be revenue-generating opportunities as well because many customers actually prefer non-direct sales channels.
The first step to reassessing your account coverage model is to plot out the full distribution of all your customer accounts from a gross profit (not revenue) perspective. It is important to look at profitability and not revenue here as revenue alone will not help identify accounts that could be moved to different coverage models. Breaking out the distribution into deciles is often helpful in terms of bucketing accounts into different categories. Many B2B tech companies have a distribution that looks something like this:
As seen in the chart above, a minority of customer accounts are driving the vast majority of the gross profit. In this example, 30% of accounts are driving ~90% of the total GP. In most cases, it makes sense to continue to serve these high-value customers through a direct model. Losing these customers or serving them in a different way could be devastating.
That being said, there is also a long tail of low or even unprofitable accounts. For the most unprofitable accounts (e.g. very negative accounts), in some cases it may be better to simply stop serving these customers altogether because you are losing money on each one with no way to profitably serve the account.
For the “long tail” of customer accounts that are low profit or even slightly negative, this is where it is worth re-assessing your coverage model and thinking through other lower cost to serve options with the end goal of improving GP. There are at least 3 viable coverage options that could be used to improve the profitability of these accounts (and maybe even grow them).
(1) Inside sales: Inside sales reps come with less of the overhead and expenses that direct sales rep comes with. They have much lower (if any) travel, lodging and entertainments costs. Inside sales reps also tend to be cheaper and can have more flexible roles (i.e. as hunters, farmers, sales support, customer care, etc.)
(2) Channel: Indirect reps or channel partners can also be used to lower the cost to serve and improve account profitability. This go-to-market strategy can be more appealing to customers who are used to making purchases from a trusted channel partner. In addition to saving money on expensive direct sales reps, many of the same levers used to compensate direct sales reps (tiered commissions, accelerated payout above 100% quota attainment, etc.) can be used with indirect sales reps. If managed correctly, these compensation levers combined with the right channel partner could actually drive further top-line growth.
(3) Off-shoring sales support: Reducing the cost of sales support is another lever lowering the cost to serve. Sales support (e.g. admin functions, sales operations, product support, etc.) can often be handled in near-shore or far shore locations via virtual support at a fraction of the cost of on-shore resources. While this approach should be balanced with a need to serve customers well, many sales support activities (including some that are customer facing) can be handled in lower cost locations.
In today’s world, technology companies worth more than $1 billion—and many worth $10 billion—have fewer reasons to go public than they did in the past. It’s a new paradigm shift that has really changed many of the dynamics in the startup community. A few of us in McKinsey’s High-Tech practice put together an article on the software IPO environment and the implications for founders and VCs. We hope it’s an insightful read.
The full article is available here.
It’s been a few years since I’ve written extensively about education technology and the opportunities that exist in the space. Since my last set of posts back in December of 2012, the space has continued to be a fast growing sector with much opportunity. Back in 2012, the sector was a $4.1T industry globally. That number just topped $5T in 2015 with a 7% CAGR. Unsurprisingly, the education sector remains the second largest industry, trailing only healthcare in terms of global market size.
Likewise, venture capital investment has picked up substantially in the last 3 years. In 2012, Series B investments totaled just $159M—that number is expected to top $500M in 2015 once the final numbers are published. Similarly, deal activity across all stages has picked up. In 2012, the total number of deals across VC/PE was ~500 deals—that number will reach nearly 800 deals by end of year 2015.
Most importantly, exits have finally begun to provide some hope for returns. A scarcity of exits has long been one of the big problems for entrepreneurs and investors considering EdTech. Indeed M&A activity has historically been slow (<1% of all M&A exits from 2002-2012) and IPO showings have often been abysmal (e.g. Chegg which fell 23% during its IPO debut and now has a market cap of just ~$620M, half of its opening day valuation.)
In the last three years, however, there have been a handful of successful EdTech IPOs including companies like 2U and Instructure. Others, such as Coursera, Udacity and Edmodo, are all not far behind in the IPO pipeline. M&A activity likewise has been quite strong. In fact, U.S. EdTech companies tend to command higher revenue multiples than the average tech exit—3.2x for EdTech companies vs. 2.5x for the broader tech industry. Furthermore, M&A exits themselves over the last 5 years have been fruitful with 25 buyers spending more than $100M on U.S. EdTech companies.
Yet despite this progress, there remain a wide array of inefficiencies and unsolved problems. Specifically, I see 6 promising near-term opportunities for entrepreneurs to take advantage of and for investors to invest in. In no particular order here are a few thoughts of what we will see beginning in 2016.
1) Cloud SaaS will finally replace on-prem at the school district and system admin level
Having spent time working at the district level in education policy, I was always amazed at how archaic many of the tools districts and school systems use at the city-wide/admin level. Software tools that track important mission-critical information such as attendance, student demographics, building information, zone data, etc. across schools within a district are still often hosted on-premise, using archaic databases and outdated software with GUIs that look like they were designed in the ‘90s. Below is an example of what the NYC DOE ATS currently looks like:
Source: NYC Department of Education
I suspect that in 2016, as much of the IaaS and PaaS layers begin/complete their moves to the cloud through services provided by the likes of AWS, Azure, SoftLayer, etc, we will begin to see more B2B SaaS applications layered on top to replace the traditional on-prem software solutions. This will bring much needed functionality, analytics and a cleaner user experience to the education world. This in turn will increase productivity for educators working at the district and administrative level across school systems.
2) Learning content will be far more personalized
Recent survey data showed that less than 50% of teachers reported having digital resources that could be used to meet teaching standards. Moreover existing technology solutions often are not tailored to individual students and their specific needs. The next generation of student-centric software tools (across grade levels and subjects) will provide high levels of granularity and insight into the specific needs of individual students allowing for an end-to-end customized experience across lesson planning/ delivery, class activities and periodic assessments. This will be even more important for special needs students in ICT, 12/6:1 or similar learning environments. Personalizing learning content will ultimately allow for a more tailored learning experience and better long-term knowledge retention.
3) K-12 teacher development will rely more heavily on software platforms and tools
As it stands today, professional development for teachers is largely untouched by software tools and applications. At the district level, spend on professional development for K-12 teachers in the U.S. is ~$3B and usually takes 1 of 4 forms: (1) periodic school-wide workshops, (2) observation of other teachers, (3) coaching (usually by a more experienced teacher) and (4) generic online research.
In 2016, we will begin to see more PD content move to the cloud as doing so makes training teachers: (a) less expensive, (b) more accessible and (c) more personalized. Horizontal HR solutions like Workday, Cornerstone OnDemand and PeopleSoft will be re-built / tailored for the education sector enabling professional development in education to be more sophisticated and effective.
4) Higher education software tools will focus more on degree completion
As the Baby boomer generations’ offspring (Gen X) move beyond the college-age window, the college enrollment growth rate will begin to slow and the focus for many higher-education institutions, from a revenue perspective, will shift away from recruitment/ matriculation and towards retention/ graduation. As of 2012, ~50% of all college students were in at least 1 remediation course.
In the years ahead, there will be a greater focus on retention and remediation of students already admitted into colleges. Software tools will increasingly be used for (1) recruiting the right type of student to admit, (2) providing BI and predictive analytics platforms for identifying and tracking high at-risk students and (3) supporting remediation instruction for at-risk students to get them back “on track.”
5) Online courses and degrees will become more relevant
While online courses (including MOOCs) and degree programs will never replace the off-line experience, these offerings will increasingly be used to supplement off-line instruction as well as provide a new delivery format to non-traditional segments (such as continuing education students). Two important trends are happening that will accelerate the pace at which this happens in 2016: (1) online courses and degrees are becoming more socially acceptable (many programs have been accredited, employers are increasingly hiring graduates from these programs, etc.) and (2) the infrastructure (managing enrollment, handling payment, providing tech support, hosting platforms, etc.) to provide these offerings is cheaper and more readily available.
As such, we will see a greater number of higher education institutions join the ranks of UNC, USC, ASU and many others that provide courses and degrees online. This trend will create a range of software opportunities across: video collaboration, course development and delivery, student / faculty services and recruitment / retention.
6) Demand for software tools that teach skill-based training will increase
As colleges increasingly charge exorbitant tuition fees while failing to equip graduates will real skills, demand for skill-based programs, vocational certifications and other alternative teaching tools will increase. In 2013, the number of vocational certificates granted was nearly 1M—up 35% from 2005. Similarly, from 2013 to 2015, the number of graduates who graduated from coding programs (such as Codecademy) increased 630%+.
In 2016, we will see an even greater emphasis on tools for skill-based training. Some of this will be purely software delivered via the cloud and some will be more hybrid: software mixed with in-person training. Companies like Lynda (acquired by LinkedIn), Udacity, General Assembly and Udemy have already made significant dents in this space. We will see much more of this in the upcoming year.
There is an important difference between revenue and bookings that comes into play for early stage SaaS businesses that are growing rapidly. This difference has implications on both the revenue and cost side of the equation and can also affect important decisions such as how much to raise when speaking with the investor community.
Before we get to growth SaaS businesses, however, let’s first talk about legacy software pricing. In the traditional software world, software was typically sold as a perpetual license. Customers would make a one-time payment for perpetual use of software and pay for annual support and upgrades each year. In this world, bookings = revenue and revenue was generally recognized at the time the contract was signed and the software provided to the customer. The benefit of this model was immediate revenue recognition; the downside was lumpy and unpredictable revenue.
In the SaaS world, software is provided on a recurring (often monthly) basis. The software, support and upgrades are all included in the subscription. This allows for stable and predictable revenues that are smoothed out over the life cycle of the contract. The down side, however, is that there is often a discrepancy between bookings and revenue that must be understood and accounted for appropriately.
This issue is best understood with an example. Assume for a moment that a SaaS business is selling software in 3 year contracts and that churn is 0% (for simplicity.) In a flat revenue business, where growth is 0% YoY, there are no major accounting issues or business implications because revenues = bookings. For example, if bookings are flat at $100M, the business would recognize $100M of revenue each year. $33M from 2 years ago, $33M from last year and $33M from this year.
The challenge that comes into play is when a SaaS business is in growth mode. For example, a SaaS business that books $25M in Y1, $50M in Y2 and $100M in Y3, would have the following revenue numbers:
As seen in the table above, for a growth stage company that is doubling in bookings YoY, revenues do not equal bookings. There is a lag effect between bookings and revenue and it becomes necessary to take a haircut on bookings to get to revenue. This haircut will of course decrease over time as growth slows, but it does create an important accounting dynamic that has real business implications
One of the largest implications for early stage companies is in the amount of money a SaaS business must raise when going out to the VC market for financing. The underlying cost structure (COGS, sales expense, marketing expense, R&D, etc.) must be looked at as derived from bookings not revenue. This is a result of the fact that the SaaS business is incurring these expenses as a proportion of bookings not the revenue actually being recognized. Because expenses are incurred in line with bookings (and bookings > revenue), the result is that EBITDA is low (and generally negative for most early / growth stage SaaS companies). EBITDA ultimately ties to cash flow, burn rate and the required investment. Thus, it is key to make sure the raise is in line with what the business needs from a cash flow, and ultimately booking / expenses, perspective.
In the tech ecosystem, we often associate entrepreneurial financing almost exclusively with venture capital. As a result, most of the fundraising resources for entrepreneurs are geared around venture capital. Likewise much of the media attention in the startup financing world is focused on venture capital investments.
The reality, however, is that there are many different forms of financing beyond traditional venture capital financing. And the type of fundraising instrument used is as important as the quantity being raised and who it is raised from. There is quite a bit of information out there about raising from friends and family, angel investors, crowd funding platforms and several of the other more common sources of financing outside of venture capital. But there is very little information about financing a startup through debt.
As such, Brian Feinstein of Bessemer Venture Partners, Craig Netterfield of Columbia Lake Partners and I put together a white paper on venture debt, which was released last week. It’s meant to be a fairly comprehensive guide for entrepreneurs who are interested in exploring venture debt as a viable option. Feel free to check it out here and send us any questions as they arise.
I recently updated my resource section to include a variety of papers and presentations I authored or co-authored while at Columbia Business School. As I was sorting through my hard drive and getting rid of old files, I realized that a lot of time and effort went into some of these and that someone, somewhere might find some of this information useful.
So I’ve uploaded some of these thought pieces under 3 different sections:
- Investment Memos: This sections contains three different investment memos on Airbnb, Prosper and Starwood. The first two are focused on later stage venture / growth equity investments whereas the Starwood memo is more of a traditional Buy/Sell/Hold analyst report.
- Roadmaps & Theses: The next three sections contain a set of VC style investment roadmaps from the two internships I did in venture. The first deck is a roadmap focused on wearable tech, specifically Google Glass, from my time at Gotham. The second deck is a playbook on vertical saas opportunities that I put together for BVP. The final paper is an initial viewpoint on the manufacturing software sector that I put together for BVP while doing a deep dive into the space.
- White Paper & Thought Pieces: The final section is more or less a catchall for a few other pieces that I thought were interesting but didn’t naturally fit into the other two categories. This section contains an in-depth analysis on M&A activity in the tech sector and the resulting implications for venture investors. This section also includes a deck that very accurately projected iPhone sales for Apple in Q3 of 2014 before actual figures were announced. Both of these papers rely extensively on regression analysis and other statistical methods.
So there it is, a few resources that I thought were interesting. I’ll continue to add to this collection as the opportunity arises.
Yesterday I graduated from Columbia Business School ending a two decade educational journey that started on the west coast and end here on the east coast. These past two years have been two of the best years I’ve had both personally and professionally. And so I just want to take a moment to say thank you.
My experience at CBS has been inextricably tied to New York City. Some of the best professional opportunities I’ve had were a result of being here in the city. During my first year, the guys at Gotham Ventures were nice enough to give me the opportunity to learn the ropes and get an insider’s perspective on the venture business. That experience was only enhanced during my second year when I worked on a variety of projects with Bessemer Venture Partners. Lucas and Brian – thank you both for taking a chance on me.
Back on campus, there were two organizations that really shaped my MBA experience. The first, InSITE Fellows, is one of the most innovative student groups I’ve come across. Before I even stepped foot on campus, I knew I had to join. Huge thanks to the year above me for letting me in and the current fellows for being the smartest yet also most humble group of soon-to-be founders, investors and technologists I know. And a big thank you to the folks at 2U, Betterment and the many other startups I was fortunate enough to work with.
The second group was my cluster—Cluster E. I really couldn’t have asked for a better group of people to spend time outside of class and work with. Within my cluster we had a diverse mix of veterans, attorneys, teachers, entrepreneurs and of course…bankers and consultants. I’m amazed by how talented, but at the same time, down to earth everyone was. It was an honor to get to know all of you and I know this is just the beginning of many long friendships.
Finally, I have to thank my family, with-out them I wouldn’t be here today with this degree in hand. Mom, Dad and Andrew thank you for your support throughout these two years and throughout my entire life. Mom you have been my rock since birth—I’d be nowhere without you. Liza you have been my biggest cheerleader since our Cornell days; I can’t thank you enough. And to my extended family—I couldn’t have asked for a better group to celebrate the weekend with. I only hope that I can shower you all with as much love and support as you have showered me with.
And lastly, thank you Columbia Business School. What an amazing place #attheverycenter. Next stop, McKinsey & Company but not before one last stretch of traveling and relaxing with friends and family.