BUSINESS GUIDE - Driving and Measuring Sales Success in a SaaS / Cloud environment
By Stuart Janicki • 28 May 2014
The Cloud computing market can be pictured as three overlapping areas:
- Software as a Service (SaaS)
- Platform as a Service (PaaS)
- Infrastructure as a Service (IaaS)
SaaS is the most mature segment and is comprised mainly end user applications like Netsuite (used by Cloud Direct) and Microsoft Dynamics. PaaS is the service and management tier of the cloud model, which includes intelligent provisioning, and application / network management. IaaS is the base layer which includes storage, backup, disaster recovery, security and databases.
Cloud Direct leverages the cloud in every possible way – avoiding ‘on premise’ solutions wherever possible. As a provider of Cloud services, it provides us with a great understanding on the benefits and challenges associated with the technologies at all three levels. By using cloud for backup, disaster recovery, security, CRM, Financials, email, voice and collaboration – we avoid capital expenditure, ensure all our resources are focused on our customers, remain nimble, make use of the very best technologies available, and know we can grow without the burden of legacy systems.
We believe our customers should do the same and that our partners are often best placed to help them choose the right solutions and gain the maximum benefit.
Seven Steps to Driving and Measuring Sales Success
Businesses involved in providing Cloud Services should recognise that the financial model is fundamentally different to that of traditional IT services – largely driven by the ‘utility’ or subscription model of the Cloud. All Cloud business must include the following key performance indicators (KPIs) to help guide them to success: Committed Monthly Recurring Revenues (CMRR), Customer Acquisition Cost Ratio (CAC Ratio), CMRR Pipeline, Cash Flow, Customer Churn, Customer Lifetime Value (CLTV) and Commission Plans
Committed Monthly Recurring Revenues (CMRR)
‘Bookings’ has been the traditional bedrock of software sales metrics. But booking are misleading in the Cloud arena as it does not take into account the time period over which a contract is won, nor does it provide a sense of the predictability of future revenues. For Cloud businesses a much better metric is available: Monthly Recurring Revenue (MRR). This is the monthly equivalent of contacts signed e.g. a £1200 annual contract would be recorded as £100 MRR (£1200 / 12 months).
A tweak on this is to measure the Committed MRR (CMRR) which includes the MRR for existing customers plus any pipeline on new MRR less any predicted churn or lost MRR. This net CMRR provides a pure and simple steady-stage metric of the amount of cloud-based revenue a business has.
Customer Acquisition Costs Ratio (CAC Ratio)
A challenge with recurring-revenue businesses is that revenues take a long time to build – yet the sales and marketing investment needs to be made up front. The Customer Acquisition Cost Ratio (CAC Ratio) is a metric that allows you to judge the profitability or ROI for sales and marketing investments. The CAC ratio is based on new CMRR Gross Margins added each period and is calculated by dividing the new annualized net gross margin added in the quarter (ignore any churn), by the sales and marketing costs of the previous quarter (ignore account management associated with existing customers):
The result is a single number that indicates the return on your acquisition investments within the year. Thus 0.5 indicates that 50% of your investment is returned or, the payback is two years. A CAC ratio of below 0.33 is not good – a payback of over three years should indicate that investment is too high relative to the effectiveness of the current sales team.
A CAC ratio above one (1) is excellent indicating a payback within the year – and a good time to consider increase investments.
Note that ‘pay-back’ years is simply the inverse of the CAC ratio.
As CMRR has replaced ‘Bookings’ as a proxy for future sales value, we need to be able to measure CMRR Pipeline. It’s this measure that will help determined commission plans, planned investments and underpin business reporting. There are four criteria you will need to understand for your business before producing CMRR Pipeline figures: 1) average deal size 2) average sales cycles 3) measure period (weekly, monthly or quarterly) 4) Qualification criteria (committed, probable, etc.)
Once selected, it’s important to be consistent with the criteria. Eventually, you will be able to measure pipeline forecasting accuracy by comparing it to actual results – and then honed over time to be a good ‘leading’ (as opposed to lagging) indicator of future performance.
Cash Flow has and remains an important measure for all businesses. The recurring-revenue model makes the measure more important. Because payment terms are rarely ‘upfront’ they almost always lag well behind the investments needed to provide the solution. Thus the working-capital requirements of the Cloud model are high. Sales commission plans can be used to encourage upfront payments – annually or quarterly to ease the burden.
Customer Churn is the gangrene that will eat away at the success of a Cloud business. Almost ahead of the investment in new business acquisition, Cloud providers must work hard to minimise churn. In a traditional software model, sales can be made regardless of success of failure of the intended project. In the Cloud world, this is no longer the case – customers can cease using the service at any time – even with a contract in place. Churn is measured as a percentage of the revenues lost i.e. lost MRR in a month / quarter divided by the revenue for the month / quarter. A churn rate of less than 1% per month or 12% per year is considered good.
Customer Lifetime Value (CLTV)
Customer Lifetime Value (CLTV) is the net present value of the future recurring profit streams of a given customer, less the costs of acquisition. This is best described with an example:
Customer Revenue: £1 per year Business CAC Ratio: 1.0 Gross Margins: 70% General Overheads: 20%
So we can calculate:
Gross Margin: £0.7 (£1 x 70%) Profit: £0.5 (£0.7 less 20% for overhead) Profit over 5 years: £2.50 Acquisition Cost: £0.7 (as the CAC Ratio is 1.0) CLTV: £1.8 (£2.5 less £0.7) Annual Profit: £0.36 (£1.8/5) or 36% profit margin
This calculation could be improved by discounting future cash flows and allocating overheads more accurately.
It’s important to have an effective sales and marketing engine and a good metric to use for this has been described earlier – the CAC Ratio. Only when the CAC Ratio is acceptable, should increased investments be made in customer acquisition. Scaling the sales force before it is effective will not produce success especially given the increased up front investments associated with the Cloud.
An effective sales team might typically require £200,000 CMRR before it has gained enough experience to then scale. Another measure is to wait until at least two sales reps (to avoid scaling based on the performance of the first super-star) can sign annual contract values (CMRR x 12 months) at 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 associated with securing the customer.
For a direct, enterprise sales business model, these thresholds are likely to be around £50,000-£75,000 CMRR (approx. £0.6m-£0.9m annualized) For a tele-sales business, this may be lowered to £40,000-50,000 MRR (£0.5m-£0.6m annualized).
A good sales commission plan should do two things:
- Tell sales people where to spend their time and effort
- Tell sales people what the company values
In other words, commission plans drive behaviour and should be aligned with the key metrics of: MRR, Churn, and Cash flow – with a very strong emphasis on MRR above all else. The new business sales team should be paid on new CMRR with a typical amount of commission equal to one month of revenue signed e.g. a rep signs a deal for £2000 MRR will receive a payment of £2000. Based on a notional 12 month contract, this is equivalent to 8.3% of the contract value which is not untypical in the traditional software arena. Additional payments for extended contracts might be included but this might be affected by the level of churn in the business and the general trending on market prices. If, for example, churn is low and prices are rising – then have fixed revenues for three years is not so attractive. If on the other hand, there is little lock-in and prices are dropping, a multi-year deal is preferred.
Incentives for more favourable cash flow terms (such as multi-year pre-payments) can be considered. Account management should be commission in a similar fashion to new business – but modelled on CMRR and churn assumptions instead of a new CMRR sales quota.
Various accelerators to encourage over achievement can be included. For example:
Percentage of Quota Commission Paid 0 - 25% £0.25 per £1 of MRR 25% - 50% £0.5 per £1 of MRR 50% - 75% £1.0 per £1 of MRR 75% + £1.5 per £1 of MRR
To avoid sales reps sand-bagging deals - pushing them from one quarter to the next, quotas should be set annually and commissions defined annual targets instead of quarterly targets.
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