BESSEMER CLOUD COMPUTING LAW #6: Build the Revenue Engine
Hyper-growth is the goal of most aggressive cloud CEO’s, but how do you know if your sales and marketing investments are ultimately “profitable”? The answer to this question can be found through measuring your Customer Acquisition Costs and the CAC Payback Period. When we introduced a similar concept of a CAC Ratio five years ago the response was extremely positive, so we have included it again, but with a significant simplification based on real world feedback from dozens of companies. The CAC Payback Period is now a statement in months, of the time to fully pay back your sales and marketing investment. This single number is the key to determining your level of sales and marketing investment.
It can be calculated simply by dividing the sales and marketing costs of the previous time period (typically a month or a quarter) excluding any account management costs attributed to your “farmer” organization, divided by the new annualized net gross margin added during the same time period (forget the effect of churn and upsells for now).
As an example, if your company added $100k of CMRR in a quarter with 70% gross margins, the denominator would be $70k. If your fully burdened sales and marketing costs were $770k then that would be the numerator. The CAC Payback Period would equal an encouraging 11 Months.
For SMB customers with higher churn rates and thus shorter monetization windows, CAC Payback Periods of 6-18 months are typically needed, whereas enterprise businesses with high upsells and long retention periods may be able to subsidize payback periods of 24-36 months in some cases. A CAC Payback Period of 36+ months is typically a cause for concern and suggests you may want to slam on the brakes until you can improve sales efficiency, whereas a Payback Period of under 6 months means you should invest more money immediately and step on the gas (and please call Bessemer immediately because we want to fund you!) as your customers are likely very profitable within the first year.
It’s also worth noting that many companies also chose to track a dollar based average CAC per customer, yielding conclusions such as “last quarter our Customer Acquisition Cost was $12,500 in the SMB space and $45,000 in the mid market.” The CAC Payback Period and customer averages typically work very well for growth stage businesses, but for earlier stage businesses you likely also need to use some rules of thumb around sales rep performance because it can be very difficult to isolate the financial impact when including executive team involvement and early friendly customers.
Freemium or heavy “land and expand” businesses may also find that just measuring the CAC Payback of their initial deals understates the leverage in their model. In those cases you may choose to do a blended CAC and include upsell MRR as well as account management costs in the formula, or focus on the medium-term value of the customer contracts rather than just the initial subscription amount, by including all CMRR growth and all sales and marketing costs including account management.
Years ago, Bessemer was fortunate to invest behind Mark Leslie at Veritas, and as a result our firm became big believers in the Sales Learning Curve (SLC), a concept Mark helped pioneer. The core concept is that software organizations often fail because they staff up their sales efforts too quickly, before the sales model has been refined. This concept is even more critical for cloud businesses, given the large upfront investment required to acquire customers. Ramping up too quickly will burn precious cash reserve and may fool the product team into missing some critical elements of the real product market fit that will be important to go big over time. This typically means you should hire sales reps slowly upfront, only focus on your core geography until your business starts to scale considerably, and separate your “hunters” and “farmers” as you start to ramp.
For an enterprise-oriented direct sales business, it typically takes at least $300,000 CMRR to climb the Sales Learning Curve. You should tune your model before you scale, which typically means stopping at three field sales reps until you hit at least $300,000 CMRR or at least two of your reps are making their ~$100,000 CMRR quotas. For companies with hybrid inside sales models or freemium offerings, the quotas can be lower but the attainment hurdles are similar. 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 associated 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 forces 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.
You should also separate your “hunters” and “farmers” and pay them all on CMRR growth. As soon as you have climbed the Sales Learning Curve and have a sizeable customer base, you should supplement your sales force with renewal-oriented account managers. When a cloud company starts to hit the sales inflection point, it is important to keep the new business reps (the “hunters”) busy with finding new deals, while a team of account managers (the “farmers”) tends to the established customers. The new account team should be paid on new CMRR with a standard deal structure (such as a one year deal, with quarterly pre-payments), and incentives for more favorable cash flow terms (such as multi-year pre-payments). You should think of account management as a sales function, and that group should be compensated in a similar fashion – but modeled on your CMRR and churn assumptions instead of a new CMRR sales quota. You’ll typically find that the compensation plans are weighted more heavily to base (~75-80%) with less bonus upside, whereas standard “hunter” compensation plans are typically 50% base and 50% commission at quota.
To create a repeatable sales process, focus is also critical, which typically means that you should restrict yourself to your core market. If you’re based in North America with a direct sales model (in person and/or tele-sales), prove your business in North America first. Channels are hard in Cloud Computing in general, and if you can’t sell it yourself then it’s unlikely others will be able to sell it more effectively for you. Only after reaching $1M in CMRR should you invest heavily in channels or international expansion. If you’re a freemium business or enjoy viral adoption more broadly, you may want to consider regional marketing and/or support resources in other regions earlier in the life of your business, but avoid becoming over extended before nailing your home markets. You can think of this as a “bowling pin” strategy on a geographic basis, or good military strategy by avoiding concurrent wars on multiple fronts; it’s also good business strategy for Cloud Computing.
Finally, do not confuse any of this with a message to build your business slowly or to under- invest in sales or marketing. In fact, it’s quite the opposite. The 5 C’s of Cloud Finance and the Sales Learning Curve are tools to help you know when and how to invest aggressively to maximize the business’s long term value creation with the least dilution for you as the executive team. If the metrics are strong, you will be able to finance the business at very attractive terms. You will actually be destroying value if you don’t invest behind success when the ROI is strong.
For a PDF of Bessemer's Top 10 Laws of Cloud Computing and SaaS please click here.