Hi everybody, I’m John Smith, General Partner with Innosphere Ventures leading the B2B software practice. I have over 30 years’ experience founding and building software businesses, taking them from scratch, to over 100 million dollars in annual revenue. Now I’m a Venture Capitalist ready to guide you on your journey helping you build your successful B2B SaaS business.
Today, I’ll be talking to you about how to build a successful SaaS business. On the innospherefund.com website, I have a downloadable version of the presentation where I’ve sprinkled in over 40 hyperlinks of thought leading articles providing much more detail on the concepts that I will cover today, so I really encourage you to download the presentation.
Okay so let’s level set with a quick description of What is Software as a Service? Well, it’s software that is running in the cloud provided to consumers on demand through a recurring revenue model with subscription-based pricing. The consumers avoid the expense and hassle of running the software on their own systems and the software is available as a web app as well as a mobile app.
Okay so what is the market for building a SaaS business? Today there are over 15,000 SaaS companies in the world. Gartner projects the SaaS market to be over 143 billion dollars by 2022 and it’s growing fast. The tailwinds of digital transformation and the disruption caused by COVID-19 have dramatically accelerated SaaS growth and SaaS company valuations so now is the best time in history to build a SaaS business. You can find an unsolved problem in an exciting market niche by using your domain expertise and industry specific insights. Look for opportunities to digitize and automate workflows or opportunities to integrate analytics for better decision-making operational efficiency and customer experience.
Techniques to find opportunities include the “job search method”, the “app store method”, and the “what they’re using excel for” method. Now, there are many verticals to find an exciting market niche including Fintech, Healthtech, Energytech, Logistics Tech, and many more. You’re looking for opportunities that result in a one billion dollar plus serviceable addressable market. To calculate your addressable market, let’s take an example of an Insuretech solution with an annual average contract value of six thousand dollars. There are four hundred and twelve thousand insurance brokers and agencies in the United States, so the total addressable market is 2.4 billion dollars. Next find the subset of brokers that are a match for your buyer persona. In this example, let’s say it’s 200,000 so the serviceable addressable market becomes 1.2 billion dollars. Next, calculate your serviceable obtainable market by taking a reasonable fraction of your SAM given the competitive landscape, in this case the SOM becomes 300 million dollars which is big enough to build a 100-million-dollar business.
All right next up, what are go to market strategies for a SaaS business? So, building your go to market machine is at least twice as hard as building your product. This takes a lot of hard work. It’s very important to make sure you’re not spending money too early on scaling marketing and sales. So, first test your idea by starting with market research, understand the exact problem you’re solving, develop buyer personas, develop a laser-focused message, do a little marketing, test to see if people will buy your product, and then continue to iterate until you have it right. This is establishing product-market-fit. The key to establishing product-market-fit is finding a great market first, then understand the problem you’re solving and design a solution to the problem.
Product led growth. Now this is the idea that the product leads the initial customer experience. The sales and customer success teams work together helping the customer be successful with the product delivering value before capturing value. The key to success will be ease of use. Customers need to see value quickly. So, next figure out your go-to-market fit. Identify the best sales model to access your buyers and build the repeatable go-to-market playbook lined up on the right use case to create urgency. Continue to iterate until you get to the point where you’re confident the go-to-market machine is in place and it will work. Now you can scale your lead generation, scale the remote sales team by hiring Superstar sales reps and Make. It. Rain. There is a slide in the downloadable presentation that shows you how to calculate your customer cost per acquisition for both outbound cold prospecting and paid ads to ensure you’re getting the desired return on investment for your marketing and sales spending.
All right, so how do you make the customer journey pleasurable? For a SaaS solution great user experience is more than making the UI beautiful and easy to use. User experience is all-encompassing covering everything along the customer journey. It’s the key ingredient to the success of the business. You want to make everything easy for the user so here’s my “easy button” showing the areas where the user experience designer needs to be involved designing all the user points of interaction making everything easy and consistent across the entire business. Now the seven principles for great SaaS user experience include: frictionless sign up, laser focus on your target audience, simple onboarding, very easy to use user interface, personable, beautiful design, and making support readily available. Get your user experience designer involved early and often from the very beginning of the process of building your solution including your landing page. Have your data analyst analyze your customers usage data to make better decisions about your go-to-market, your product and customer success. Deliver a positive user experience in all aspects of the customer journey.
So how do you price SaaS products? It’s very important to align your pricing model with your buyer personas and make it easy to understand. Don’t create friction for the buyer, they need to find themselves on one of the tiers with everything they need to successfully use your product at a price that makes sense to them. Now too often companies put in place a restriction to get the buyer to move up to the next tier. This turns into an annoyance and makes the buyer look for another vendor. So, for example setting the number of allowed dashboards or reports too low for a particular tier. You want the buyer to feel good about the pricing like you designed it specifically for them. So make sure your product delivers value with your freemium before they hit the paywall. Keep the freemium simple and high value. Now pricing isn’t a set at once and done activity, you need a culture of continuous rapid improvement with experimentation to get it right over time. HubSpot is an example of a pricing model with different tiers, per user fees, a freemium and a discount when multiple products are bundled together.
So how do you build the product for a SaaS business? First, develop a multi-tenant architecture from the very beginning using AWS as your cloud provider. React is quickly becoming the popular choice for front-end development while Python and node.js are the choices for the back end. Start your development with serverless Lambda functions to quickly build your application and keep costs down. The use of Lambda functions initially negates the need for Docker and Kubernetes, but they will be useful once the business is ready to implement a more scalable application, with Lambda functions becoming part of a microservice. Microservices communicate with each other asynchronously using the SNS message bus. Use data analytics for trending and predictive analysis. Use AI to provide personalized recommendations and increase customer engagement.
So what methodology do you use to build a SaaS product? You want to use a world-class Agile product development methodology to ensure a rapid timely delivery of high-quality products and have the flexibility to respond quickly to evolving market needs. The state-of-the-art Agile methodology is the Scaled Agile Framework known as SAFe the creator and Chief Methodologist of SAFe is Dean Leffingwell the world’s authority on lean agile best practices. The SAFe methodology is designed to provide just enough process for all company sizes so you can start at the essential level and work your way up to full SAFe as the business grows. The agile, the scaledagileframework.com website goes into great detail on how all the pieces of the methodology work. You should also use the Agile methodology in your marketing and customer success functions to continuously improve how those teams get work done.
Okay so how do you ensure customer success for a SaaS business? Now customer support is reactive, but customer success is proactively delighting your customers. Customer success focuses on the complete user experience making onboarding easy, providing education up front, understanding how customers are using the product, and proactively solving customer problems. In the SaaS recurring revenue model, you earn your revenue every month. So customer success is responsible for ensuring customers renew their contracts and for finding upsell and cross-sell opportunities. Your customer success managers need to possess and develop a wide range of skills, technical skills, sales, problem solving and soft personable skills. With a product led growth strategy you need to deliver value to customers early by getting your CSMs involved in the sales process before asking for payment.
All right, well how do you build a team for a SaaS business? So first don’t underestimate the power of culture. Creating an empowering culture is very critical to building a high performing team which will lead to your ultimate success. As you’re getting started, your organization will look something like this. A founding CEO, a CTO with a product manager and around four engineers, a remote sales rep and a customer success manager. The rest of the team will consist of outsourced partners including a user experience designer, marketing specialist, finance and HR. Now the Innosphere Ventures team has vetted a set of outsourced partners for every function of the business to meet your needs. This includes user experience, product development, customer success, finance, HR, a variety of marketing specialists, along with a consultant to teach you how to build a SaaS sales organization. All these partners are state-of-the-art thought leaders in their functional areas enabling you to quickly build a world-class company even as an early-stage startup.
As you grow the business and receive your VC funding, the organization will evolve into something like this, a Chief Revenue Officer leading the sales organization of remote sales reps, SDR’s, channel development managers, and consultants. Chief Marketing Officer leading a team consisting of the user experience designer, data analyst, and a variety of specialists. A Chief Customer Officer leading a team of CSMs, new customer concierge and training specialists. A Chief Technology Officer leading the product development organization consisting of product managers, architects, UI designer, data scientist, scrum master, and the development, QA, devops engineers. A Chief Financial Officer leading the finance team and a Chief People Officer responsible for HR. Many of these people will continue to be part of the outsourced partner’s organizations working with your employees. Now the business tool suite slide in my downloadable presentation lists my recommended 17 tools along with their pricing to cover all the functions of your business. This set of SaaS tools have integrations with each other to create a connected enterprise. Being that they are SaaS tools, they provide a great set of examples for how you should consider pricing and marketing your SaaS product.
So, how do you know if your SaaS business is winning? Once you have your SaaS company established you need to put in place a system to manage the business. This is done by establishing a set of metrics that will allow you to keep your finger on the pulse of the business. You need metrics for all functions of the company. Revenue and cash, customer acquisition, customer success, product development and the SaaS value drivers. The SaaS value drivers are a key set of metrics that if optimized will have a profound impact on the valuation of the business. In the downloadable presentation there’s a slide listing my recommendation for metrics covering all five business metrics categories with the desired target values for each. So, for example, churn should be less than six percent, funnel conversion rate should be greater than 1.5 percent, and viral coefficient should be greater than 0.2. These metrics need to be actively monitored so you can make course corrections quickly. So, having a dashboard that gives you in-month performance and the ability to set thresholds alerting you to potential issues before they become problems is essential to keeping the company running in the right direction.
So, what does a five-year financial model look like for a successful SaaS company? Well, here is an illustrative example of a five-year pro forma income statement for a fictitious SaaS company we’ll call Newco. We start year one when Newco is ready to earn revenue. There has been a lot of work prior to this point, isolating a target market niche, establishing product market fit. This example shows how a successful company can expect to ramp revenue over a five-year period. So, here we have a six-thousand-dollar annual average contract value ramping up to seven thousand dollars and a customer count ramping from 48 in year one to a little under 1800 in year five. The COGS shows a breakdown of the key areas and how you want to drive to a gross margin of around 77 percent. The operating expenses for each of the three areas will improve as a percentage of revenue as the company reaches breakeven and becomes profitable with a net income margin of 23 in this case. This will drive the total headcount to 118 people including employees, independent contractors, and the staff with your outsourced partners. The required investment for Newco would include pre-seed funding, a 1.5-million-dollar seed round and a three-million-dollar series A round of financing. Now the metric values in year five are very healthy so Newco would be on a path to becoming a 100-million-dollar business.
So, there you have it, an overview of what you need to do to build a SaaS business and what success looks like. So go to the innospherefund.com website and download the Building a Successful SaaS Business presentation so you can go deeper into the concepts I’ve covered today with all the hyperlinks and extra slides.
Once you’ve established a product market fit for your business and are ready for seed funding, reach out to Innosphere Ventures and let’s see if we can be your partner helping guide you along your journey to success!