I remember the mid 80’s when Unix entered its hype phase. Traditional proprietary OS companies, seemingly overnight, developed competitive offerings for the Unix market. As a hardware vendor, if you didn’t have a Unix-based solution to offer – even if it was weak – you were toast. Similarly, today, if you’re a high tech vendor it is highly likely you have some sort of Cloud-based offering – even if you’re an incumbent and even if it’s weak.

It hit me last week at the Cloud Connect Conference in San Jose that Cloud Computing may have officially reached its hype phase.  What was my epiphany? When I received an invitation to form a group to discuss “Optical Character Reading In the Cloud”. Seriously? OCR in the Cloud?

I’m sure it was a legitimate invitation to a legitimate discussion but I just had to laugh. It reminded me when my kids were younger and they demanded my wife and me to add the words “in bed” at the end of reading our paper fortune inside our Chinese Fortune cookies. I’m sure it was amusing at first but after repeated readings, it grew a little tiring – at least for the grownups.

With every company adding the words “in the Cloud” to their every marketing pitch and product position it is beginning, for me at least, to feel the same as adding those words “in bed” at the end of those fortunes in the cookies; somewhat wearisome.

Cloud Computing is a great evolutionary business model and technology transformation. It provides an innovative way to deliver new solutions at a much reduced price for consumers/businesses. However, I hope the hype starts to get dialed back soon…just a little…in bed.

It rears its ugly head when a start up CEO comes into our office to take us through their business, introduces the management team and describes one of the executives as the “VP Sales & Marketing”.

At that point, I stop listening and start thinking about how I can end the meeting on a professional note. Like the mythical Unicorn, I don’t believe in the mythical VP Sales & Marketing. Actually, I am more likely to believe in Unicorns than a VP Sales & Marketing.

Why? Simple. Sales and Marketing are vastly different functions that require substantially different personalities, skills, and decades of experience to master. In my 30 years of operating experience, I have found very few people - I mean less than a handful – who are experts at both functions. And, for that rare individual, in my experience I do not believe it is possible to head up both functions simultaneously.

A CEO who doesn’t understand this basic fact, or doesn’t believe it, is not a CEO I want to invest in. Here is why.

Someone who is a head of Sales must have an in depth understanding of current key deals in the sales pipeline,  a deep sense of the probability of whether those deals will close, and what it will take for them to close. This is a 1:1, short-term focus game and success is predicated upon a career of working closely with buyers. In many cases, it also requires someone to travel and meet with prospects to gauge for themselves whether or not a deal is really a deal. It is the realm of oral communicators.

The head of Marketing, on the other hand, must develop and maintain an in depth understanding of the overall market and the company’s brand in that market. To do this, he/she must constantly work with industry analysts, the media, execute tradeshows, keynotes, and the web. Perhaps even more importantly, today’s head of Marketing must be an excellent demand creator (the “owner” of future revenue) through sales-ready leads.

Marketers must know how to generate those sale-ready leads for the lowest acquisition cost and ultimately nurture any sales-ready leads that fall out of the sales pipeline. This is a 1:many game and requires constant refinement through analyzing campaign, market and customer data. It requires continuous meetings with internal staff including the CEO, Product Marketing, Sales, etc. It is the realm of verbal/written communicators.

A CEO who has combined the Sales and Marketing functions, indirectly but undeniably, telegraphs me that he/she does not truly understand the diverse nature of these positions and the fact that it is impossible to execute both functions simultaneously with excellence. In most instances, I have found that the CEO who makes this serious mistake hasn’t worked with someone who is an excellent Marketer and therefore discounts the role it plays.

So, if you ever come and present to me and think you are going to show me a “real” VP Sales & Marketing,  don’t be surprised when I look at you as though you’re trying to convince me there are Unicorns and excuse myself early from the meeting.

Recently, I’ve had a few conversations with people regarding my version of the Customer Acquisition Cost (CAC) ratio. As a reminder, my version of the CAC ratio is: [($Total Sales + $Total Marketing)/$First Year Contract Value]. The objective is to make the CAC ratio less than 1 which implies a customer acquisition payback of a year or less. This is the ratio I recommend companies use to measure their sales/marketing effectiveness. I discussed this a year or so ago in this blog in a post titled “The Capital Needed to Create a SaaS Company”.

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Will Price when he was with Hummer Winblad and Phillipe Botteri at Bessemer Ventures suggest slightly different approaches and put the Sales and Marketing costs in the denominator with FCV on top of the equation. This makes sense if you’re looking at a company from an investor’s view but I come at things more from an operational perspective and developed my approach in 2004 when I was running Siebel’s CRMOnDemand division. I found that my approach allowed me to easily determine whether or not my Sales and Marketing teams were paying back our customer acquisition costs within 1 year and to track the trend. With the other mathematical approaches, in my opinion, it’s a little harder for the operational executive to determine what’s going on. All approaches are mathematically sound; it’s just a matter of preference.

One of the common issues I’ve been debating is why not use Total Contract Value v only First Year Contract Value so that Sales and Marketing get complete credit for multi-year deals.

Here is how I like to think about the issue.

With early stage companies that use a SaaS business model, companies should be primarily concerned with the preservation of cash not necessarily revenue.  The CAC ratio as I have proposed it focuses on actual Sales and Marketing expenses – which takes real cash – and the First Year Contract Value which represents actual first year cash inflows.

For early stage companies, I feel this is the most appropriate way to look at the CAC ratio because it measures ‘real’ cash inflows v ‘potential’ cash inflows. As the company matures and revenue becomes increasingly more important and cash less so you may want to adjust this ratio to give at least partial credit for multi-year deals.

I want to also comment a little further on the “$Total Marketing” in the CAC ratio. To really maximize effectiveness here, companies must hold the marketing function accountable for accurately creating and predicting future revenue for the company. Rather than just being responsible for managing corporate brand, marketing must be transformed and own the lead generation function and held accountable for accurately predicting out of period, future revenue.

Asking the sales organization to predict future revenue is like asking a sprinter to run a marathon. Sales is incented to predict and close in period revenue. They are terrible at predicting out of period revenue – just take a look at the garbage your CRM system contains in terms of future pipeline coverage. And, many companies make guidance statements based upon this highly subjective data – no wonder so many companies miss their forecasts.

As the former head of marketing for a multi-billion dollar software company, I am all too familiar with the pressure of delivering leads and generating statistically relevant data for Wall Street predictions. Consequently, I firmly believe the marketing function as we have known it must be transformed. Instead of just a brand organization, Marketing must become accountable for accurately predicting  Q+1…Q+N revenue by building a lead generation and lead nurturing function that monitors, tracks and predicts lead conversions and conversion rates.

That’s why I am a big believer and an investor in Marketo. They are building applications for Marketing and Sales that enable those groups to minimize CAC costs and accurately predict and maximize future revenue. And, whether you choose to use Marketo or another similar application, your company must transform its marketing function and hold it accountable for creating and accurately predicting future revenue: only then can you expect to truly minimize your CAC ratio. ]]> http://www.interwest.com/software-as-a-service/brand/minimizing-the-customer-acquistion-cost-cac-ratio/feed/ 3 http://www.interwest.com/software-as-a-service/market-leadership/saas-lead-generation-not-sales-capacity-drives-the-model/ http://www.interwest.com/software-as-a-service/market-leadership/saas-lead-generation-not-sales-capacity-drives-the-model/#comments Fri, 12 Jun 2009 04:39:39 +0000 Bruce Cleveland http://www.interwest.com/software-as-a-service/?p=158 One of the key issues that concerns investors and management teams alike vis a vis the SaaS business model is its potential to consume a large amount of capital until finally reaching profitability. Many people have written about this topic, including me.

SaaS companies are typically built upon a stream of relatively low cost subscription licenses, paid out monthly/quarterly/annually — even multi-annually. Unfortunately, for the vendor, the subscription model usually generates far less up front cash than a traditional ‘perpetual license’ software model. But, over time, the compounding effect of the SaaS model can build into a nice annuitystream — provided churn rates are minimized.

It is this up front cash differential that is the primary appeal of the SaaS model over the traditional software model with customers. However, this differential is also what makes the model vexing for the SaaS management team and the investors.

If we examine the income statement of a typical SaaS company, we find that the operating ratios are not that disimilar from a traditional software company that uses a perpetual license model.  Both require similar sales, marketing, engineering, SG&A, etc expenses. However, the SaaS company has the additional burden of absorbing the expense of delivering and managing the service.

The compounded problem of less up front cash and additional expense can make the SaaS model a challenge for the vendor. Therefore, in order for a SaaS company to be successful it must be very efficient in how it designs, builds, markets and sells its service.

Also, while the operating ratios of both models may appear to be similar there are some fundamental differences in how each generate revenue. In a perpetual software license model, revenue is a function of sales capacity. That is, revenue generation is driven by the number of fully onboarded and trained sales representatives. In contrast, SaaS revenue generation is a function of lead generation; sales capacity should only be added once it is determined that sales will be unable to keep up with total lead pipeline generation.

In a traditional software company, lead generation typically comes from 3 primary sources: sales, marketing and partners. We can debate the ratios but basically a traditional software company should expect the sales, marketing and partner organizations to each deliver 33% of the leads in each period in sufficient quantity such that there is an overall pipeline of 3x+ the total number of qualified opportunities needed to achieve the period’s revenue objectives.

In a SaaS model, given its cash constraints and dependency upon lead generation to drive revenue, it is imperative that the lead generation function be highly structured and optimized. 

In all companies, but especially in a SaaS company, the marketing function should be held equally accountable for revenue production as the sales organization; sales should be held accountable for “in period” revenue production and marketing should be held accountable for ”future period” revenue production – where “future period” revenue is in the form of contacts generated by any form (sales, marketing and/or partners) that are qualified and then converted into “sales-ready” leads.

In addition, rather than just the 3 primary lead sources discussed previously (sales, marketing and partners) one other lead source must be added. This critical lead source is “customers”. Done correctly, this is the lowest cost lead source and most valuable; there is nothing more credible than a customer who is willing to promote the benefits of your products. In a SaaS model constrained by cash, it is imperative that you harness this lead source and maximize its effect.

Here are two simple suggestions to help you leverage your customers in the lead sourcing/generation process: 

1. Make it easy for your existing customers to share with anyone else the output of your application. For example, the UI should enable a customer to send graphical reports with data generated by your application with the phrase ”powered by..”  at the top and bottom of the report.  And, you should enable/encourage the recipients to click on ”powered by..” which can take them to a landing page where you can serve an offer to trial the application. 
2. Create a community. There are a number of community applications out there (e.g. Jive, Lithium, HelpStream, HiveLive, etc.)  and you can pick any one of them that appeals to you depending upon the type of features you desire (e.g. ranking/ratings engine, chat, surveys, etc.). These applications enable you to embrace your customers daily, query what they like and don’t like about your products and to use them as mavens and/or super references. You can then use your community as part of your SEO/SEM strategy. On your landing pages, you can offer the prospect a trial and at the same time give them the ability to roam/query your community to find out whether your “marketing hype” matches up to reality. Nothing like a real customer to sell a prospect.

The bottom line is that in order to make the SaaS model successfully work for you – as well as your customers – you need to focus on lead generation. And, due to the cash constraints, you must be hyper-efficient in managing your lead sourcing/generation process. The key here is to harness the power of your customers. Without them, you will place the financial burden of lead generation primarily upon your company and potentially consume more capital than is necessary.

I have listened to hundreds of presentations from entrepreneurs looking for funding since I joined InterWest Partners. They all have one thing in common: the majority of the presentation is spent on the product they are building and the market they are targeting.

Similarly, when a venture firm does its due diligence, it spends a significant amount of time and effort speaking with current or prospective customers and analysts to gauge their level of interest, the importance to the business, ROI, usage rates, etc.

This is all very laudable.

However, if you were to perform autopsies of technology start-ups that have failed, I think you would find that most were able to build the products they said they would—and that the customers who purchased them received more than marginal utility from them.

So, if these companies were able to build their products and were able to find customers who used and liked them, why did they ultimately fail?

I believe that one of the primary reasons has nothing to do with products or markets. Instead, most of these companies went under due to their failure to create a recognized and differentiated global brand– a brand that linked their company and the use of their products with their customers’ success.

Global brands must be engineered – they seldom just happen on their own. It takes a management team that understands the value of building a brand and one that knows how to do it and is willing to invest a significant amount of effort.

When I think of great high tech brands, I think of those built by IBM, Microsoft, Oracle, SAP, or more recently Salesforce.com. Each of these companies invested heavily in their brands and their “brand promise.” When you think “SAP,” you think “runs my business.” If you think “Salesforce.com,” you think “No More Software.” Oracle invested heavily in PR and advertising for many years – and still does today – to build its brand as a leading provider of database and information technology.

So, if creating a global brand is important, what can you do if you’re a small technology start-up with very little cash to create a global brand?

Well, consider the example of Salesforce.com’s Marc Benioff. Marc created controversy by taking on the CRM Goliath at the time — Siebel Systems – even when his product was substantially inferior and he wasn’t focused on the enterprise market. He created conflict and drama through the use of his “No More Software” campaign and got the media to write about him at virtually no cost in order to achieve an unfair share of voice in the market.

It’s a good strategy. Technology journalists are weary of writing about speeds and feeds. If you can give them juicy content about your company’s plans to upset the status quo–with some credible evidence to back up your statements–you will get “free” press all day long.

As I wrote earlier, you must engineer your brand — and your brand objectives — into your day-to-day operations from the very beginning. You must measure yourself against these objectives weekly if you are serious about achieving these goals.
Here are some questions to ask yourself and your team to gauge your progress:

1. How many keynote speeches at major industry conferences were you and/or your key executives personally invited to deliver last year? Not panels, keynotes. You should be giving at least one keynote every quarter, perhaps more often, or you really aren’t relevant. If not, why isn’t your PR agency getting these for you?

2. Do the leading industry analysts regularly follow your space and are you in the furthest upper right hand corner of their charts? If not, what are you going to do about it? Achieving this position takes a dedicated effort by the CEO and key product and marketing executives. It won’t just happen because you build a great product.

3. Does your Web site support a community of your end users and partners with content, ratings and a way for the community to suggest new product ideas? Hosting a “User Week” is fine, but it’s only once a year. Today, you can receive customer feedback on your products and funnel it to your organization daily.

4. If you did a random survey of influential CEOs in your industry, would they know you personally and would they recognize your company’s name and products? If not, what are you going to do about it?

5. If you took a random sampling of your employees, customers and partners, would each of them use the same words to describe what your company does and its value proposition? Does every employee in your company know the corporate mission statement? Have you tested every customer facing employee to ensure they deliver the corporate messages identically? A global brand starts with consistency.

These are five things you and your team can do to start separating yourself from the rest of the pack. From my experience, the great companies never neglect their brands.

And if you’re still looking for funding, a good place to start paying attention to your brand is during your presentations to venture capital firms.