Tuesday, October 9, 2012

SaaS customer acquisition: Feed it or starve it?

If you manage a software-as-a-service (SaaS) company, at some point you'll be forced to make a tough decision about your customer acquisition process:  Feed it or starve it?

Should you pony up the money to feed a full-blown sales and marketing effort?  Or should you starve the process and keep the cash in your piggy bank?

Because of the way the SaaS business model works, if you feed the customer acquisition process, you hurt profits and burn cash.  In fact, the more customers you acquire, the more money you lose, and the more cash you burn… at least in the short term. (David Skok of Matrix Partners calls this the "SaaS Cash Flow Trough.")

And if you starve customer acquisition, you improve profits and save cash.  The downside: you might actually kill the company.

Faster growth = lower profits

The problem is timing.

To acquire customers, you pay money now - for sales people, marketing people, tradeshows, pay-per-click campaigns, search engine optimization, direct mail, or whatever else you do to attract paying customers. 

But those customers don't pay you money now, or at least not all of it.  They pay you over the life of the subscription.

Earlier I've described this as the "Wimpy effect" after the Popeye cartoon character who promises "I'll gladly pay you on Tuesday for a hamburger today."

Here's how that looks on an income statement:  costs are higher than revenues.  Profitability goes down and cash flows out. 

In fact, the faster you grow and the more customers you acquire, the more the costs exceed revenue, the more profitability goes down, and the faster cash flows out.

So here's where that critical decision - starve it or feed it - jumps out at you.

The "starve it" option

You could choose the "starve it" option.  Cut sales and marketing headcount and scale back spending on customer acquisition programs. 

The good news is that you post higher profits and burn less cash.

The bad news is that you don't attract many customers.  That means you're giving up revenues, both in the short term and in the long term.

And if you're in a very competitive market, it's likely that you're losing market share.  The prospects you're not attracting are adopting somebody else's SaaS solution and they're lost to you.

At the end of the "starve it" route, you'll have a better looking income statement and more cash on hand.  But you'll also have a smaller company with fewer customers that's losing momentum, having a tough time competing, and dimmer long-term prospects.

The "feed it" option

Or you could choose the "feed it" option.  Put more money into sales and marketing and ramp up your customer acquisition programs.

The bad news is that you hurt profitability and burn more cash.

The good news is that you attract more customers.  There's more revenue now and lots more revenue over time.  And you're gaining momentum and market share.

Making the "feed it"option work

If you want to succeed in the long term, it seems that the obvious choice is to feed the customer acquisition effort, not starve it.  But a few things need to be in place to make the "feed it" option work.

1.  It requires enough capital to pay for the "feed."  The cash you're using to pay for sales and marketing needs to come from somewhere.

2.  The "feed it" option requires you acquire customers cost-effectively.  Every dollar you put into sales and marketing needs to generate more than a dollar in revenue over the life of the customer.  In fact, as a rule of thumb, every one dollar spent on customer acquisition should actually yield at least three dollars in long term revenue. (Commercial interruption:  SaaS Marketing Strategy Advisors can help you build an efficient customer acquisition machine.)

3.  This option requires patience and courage.  Spending money to lose money in the short term is not for the faint of heart.

4.  And finally, making the "feed it" option work requires a deep understanding and confidence in the SaaS business model.  After all, it runs counter to the common wisdom:

In the short term, every new customer costs you money.  
But with a well-run SaaS business, over the long term, you actually do make it up in volume.

Creative Commons License

This work by Peter Cohen, SaaS Marketing Strategy Advisors is licensed under a Creative Commons Attribution 3.0 Unported License. Images obtained via iCLIPART.com.