Taking Advantage of Customer Satisfaction Information

The Massachusetts Technology Leadership Council hosted a program on software-as-a-service (SaaS) sales and marketing issues last week that provided useful advice on how to use the unique qualities of a SaaS solution to enhance customer satisfaction. The program included a panel of executives who have had experience selling their solutions both under an on-premise model and via SaaS.

In the SaaS model, the provider and the customer are more closely connected. For one, the provider is responsible for delivering the solution over the life of the subscription, in contrast to the on-premise model in which the customer licenses the solution and deploys and manages it on their own.

In the SaaS model, providers and customers are also tightly coupled through the renewal mechanism, by which customers periodically renew their subscriptions. Happy customers are essential for renewals, and high renewals are essential for the provider's success.

The panelists noted several effective marketing practices that have had a positive impact on their SaaS business:

• Their companies closely monitor customer satisfaction through their on-going connection to their customers. They do this through quantitative surveys, as well as through focus groups, observing customer behavior, and close review of support calls.

• Nancie Freitas, CMO of Constant Contact, explained how the company uses customer satisfaction data to drive product enhancements. Customer support reps work closely with engineering to address user issues, and each new release, delivered every two months, is explicitly designed to address flaws identified by customers. Success is measured by gains in the "net promoter score," the number of users who are likely to recommend the product to others.

• Some companies gather aggregate data on customer usage and provide it as benchmarks to their customers. This helps customers better assess their activity and understand best practices.

• Brian Zanghi, CEO of Kadient, explained that they monitor customer usage to identify follow-on sales opportunities. Heavy usage may indicate that the customer is a prospect for additional subscriptions.

SaaS enables - in fact requires - that companies stay closer to their customers. Marketers should take advantage and leverage the insights gained from that on-going connection.

The Risks of Spending Too Little on SaaS Marketing

Though most companies worry about spending too much on sales & marketing, there are also risks in spending too little. In the interests of conserving cash in the short term, companies could be jeopardizing long term success.

I'll talk about two specific types of under-spending risks. I've labeled them 1) climbing a mountain wearing flip-flops, and 2) the Ferrari stuck in the garage.

Climbing a Mountain Wearing Flip-flops

Companies expose themselves to one type of risk by denying sales & marketing the resources they need to complete their required tasks. They're asking them to take on a steep challenge without providing them the proper equipment, like asking them to climb a mountain wearing flip-flops. The company may save money on the footwear (I just bought a pair a flip-flops from Old Navy for $2!), but it's hard to imagine them getting very far on the journey.

Think about what companies are asking from sales & marketing. Here's some of the critical tasks they've been assigned:

• Build visibility in the market
• Establish a positive reputation, market leadership, and credibility
• Generate and cultivate qualified leads
• Prepare effective and timely sales support tools
• Pursue qualified opportunities
• Close new business
• Build loyalty among existing customers
• Secure renewals.
  

Some of these challenges are unique to software-as-a-service (SaaS) companies, making the sales & marketing task particularly difficult. For example, SaaS companies generally need to attend much more closely to their existing customers in order to secure renewals. Also, SaaS companies tend to introduce product enhancements more frequently than on-premise application vendors. These enhancements require more frequent updates to marketing and sales material.

The size of the task explains why most SaaS companies provide relatively high funding for their sales & marketing organizations. For those companies for which financial data is publicly available, they spend, on average, 45% on sales & marketing relative to subscription revenue. In some instances, they spend as high as 82%. Sales & marketing expenses typically account for their single largest budget item.



This high level of spending relative to subscription revenues is inherent in the SaaS model because sales & marketing expenses are generally recognized up-front, while revenues are spread over the life of customer subscriptions.

If your company is spending below that 45% average, you may want to look at whether your sales & marketing organization has the resources it needs. You'll recognize this problem, for example, when over-loaded sales reps are unable to follow up on qualified opportunities, existing customers are unaware of product enhancements, your company is consistently overlooked by influential analysts, or marketing collateral is out-of-date or unavailable.

A Ferrari Stuck in the Garage

SaaS companies expose themselves to a second kind of risk when they under-fund a sales & marketing operation that is well-built and runs efficiently. Efficient sales & marketing operations can generate high lifetime revenues with low customer acquisition costs. (See "Marketing Spend: How Much is Enough," for an extended discussion of this "lifetime customer revenue/customer acquisition costs" ratio.) Under-spending on sales & marketing in this instance means a lost opportunity to leverage an efficient machine.

Top performing SaaS companies can generate more than $10 in lifetime customer revenue for every $1 spent on sales & marketing for customer acquisition. They've built a high-performance vehicle. But if they chose not to fill it with fuel, they'd have the equivalent of a Ferrari stuck in the garage. Their investment would be squandered. The consequences are foregone opportunities for growth and market share.

Short-term Cash Conservation or Long-term Capital Destruction?

In general, I advise that companies be careful with their sales & marketing spending. In fact, I've probably spent as much time in my marketing career poring over "opportunities yielded per program dollar," "mid-funnel conversion" ratios, and other metrics as I have pondering ad layouts or direct mail offers. Companies selling via the SaaS model have little room to spend foolishly on sales & marketing. And companies spending too aggressively on sales & marketing - the Wile E. Coyotes - can quickly get into trouble.

That said, however, companies should also recognize that under-spending exposes them to significant risks as well. Though they may conserve cash in the short term, they may be losing an opportunity to grow even faster. In a market in which 2 or 3 vendors are looking to emerge from a crowd , under-spending could cost visibility and market share. Saving a few thousand dollars in the short term could forfeit a long-term market leadership position and millions in future revenues.

Marketing Spend: How Much is Enough?

Workday, a software-as-a-service (SaaS) provider of HR and financial solutions, raised another $75 million last month to fund growth. This is in addition to $75 million raised in earlier rounds, bringing the total to $150 million in funding.

Workday will probably use some of the new funding to build out its application and its operations and support infrastructure, but I suspect a large portion will be spent on sales & marketing to acquire customers.

Is this amount too much? Too little? Just right?

A formula to assess the level of spending on customer acquisition could be helpful.

Average lifetime value of customer/average cost of customer acquisition

In this formula,

Avg. lifetime value of customer= avg. monthly recurring revenue * avg. length of subscription

and

Avg. cost of customer acquisition = sales & marketing expense/new customers

According to this formula, a calculation yielding "1" would indicate that the cost of acquiring a customer would be equal to the revenues derived from that customer over time. In other words, $1 in customer acquisition expense yields $1 in lifetime revenue.

A number greater than "1" would indicate that customers are contributing more than the costs of acquiring them, and the excess could be applied to fund development, support, operations, and other expenses, or even show a profit. That is, $1 spent on acquiring a customer would generate more than $1 in lifetime revenues from that customer.

A number less than "1" would indicate that the cost of acquiring customers exceeds the revenues they'll contribute over time. SaaS vendors may run at a rate of less than "1" for a period of time, funding the shortfall with debt or outside capital, but it's not sustainable over a long period.

(There are certainly more sophisticated formulas, using gross margin, cash flow analysis and other elements, which would provide indicators for profitability and capital requirements, but in this instance I've opted for simplicity in order to focus on sales & marketing spending. Bessemer Ventures and Joel York are excellent sources for more in-depth financial analysis.)

For illustration, let's run the formula using financial results reported by salesforce.com for the fiscal year ending January 31, 2009.

• Revenues from subscriptions in FY 2009 = $985 million
• Sales & Marketing costs in FY 2009= $534 million
• New customers acquired during FY 2009 = 14,400
• Total customers at Jan. 31, 2009 = 55,400

salesforce.com reports that the average length of a subscription contract is 12-24 months, though I suspect they renew most of these contracts, so the average length of a subscription is much longer. For the sake of this exercise, I'll estimate 5 years.

• Avg. lifetime value of customer= ($985,000,000/55,400 customers) * 5 years =$88,899
• Avg. cost of customer acquisition = $534,000,000/14,400 new customers = $37,083
• Average lifetime value of customer/average cost of customer acquisition = 2.40

Based on these data and my assumptions, for each $1 spent on customer acquisition, salesforce.com generates $2.40 in lifetime customer revenues.



I've calculated the ratio for several publicly-held SaaS companies, using the same estimate of a 5-year customer lifespan.

At the high-end of the scale, athenahealth generates about $10 in lifetime customer revenues for every $1 in sales & marketing costs to acquire a customer.

RightNow, by contrast, generates 40 cents for every $1 spent acquiring a customer.

Use these numbers with caution. For one, they represent only a single year's worth of data and can be skewed by unusual events. Taleo's ratio, for example, is affected by its acquisition of Vurv and its entire customer base in 2008.

More data and deeper analysis would be required to assess the potential profitability, cash requirements or overall financial health of SaaS companies, but the formula does give useful guidance on marketing spending.

• Extending the life of the customer's subscription is critical to success. Be certain to allocate resources to retain your current customers. Losing customers you've already paid for can be disastrous.
• Carefully control spending to maximize effectiveness. To the extent possible, measure the impact of all sales & marketing activity on acquiring or retaining customers. Certainly, this is critical to on-premise vendors as well, but it's especially so for SaaS companies.
• Carefully identify your target prospects and avoid deals that don't offer an adequate potential lifetime value. There's no point in spending $5 to acquire a customer who's maximum potential lifetime value is $3. That's spending money to lose money.
  
• Ensure your pockets are deep enough to carry you while you wait for revenue. Though you're making the sales & marketing investment up front, the returns are spread over the lifetime of the customer. You need to have adequate funding to bridge this mismatch of immediate investment and long-term return.