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a16z Podcast | Valuing Today's Fast-Growing Software Companies
21 segments available
Here's a head scratcher: When faced with valuing software-as-a-service companies (in simple terms, those that sell software via a subscription model and the cloud), the faster the business grows the worse the economics may look. At least in the beginning. Andreessen Horowitz’s managing partner Scott Kupor, Jamie McGurk, and Preethi Kasireddy unpack the SaaS model, describe how a16z figures out the value of these companies, and determine what makes them so “sticky.” Finally, if growth hurts so bad -- in economic terms anyway -- when does it start to feel better?
Segments Timeline
Understanding SaaS Valuation
Scott Kupor introduces the discussion on valuing SaaS companies, addressing the common perception that these companies are overvalued. He sets the stage for a deeper exploration of the metrics and frameworks necessary to evaluate whether the current market conditions reflect a bubble or normal behavior.
"hi this is a Scott Cooper from injuries and Horowitz and I'm here with pretty casa ready and Jamie Mukherjee from our corporate development teams and we want to talk today a little bit about sass eval..."
Revenue Multiples and Profitability
Jamie McGurk discusses the two main metrics that lead to bubble concerns in SaaS: revenue multiples and expected losses. He explains how the current trading multiples of companies like Workday raise questions about their valuation, emphasizing the need for a nuanced understanding of these financial indicators.
"bubble or is this all just normal behavior so I think there's two things that people look at and point to 20 point to the bubble and and one is revenue multiples that a lot of these sales companies ar..."
The Flaws of Traditional Metrics
Preethi Kasireddy highlights the limitations of using traditional metrics like revenue and earnings per share (EPS) to evaluate SaaS companies. She explains how SaaS revenue is recognized over time, contrasting it with perpetual models, and emphasizes the importance of understanding customer lifetime profitability.
"yeah um well SAS it's a little bit different right from from perpetual models and SAS you getting the revenue from the customer over an extended period of time and so it wears professional model model..."
The Importance of Billings
The discussion shifts to the concept of Billings as a crucial metric for SaaS companies. The speakers explain how Billings serve as a leading indicator of future revenue, providing predictability in cash flow and helping investors gauge the health of a SaaS business.
"whether that was a good purchase or not you know for us as a company and so I think and then you know if we kind of just use that same example on the SAS side right if you know your workday for exampl..."
Understanding Deferred Revenue
Jamie McGurk elaborates on how deferred revenue on the balance sheet can be a proxy for Billings. He explains how changes in deferred revenue indicate the growth or shrinkage of Billings, reinforcing its role as a leading indicator for revenue growth in SaaS companies.
"next three years so there's predictability in the cash flow there's visibility into the future and so what's different about SAS is a lot of financial analysts like it because you can really predict t..."
Customer Acquisition and Profitability
The conversation concludes with a focus on customer acquisition strategies in SaaS. The speakers discuss the importance of understanding the long-term profitability of customers and how this impacts the overall valuation and financial health of SaaS companies.
"sure I think a great example of that is cast lights recent IPO where you know if you look at what the revenue was you know on the income statement on a trailing basis or even on a forward to projected..."
Customer Acquisition and Profitability
This segment explores the concept of customer acquisition in the SaaS model, where companies often incur upfront costs to acquire customers. The speakers discuss the long-term profitability of these customers and how the SaaS model differs from traditional software licensing, emphasizing the importance of customer retention and lifetime value.
"customer is profitable but potentially over a longer period of time than we're used to thinking about right so again if we kind of go back to maybe the simple example we started with you know that Ora..."
Navigating Negative Cash Flow
The discussion continues with the challenges of negative cash flow in SaaS companies. The speakers explain how initial high spending on customer acquisition can lead to deeper cash flow deficits, yet ultimately result in faster growth and profitability. They address common misconceptions investors have about this cash flow dynamic.
"stick around for 3 5 10 years any more so than you know that Oracle perpetual license customer and and how does that kind of Phaedo play into how people think about long-term profitability yeah sure w..."
Understanding Customer Lifetime Value
In this segment, the speakers delve into the metrics of customer lifetime value (CLV) and customer acquisition cost (CAC) in the SaaS context. They explain how understanding these metrics helps investors gauge the sustainability of customer acquisition strategies and the long-term profitability of SaaS businesses.
"a customer a company will spend a ton of money and acquire customers and they're just trying to reach profitability but when they actually accelerate that growth they'll go into an even deeper negativ..."
The Stickiness of SaaS Customers
The conversation highlights why SaaS customers tend to be stickier compared to traditional software customers. The speakers discuss factors such as product updates, decentralized purchasing decisions, and the ease of use of SaaS products, which contribute to higher retention rates and customer loyalty.
"think of those because you know again the way I at least I think without people kind of understand the details there's always this fear that hey we're spending a bunch of money to acquire this custome..."
Decentralized Budgets and SaaS Adoption
This segment examines the shift in purchasing decisions from centralized IT departments to individual departments within organizations. The speakers argue that this decentralization allows for greater adoption of SaaS products, leading to increased stickiness and integration within companies.
"have constant updates if you're a sales force customer if you're a any any SAS model customer your you're constantly getting updates to the product even on a daily weekly monthly basis versus you have..."
Cross-Functional Collaboration in SaaS
The speakers conclude by discussing the role of cross-functional collaboration in enhancing the stickiness of SaaS products. They emphasize how collaboration across departments fosters greater usage and reliance on SaaS solutions, further embedding these tools into the fabric of organizations.
"all these things and now you've got department level purchases and you see a bunch of SAS companies you know Marketo would be a great example right of a company that's you know selling to the marketin..."
The Growth Hurts Problem
This segment introduces the 'growth hurts' problem faced by SaaS businesses. The speakers discuss how rapid customer acquisition can lead to negative cash flow, complicating financial statements despite the intention to grow. They explore whether this aggressive growth strategy is rational or if companies should focus on stabilizing their existing customer base instead.
"traditional products you guys think that's true or no I do think it's true and I think there's one other component to which is there's a lot more cross-functional collaboration so marketing to enginee..."
Understanding Customer Acquisition Costs
The discussion shifts to the costs associated with acquiring new customers versus retaining existing ones. The speakers emphasize that retaining customers is significantly cheaper, which can lead to improved profit margins over time as the proportion of recurring revenue increases. They highlight the importance of understanding these dynamics in the early years of a SaaS company.
"be happy with the business yeah sure to sort of answer that question I want to use NetSuite as an example so if you look back to 2010 to 2012 they spent a lot more on SNM and and they went into negati..."
The Path to Improved Margins
In this segment, the speakers analyze how SaaS companies can achieve better margins over time. They note that while initial financials may look unfavorable, as the customer base grows and recurring revenue increases, profit margins can improve significantly. The conversation underscores the long-term potential of SaaS models despite early challenges.
"what they've sort of been tracking and their margin improvement over time so far I think I think we can say that they've they're on the right track right so we've so we've seen at least in the public ..."
Economies of Scale in SaaS
The speakers discuss the economies of scale that SaaS companies can achieve, particularly in sales, marketing, and R&D. They explain how multi-tenancy allows for shared infrastructure costs, leading to lower marginal costs per customer as the business scales. This segment highlights the financial advantages of SaaS models compared to traditional software licensing.
"higher gross margins as well so it gives you more room to kind of pump money into sales and marketing in R&D and so forth to continue that product development that you need to do to have a sticky cust..."
Timing Issues in SaaS Growth
This segment addresses the timing challenges that SaaS companies face regarding revenue and expenses. The speakers explain that while initial costs can be high due to infrastructure investments, the hope is that as customer numbers grow, these costs will be spread out, leading to better financial outcomes over time. They emphasize the importance of understanding these timing dynamics in evaluating SaaS business models.
"in a traditional perpetual license company so you know I don't know if you agree with that or not but maybe just you know give some perspectives on you know what that might look like and what that mea..."
The Legacy of Enterprise Software
The conversation concludes with reflections on the legacy of enterprise software and its implications for SaaS. The speakers discuss the challenges of maintaining multiple software versions in traditional models and how SaaS can alleviate some of these issues through streamlined updates and maintenance. This segment underscores the transformative potential of SaaS in modern business environments.
"you know my hope of course is that as I build more and more customers that that cost that gets to the marginal cost that get its assigned to each customer ought to be better and better right but again..."
Multi-Tenancy Benefits
This segment explores the advantages of multi-tenancy in SaaS, where most customers run the same software version. The speakers discuss how this model reduces maintenance costs and allows for economies of scale in research and development, ultimately leading to greater profitability over time.
"certainly at a minimum from a cash perspective right I'm gonna have to go be out of cash on this stuff you're right the accounting laws may help me or ties and appreciate that expense over a period ti..."
SaaS and Traditional Subscription Models
The discussion shifts to draw parallels between SaaS and traditional subscription models, such as cable and telephone services. The speakers analyze customer acquisition costs and retention strategies, highlighting the similarities in business dynamics and the importance of understanding these models for evaluating SaaS companies.
"over time is every customer or at least in most cases most customers are running the same version of the software right and so I've got all kinds of economies of scale of my Rd organization not having..."
Understanding SaaS Valuation Challenges
In this concluding segment, the speakers address the challenges of valuing SaaS companies compared to traditional businesses. They emphasize the need for a shift in mindset regarding revenue recognition and profitability, encouraging listeners to focus on customer acquisition costs and lifetime value as key metrics for assessing SaaS performance.
"there something else you think that's you know making this harder for people to understand or is it just that because everyone's been trained on the perpetual license model that this is just kind of a..."