By Geoff Roberts 8 min read
One of the single best pieces of start-up or SaaS related content that I stumbled across in 2016 was David Cancel and Dave Gerhardt’s Seeking Wisdom podcast when they welcomed Hubspot CRO Mark Roberge to the show. Prior to Outseta I was lucky enough to work at a company where Mark was a board member, so I decided on a whim to tune in. The entire 52 minutes was insightful - I suggest you check it out for yourself - but it was one of the first things out of Mark’s mouth that gave me pause for thought.
Mark described his framework for advising SaaS start-ups as…
Then unit economics
The basic concept he introduces is thinking of each of these as distinct stages in a start-up’s life cycle. Before you do anything else, you need to figure out how to make customers successful with your product. Only then should you turn your attention to the viability of the business model. And only when the business model is healthy should you be concerned with your start-up’s growth rate. You get the idea.
To be honest, this didn’t strike me as a surprising concept or even really a new idea - but it stuck with me because of how simply and concisely it conveyed a framework that made so much sense. There's a heck of a lot of logical thinking and important start-up concepts inherently baked into a framework that's articulated in just seven words. This post serves to unpack and explore the simple beauty of this framework.
It makes good, logical sense that before your start-up is ready to grow you need to figure out how to make customers successful with your product. I think that few people would argue that, but surprisingly few companies actually practice it. Customers are like crack - you get a little taste, and you immediately want more. Lots more. And with most start-ups having limited runway, it makes sense that many founders decide to forge ahead with the intention of figuring out how to make customers successful on the fly as they bring them on. The problem is that rarely happens, especially if customer acquisition begins to take off.
Sam Altman, President of start-up accelerator Y-combinator, shares a similar sentiment in his Start-up Playbook, “Your goal as a startup is to make something users love. If you do that, then you have to figure out how to get a lot more users. But this first part is critical—think about the really successful companies of today. They all started with a product that their early users loved so much they told other people about it. If you fail to do this, you will fail. If you deceive yourself and think your users love your product when they don’t, you will still fail. The startup graveyard is littered with people who thought they could skip this step.”
The value of looking at “customer success” as a stage of growth is really two-fold for me. First, there’s a lot written in marketing circles about “vanity metrics.” I would argue that most companies that are focused on growth before they’ve figured out their recipe for customer success are only achieving “vanity growth.” Inevitably customer churn will become a show stopper.
Additionally, the emphasis on customer success inherently implies “do things that don’t scale” to me. This is a tried and true start-up mantra. Do whatever you need to do to figure out how to make your early customers successful, even if it’s not scalable or profitable. This is perhaps the single biggest competitive advantage that start-ups have over established competitors, and I love that this framework emphasizes it.
As Mark mentions, it’s important that you find some sort of leading indicator of customer success that you truly believe in before you’re ready to leave this stage and focus on unit economics. I think one useful and easy measure of customer success can be simply asking your customers the question, “how disruptive would it be to your business if I took our product away?” No doubt about it, finding the recipe for customer success is the most challenging of the three stages. The best founders are the ones who take a deliberate approach to finding customer success and fight the urge to chase growth prematurely.
Now that you’ve figured out how to make your customers successful with your product, you must turn your attention to the fact that you’re running a business. If it’s costing you $1,000 to acquire a customer with a lifetime value of $1,000, it’s going to be tough to make a living. If you’ve gotten to this stage at all, kudos to you - you’ve found a recipe for making your customers successful; now you just have to figure out how to do it cost effectively.
Challenges at this stage can look very different. Maybe you’ve handheld each and every one of your early customers, with your team spending hours upon hours onboarding each new account. Employee time costs money, and it’s entirely possible that you’ve spent so much time with each early customer that your relationship with them isn’t even close to being a profitable one. Or maybe it’s the efficiency of your lead generation programs that’s to blame - you’re generating some leads that are turning into paying customers, but your average cost per lead is prohibitively high to support any sort of true growth potential.
In an industry obsessed with automation, this is likely the time for automation. This is the time to bring people onto the team with a “growth hacking” mindset. This is the time to be endlessly analytical and obsessed with all of the metrics related to your customer acquisition programs.
Whatever you decide is the indicator that you’ve gotten your unit economics in order; from a particular payback period to a target LTV:CAC ratio, once it’s achieved (and there’s reason to believe it can be sustained)... now you’re really on to something. Now you’re dangerous.
David Skok’s SaaS Metrics 2.0 - A Guide To Measuring And Improving What Matters is a great resource at this stage, including insights from the metrics that fueled the growth of companies like Netsuite, Hubspot, and Constant Contact.
At this point, you’ve found a recipe for making customers successful and your churn rate is healthy. On top of that, your unit economics prove that you’ve found a viable business model - one where you invest money into one end of your customer acquisition machine and a healthy return is spit out at the other end. You have made a real, viable, compelling case for investing in growth.
By the time you reach this stage you should have plenty of options, and doors opening for you left and right. With healthy unit economics, you may choose to reinvest some of your business’ profits back into the company to grow as fast as you can organically. Or maybe this is the point where you want to stake your claim as the leader in your market, and you want to raise that big series A to support that goal. Either way, by following Mark’s framework you’ve put yourself in a position to chase down growth via whichever path suites you best.
The question you now must answer logically becomes “how fast should we try to grow? What growth rate should we be shooting for?” Much has been written on this topic - I had always been told that as a SaaS business starts to scale, showing an annual growth rate of 50%+ for 2-3 years was the path towards an exit with a company valuation of 5x-6x your company’s annual revenue. Brad Feld, Managing Director at Foundry Group, introduced The Rule of 40% for a Healthy SaaS Company. This rule is more for SaaS companies at scale (greater than $50mm in revenue) but it states that a company’s growth rate + profit should add up to 40%. Tom Tunguz of Redpoint Ventures explored the rule of 40% further, finding that for early stage SaaS businesses this metric if often well over 100%. “But for early stage companies, whose metric may exceed 100% or more, founders should focus more on the unit economics (average revenue per customer, cost of customer acquisition, churn rates, contribution margin), which drive the business’s top line and bottom line. Everything else will take care of itself.”
In an early stage SaaS business, if your unit economics are healthy you have an opportunity to step on the gas - but more important than any specific target growth rate is that you choose to grow at a rate that is responsible and that won’t derail your business. David Heinemeier Hansson, CTO and Founder of Basecamp, writes of the many ways that chasing exponential growth can devour and corrupt your company. If you’re lucky enough to work at a business that’s found a recipe for customer success and has healthy unit economics, then of course you should be investing in growth. We all want to grow - but how fast and aggressively you pursue growth is at the end of the day a personal decision that needs to fit you and your business rather than Silicon Valley’s expectations.
More than anything, I think this framework surprised me so much because of how infrequently it’s truly followed. But stop for a moment and think about the alternative. In my head I envision a ship heading slowly towards a whirlpool in the ocean, much like Titanic heading towards an iceberg. Someone is yelling, “turn on the second engine, let’s speed up to 20 knots!” while the whirlpool (churn) looms ahead. If you’re steering the ship, do you really want to accelerate and hope that you make it through the swirling pool of water ahead? Or would you do everything in your power to keep a steady speed, or even slow down if you need to, until the seas ahead are calm?