Parthib Srivathsan / January 6, 2023 / 8 MIN READ
4 Steps for Improving Capital-Efficient Growth
Parthib Srivathsan / / 8 MIN READ
4 Steps for Improving Capital-Efficient Growth
Ok, the situation may not be that dire, but the age of growth at all costs is on pause. In our last blog, Burn-Based Growth Planning for 2023 we looked at the need to transition from Growth at All Costs to Burn-Based Planning. In this blog we focus on how to (re)balance growth and burn to grow enterprise value.
In a recent CEO survey conducted by Redpoint Ventures, respondents are observing longer sales cycles, especially those companies selling to mid-market and enterprise, and, in turn, these longer sales cycles are a leading indicator of slowing demand:
coming here... for startups.
- 45% expect slower ARR growth this year and on average are reducing their ARR (plan) by 31%.
- 42% have changed their fundraising plans, roughly split in half between accelerating and delaying their timing. More than a third of founders polled are considering selling their company, raising venture debt, or raising an inside round.
- About 20% of those polled will conduct a layoff, and on average will reduce headcount by 20%.
A Game PlanStartups need a game plan and a set of new leading-edge KPIs that provide them with guide rails to navigate the downturn unscathed. Here is a growth-balanced approach to improving your capital efficiency:
Step One: Look for Insights Within Your Customer SegmentsAs you move away from the growth-at-all-cost mindset to focus on capital-efficient growth, your game plan for extending your runway should start with optimizing your customer acquisition. Segmenting your customer base by specific customer attributes and then running segment and cohort analysis on KPIs will yield crucial insights for capital-efficient growth. This will help you identify different strata within your customer segments that can help you achieve your short, medium, and long-term revenue and cash management goals. Take Example One below. Let’s say you sell your software to three different types of customers: A, B and C. When you plot these segments on a graph with Conversion Rates on the x-axis and their average CLTV on the y-axis, customers in the top right quadrant are your Power Compounders. They deliver the highest return on CAC. If the market size of this group is meaningful, an ABM strategy focused on lookalikes of this group of “Power Compounders” would help you accelerate growth at your optimal sales efficiency.
Example One: Cohort Analysis to Identify Power CompoundersLet’s repeat the exercise but this time, on the graph, plot the groups with Sales Cycle Time on the y-axis and Conversion Rates on the x-axis (Example Two). Customers in the bottom right quadrant are your Pinch Hitters. They close the fastest at the least CAC per unit. If the market size of this group is meaningful, focusing sales efforts here would help rack up clients and grow top line at an accelerated pace.
Example Two: Cohort Analysis to Identify Pinch HittersAlmost all traditional KPIs including NRR, ACV, CAC Payback and others can be used to understand the tactical importance of specific segments. Tip: Analyze your customer base by segment and focus your outbound and messaging on your Power Compounders and Pinch Hitters.
Step Two: Improve GTM Conversion RatesOne lever to improve burn multiple is to accelerate revenue growth without additional spend, and to achieve that, your company must dramatically improve its GTM conversion metrics. That means improving the conversion rates from lead to qualified lead, qualified lead to sales opportunity, and sales opportunity to closed/won deal. You can’t improve what you don’t measure and to measure, you first need a rigorous and consistent definition of each stage in the funnel as well as clear processes that capture key attributes in your CRM or system of record:
Marketing Qualified Lead (MQL): Marketing-driven hand raiser (demo request, sales contact request, download of gated content …) that meets minimum requirements or lead score to be declared an MQL. Sales Qualified Lead (SQL): MQL that shows enough intent activity to hit the lead scoring threshold (downloads, page views, website visits, etc) and has been reviewed and accepted by an SDR or an AE. Alternatively, an SQL may be a lead that has been created and qualified by an outbound sales process. Sales Accepted Opportunity (SAO): An MQL or SQL that has been reviewed and “accepted” by an AE to be declared a Sales Opportunity. This is usually supported by being the point at which an Opportunity, as opposed to a Lead, is created in the CRM system of choice. It is a typical requirement that an AE must be able to record a projected value to the opportunity and a close date in order to be considered an SAO. Sales Qualified Opportunity (SQO): A SAO that has been rigorously qualified by the AE using a qualification discipline such as MEDDPICC to determine that the opportunity will close within a given period usually the current quarter or current month depending on the cadence of your business. Won: An opportunity that has become a contractually executed transaction with contracted ARR that will be collected within 12 months based on GAAP principles.Tip: While it is important to understand each stage and the conversion between stages, you should focus on SAOs as the critical funnel metric. SAOs represent the sales potential to meet your revenue goals. Obsess over them! You can triple ARR growth through the right funnel optimization in an early-stage business even with an immature lead pursuit process. Look out for our upcoming blog on Funnel Optimization to examine the best tactics stage by stage.
Step Three: Improve Gross MarginYour next focus should be on optimizing your spending. But the areas to trim should be balanced in light of their impact. For instance, cutting the marketing budget and pausing sales hires reduces spend, but this will also impact the pipeline and growth in the medium term.
Gross Margin is the KeyBoth R&D and Sales & Marketing expenses cannot be eliminated without medium-term and long-term impacts on the company’s ability to grow. R&D makes sure the company remains competitive, and Sales & Marketing investments fuel customer growth. However, every incremental dollar of gross margin drops straight to your bottom line, contributing to your runway. Ways to improve gross margins are:
A. Find Cost SavingsEvaluate your COGS to see if there is a way to optimize your spending on hosting and other expenses. As your business grows so does your ability to optimize your support costs by segment, and your purchasing power/understanding of the most cost-effective 3rd party components to use. While it might be hard to find efficiencies on COGS, the exercise itself would help understand where future optimizations can be made. Tip: Startup engineering teams that are pushed to innovate quickly can often inadvertently drive up wasteful cloud computing spend over time. Challenge your engineering leaders to examine cloud compute usage and look for ways to optimize usage and remove zombie assets. AWS shares some tips here.
B. Are you selling everything you should be?Another way to optimize your capital efficiency is to charge for those services that are otherwise allocated to COGS. For instance, are you billing your customers for Professional Services, ‘White glove’ services, or any other premier Service Level Agreements ? If not, your gross margins will improve by turning these into paid-for services. If you're selling to large enterprises, most are used to paying for value-add professional services.
C. Turn Your Pricing Model into Your Growth FulcrumWhen your gross margins are less than 80%, consider changing your pricing structure. The recommendation is not just to increase prices in a vacuum but to evaluate and change your pricing structure in a way that increases your average revenue per customer without affecting your net retention rates. Most SaaS companies today follow a linear pricing model where they charge a flat monthly/annual fee. If you are here, the good news is that there are a whole host of options that you can explore. A profitable price structure established price metrics that are aligned to value for each target segment with fair, clearly defined boundaries between pricing editions. Best-in-class SaaS companies have found success with a 2-tariff model where customers are charged a base fee and a usage fee like bill.com or charify.com. But prevailing wisdom is that a 3-tariff pricing model used by hubspot.com (a base fee that covers platform fees and “X” usage, and every marginal use is priced per unit) delivers higher retention and ARPU, and should be explored. Tip: See our SaaS pricing series blogs here.
Step Four: Optimize Payment TermsDuring a period of recession, customers are likely to tighten budgets requiring sellers to discount products or defer purchase decisions, extending CAC Payback. The ideal way to manage this is to shoot for CAC Payback ≤1 by collecting upfront annual payments. The more upfront annual payments you can collect, the better off your runway is. Shifting to annual payments is also a good way to respond to customer pressure to discount. You can offer a discount if the customer shifts to annual which ironically can be easier for the customer, especially enterprises. Even so, before jumping to a discount think about adding an attractive feature or capacity to those that pay annually and preserve the dollar value of the subscription. Tip: Cohort Analysis can also be used to profile customers most likely to convert to upfront payers. In summary, these new strategies should be thought of as stage-specific recommendations to help build your business. The principles are well established:
- Segment your business to meet your strategic goals
- Instrument and optimize your lead conversion rate
- Build your pricing strategy to drive sustainable growth
- Optimize gross margin by reducing COGS
- Improve cashflow through better payment terms