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As the NCAA Basketball Tournament shifts into high gear this month, millions of American workers will take extended lunch breaks to their favorite sports bars and restaurants to watch the games. This annual event provides not only an opportunity for binge-eating and work-ditching, but also affords a teaching opportunity about the dangers of the high cost of sales. Read on to see how the parable of a failed sports bar can be a cautionary tale for modern XaaS companies.
A few years ago, a very close friend of mine decided to take much of his NFL signing bonus money (I was also an investor and helped whenever I could) and build out an upscale sports-themed restaurant and bar. The project was rife with problems from the beginning, such as you might expect from a restaurant/bar owned by a pro football player with no real business experience. Construction was over budget and good help was hard to find. However, once they got things going, crowds started coming in. The food was tasty and the atmosphere was top-notch. Sales ramped up quickly.
On the surface, things were looking good. The problem was this: the busier they got, the more money they lost. On weekends when the place was packed for football or basketball games, the cash bleeding turned into hemorrhaging. It was clear that the restaurant was going under, and there were serious problems that needed fixing. The thing was, nobody involved understood what was wrong, much less how to deal with it, so we made the choice to bring in a restaurant consultant.
On the surface, things were looking good. The problem was this: the busier they got, the more money they lost.
It didn't take long for the consultant to get to the root of the problem. Almost every single item on the menu cost more to advertise, prepare, and serve than we made from selling it. The prices we charged were in line with other restaurants, but our cost structure was completely out of whack. I'll never forget what the consultant told us the first step should be: “If I were you, I'd close up shop and have a person stand outside the door with a stack of $10 bills. Every time someone comes to the door, hand them a $10 bill. You'll go out of business more slowly than if you stay open.” The restaurant soon met its demise.
Unfortunately, many XaaS companies seem to be following the same path, hoping somehow for a different result. For years, cloud-native companies have focused only on increasing revenues, not getting their cost structures in order or paying much mind to operating margins or profitability. Encouraged by investors and capital markets, these growth-at-any-cost models have led to unsustainable situations. The cost of sales and marketing is outpacing revenues.
For many XaaS companies, the cost of sales and marketing is outpacing revenues.
TSIA research and other sources, including Pacific Crest's 2015 SaaS Survey, estimate that the average Customer Acquisition Cost (CAC) for a cloud-based company is well over $1. That means that for every $1 in Annual Recurring Revenue they make, the company has to spend between $1.10 and $1.40, and they don't recoup their sales and marketing costs for over a year. This doesn't even account for attrition or downselling, where the customer reduces the size of their order and digs the hole even deeper. When it costs more to acquire new customers than you make from them, every new order just increases the burn rate, and the working capital drains away. It's like trying to fill the funnel when there's a hole in the tank.
Fortunately, there's a better way. Expand selling is TSIA's systematic approach for using services and customer success touchpoints to generate leads, drive revenue growth, and provide better outcomes with existing customers. Our research and coaching give companies the tools and processes they need to make this shift, including how to start utilizing non-sales customer touchpoints to foster upsell and cross-sell opportunities.
By focusing on generating more revenue from their existing install base, companies can dramatically reduce their sales and marketing costs, and take a solid step toward profitability. The same surveys as mentioned above estimate Customer Expansion Cost (CEC), or the cost of driving $1 in new ARR from an existing customer to be between $.25 and $.40–somewhere between 3-5x cheaper than acquiring that same revenue from new logo customers.
By focusing on generating more revenue from their existing install base, companies can dramatically reduce their sales and marketing costs, and take a solid step toward profitability.
It makes intuitive sense as to why CEC is dramatically lower than CAC. So much of the sales and marketing heavy lifting has already been done. You've already established a legal and fiscal relationship with the customer. You already have a channel of communication with them, and have the ability and authorization to present them with new offers. You know who the decision makers are and what their key initiatives might be. All of the hard stuff is out of the way, allowing your sales teams to focus on creating value for the customer with a dramatic decrease in time and effort.
Access to additional funding has encouraged companies to pursue growth without regard to profit margins. However, TSIA believes that 2017 is the year that the chickens will come home to roost. Investors and analysts will begin to require profitability, not just revenue and customers. Technology-as-a-Service Playbook: How to Grow a Profitable Subscription Business, written by TSIA executives Thomas Lah and J.B. Wood can give you a far more complete set of tools to deal with these changes. In the meantime, a membership in TSIA's Expand Selling discipline can help you get started by providing the frameworks, systems, research and coaching necessary to drive low-cost revenue from existing customers. Hopefully, your XaaS company can avoid the fate of this sports bar, and so many other enterprises of all types who managed to sell themselves right out of business.
Post Date: March 7, 2017
Steve Frost is the vice president and managing director of revenue research and advisory for TSIA. He also serves as TSIA's vice president of subscription sales research. Throughout his career, he has held various leadership and business development roles at companies like Google, Netscape, and Loudcloud, helping them define their go-to-market strategy and business development tactics. Steve is dedicated to helping technology organizations grow their services, subscription, and XaaS revenue by optimizing their practices for growth throughout the customer lifecycle.
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