Where Did That Number Come From?

For most SaaS companies, the new fiscal year begins on January 1st or February 1st. Whether your fiscal year starts in January or February, you will soon receive the gift of quota. And if  you are a sales or marketing leader, there is a good chance you will ask yourself, “Where did that number come from?

Let’s be honest. Top-down planning and target assignment isn’t always an inclusive exercise. If you are removed from the planning process more than one layer, you may have zero insight into where your numbers came from, and the numbers assigned to you may be a total shock. Even those close to the process can be dumbfounded. Many years ago, I was dumbfounded when starting a new sales leadership role at a new company. “You need to grow new bookings in your region >30% year-over-year. Don’t tell me you hit your quota and call that win unless you beat 30%. I don’t care what your compensation plan says. Anything less than 30% growth in new bookings and you may not get to keep your job.”  

So, where do the top-down numbers like these come from? How are they derived? The answer likely stems from commitments made to the company’s Board and investors, who, working in partnership with the senior leadership team, wish to drive investment returns well above average. The metrics chosen to drive returns will vary, but several common examples are described below.

  • Annual Recurring Revenue (ARR) Growth Rate: This metric measures year-over-year growth in recurring revenue and is vital for measuring the success of sales and marketing efforts. Benchmarks vary by company size and investment round. A SaaS Capital survey of 1,200+ B2B SaaS software companies indicated a median growth rate of 35% in 2022.
  • Monthly Recurring Revenue (MRR): This metric tracks the total predictable revenue generated monthly. Monitoring MRR and its growth rate helps businesses understand the monthly financial health and forecast future revenue.
  • Rule of 40: According to The Saas CFO, “The rule of 40 in SaaS is a simple financial framework that balances revenue growth versus profit margins.” The formula requires two inputs, growth and profit margin, most commonly expressed as ARR Growth Rate plus EBITDA. For a business to be attractive to Investors, ARR Growth Rate plus EBITDA must exceed 40%. 
  • Customer Acquisition Cost (CAC): CAC measures the total cost of acquiring a new customer, including sales and marketing expenses. Like ARR and MRR growth rates, CAC is crucial for understanding the efficiency of sales and marketing efforts. CAC Payback (the number of months to recoup acquisition costs) is often used for benchmarking purposes, and values vary by company size. According to ScaleXP, an SMB company with fewer than 100 employees would show “Good CAC Payback” in 7 months and “Great CAC Payback” in 4 months.
  • Lifetime Value (LTV): This metric estimates the total revenue a company can expect from a single customer account. Let’s assume the average customer invests $12,000 in your solution annually. Let’s also assume the average customer remains on your service for 39 months. In this scenario, the average LTV for your business would be $39,000.
  • LTV/CAC Ratio: Organizations do not want to spend more to acquire a customer than they are worth. Comparing LTV to CAC gauges the relationship between the lifetime value of customers and the cost to acquire them. According to Hubspot, “It’s agreed that 3:1 is a good LTV to CAC ratio, and you can interpret it as your business makes 3x what it costs to acquire a customer, or for every $1 spent on acquisition, you get $3 back.”
  • Churn Rate: The metric measures the rate at which customers leave your service. Churn is almost always bad – almost.

This list is not exhaustive; many other metrics may impact top-down goal assignment. Let’s look at the seven metrics described above and determine which might be affected by the “You need to grow new bookings in your region >30% year-over-year” challenge. (HINT: New business bookings impact each metric directly or indirectly.)

METRICIMPACTREASON
ARRDirectThe new business bookings challenge directly impacts ARR. 
MRRDirectThe new business bookings challenge directly impacts MRR. 
Rule of 40DirectThe new business bookings challenge directly impacts Rule of 40, given that the ARR Growth Rate is part of the calculation. Provided expenses are in check, new business booking helps Rule of 40.
CACDirectThe new business bookings challenge impacts CAC. CAC increases if deals are not closing quickly enough or at the modeled price point. When CAC increases, sales and marketing will be in problem-solving mode and may be heading to budget cuts.
LTVIndirectGrowing new business by 30% YoY does not directly impact LTV. However, when LTV is healthy, e.g., greater than 3:1, new bookings add tremendous enterprise value.
LTV/CACDirectAs described above, CAC directly impacts the new business bookings challenge and is a key part of the LTV/CAC formula.
Churn RateDirectChurn Rate is calculated on a customer or revenue basis. Calculations are:Lost ARR in Period/Previous Period’s ARR BalanceLost Customers in Period/Previous Period’s Customer Balance
Adding new customers has a positive impact on the Churn Rate. Remember, Churn is generally bad, and outselling a high churn rate is tough.

I will never fully understand why New Bookings were crucial to the sales leader I mentioned. He may have understood how the top-down plan was built in intricate detail. He likely had a variable compensation component tied to new business acquisition. No matter which is true, new business is always critical to the success of a SaaS business, and it heavily impacts many enterprise value metrics.

Bottom line? In most cases, there is a lot of logic behind the top-down targets that have been assigned. They are neither arbitrary nor deliberately painful. The targets simply reflect commitments made to the Board and investors, leading to a healthy business when met. Creating a plan to hit the plan is where Outset shines. Please feel free to reach out to me if you'd like to learn more. My email is daren@outsetops.com.