By Eric Mersch
There are many ways to classify SaaS companies, but differentiating companies based upon who their customers are presents the best approach for measuring performance and driving success for SaaS businesses. This is because using a customer-centric definition highlights the key operational differences that drive strategic decision making at these businesses as well as influencing the relevant performance indicators for them.
We typically classify SaaS companies in terms of three customer segments, enabling us to better evaluate their needs:
- Small/Mid-Market (SMM)
- Business to Consumer (B2C)
In this article, one in a series of three covering each of these SaaS customer categories, we will focus exclusively on Small/Mid-Market SaaS companies.
SMM SaaS Company Overview & Market Dynamics
Small and Mid-Market (SMM) SaaS Companies serve customers with annual revenues of $1 million to $1 billion and with a typical employee base of 100 to 1,000.
Customers of these SaaS companies, also referred to as “Small and Medium Businesses” or SMBs, need the same software solutions as Enterprise companies but have resource constraints that prevent them from using the top SaaS vendors. The most common resource constraints are staffing and budget. An additional non-financial constraint is the fact that these customers typically lack experience in software procurement and implementation, and this adds friction to the sales cycle.
SMB customers will want high touch sales engagement and service delivery but SMM SaaS companies will likely not have the budget necessary to justify providing this level of sales support. This reality influences their go-to-market (GTM) strategy, which relies on a lower overall sales and marketing budget and a higher mix of marketing to sales spending. In the SMM SaaS company, the GTM organization will consist of a mix of inside and direct sales teams, with the latter operating as individual contributors without pre-sales support. Customer success is usually staffed by a mix of customer support, sales, and engineering folks contributing some portion of their time to the Cost of Revenue. Most of the marketing budget will be focused on digital marketing along with targeted live events and webinars.
The industry dynamics of SMM SaaS companies pose a threat for these businesses that are not faced by B2C or Enterprise SaaS companies. SMM SaaS companies live with the risk of being “stuck in the middle.” This phrase was coined by Harvard Business School professor, Michael Porter, who used it to describe a company challenged by a product that can’t compete with higher end products and also susceptible to competitive pressures from lower cost providers.
Being “stuck in the middle” drives SMM SaaS companies to invest in one of two strategies. The first option is to move up the value chain by improving product features, functionality, and quality to maintain Average Selling Price and to compete effectively with higher end players. The other option is to outperform lower cost competitors by gaining market share, usually by lowering their price point to achieve virality. Both these strategies require close attention by SaaS Chief Financial Officers.
Financial Profile of SMM SaaS Companies
The Annual Contract Value (ACV) price range of $10,000 to $50,000 defines the parameters of SMM SaaS companies and shapes their financial profile. These lower price points influence the GTM strategy, which requires lower labor costs and a greater reliance on “one-to-many” marketing.
Aggregate Gross Margin tends to be higher for SMM SaaS businesses than it is for Enterprise SaaS companies because professional service revenue is a lower portion of overall revenue, and the absolute dollar amount generated does not adequately support (fund) a pure Direct Sales strategy. Instead, SMM SaaS companies will leverage Inside Sales and Channel Partners coupled with digital marketing to drive down Customer Acquisition Cost. This strategy allows for a portfolio approach giving the company more flexibility in managing its Customer Lifetime Value (CLTV)/Customer Acquisition Cost (CAC) ratio.
SMM SaaS Go-To-Market Strategy
The typical SMM SaaS company will use a portfolio of sales strategies designed to fit the average ACV of the sale. The most common strategies are Direct Sales, Inside Sales, eCommerce Marketplaces, and Partnerships. Some SMM companies may use all four depending upon the business model.
Direct Sales is a valuable GTM strategy if the company can deploy an enterprise grade product and sell it at a premium. As we discussed in our explanation of Direct Sales economics, the price point needs to be at least $50,000 in ACV to make this strategy profitable.
The term Inside Sales refers to the process of closing deals remotely without the live, face-to-face engagement of the Direct Sales approach. The onset of the pandemic made all selling remote so this is no longer an accurate distinction. Today, the better definition for Inside Sales is a lower cost sales strategy that leverages people who do not need or have the selling skills of Account Executives and whose efforts are combined with a robust digital marketing lead generation program. Marketing campaigns generate contact information for potential customers who demonstrate interest through some behavior such as attending a webinar or responding to a call-to-action message. The objective of these marketing campaigns is to increase brand awareness and further customer education to move respondents closer to a sale. The Inside Sales representative then reaches out to each interested customer and attempts to move them to a paid subscription. The Inside Sales strategy is successful if the combination of the digital marketing campaigns and the Inside Sales Representative (ISR) results in greater sales efficiency than either a Direct Sales or an all-digital marketing strategy.
An eCommerce Marketplace refers to an automated, self-provisioning ordering process for low ACV customers. The objective of this GTM strategy is to completely remove labor from the sales cycle, relying instead on marketing investment, product functionality and transactional efficiency to acquire new customers. This use of an eCommerce Marketplace is also referred to as a marketing-driven strategy because all leads are generated by marketing investment.
There are three key ways in which SMM SaaS companies need to employ this strategy to be successful:
- Marketing Investment – Unlike Direct and Inside Sales, the Marketplace strategy requires marketing to drive brand awareness and education. Common strategies are blogging, email marketing, host-read podcast advertising, influencer marketing, and social sharing campaigns. Educational campaigns focus on the value-add that your product offers as well as how to use it.
- Product Functionality – This often-overlooked objective refers to the necessary product changes required to make the functionality more basic to avoid integration and to make the interface more intuitive. The product should include product tours, interactive walkthroughs and in-application (In-App) tutorials.
- Transactional Efficiency – Similar to some eCommerce businesses, SaaS companies sometimes experience shopping cart abandonment by customers because of a lack of perceived value and trust in the brand, transaction & application security concerns, lack of payment options, long checkout flow, and transaction errors. Marketing can address value and trust and, to an extent, security concerns, but SaaS companies also need to invest in development resources and third-party software for user interface and security.
The eCommerce Marketplace is a mass market, low-cost competitive strategy best employed for point solutions in SaaS with a low ACV. SMM SaaS companies that successfully employ an eCommerce Marketplace strategy typically started their businesses serving a mass market with a point solution and built a higher value add product as they grew. These market and product characteristics make this GTM strategy best suited for B2C SaaS companies.
As a Go-To-Market strategy, developing strategic partnerships with other companies can make a huge impact in lowering Customer Acquisition Costs and in achieving scale earlier in the company’s lifecycle. The Partnerships strategy, also called a Channel or Business Development strategy, takes many forms with a wide variety of complexity depending upon the company’s competitive environment, maturity, and specific goals and objectives. At the highest level, a Strategic Partnership is an agreement between two companies to generate incremental sales for each party.
I use four categories to define partnership opportunities: Co-Marketing; Affiliate; Co-Selling; and Reselling. In a Co-Marketing arrangement, you associate your company with another player in the same space with similar target customers by collaborating on marketing events and content creation. An Affiliate program involves a fee for referral arrangement with third parties that are in contact with the target customers. Co-Selling Partnerships involve an agreement between two software companies to sell each other’s product to the same target customer, often at the same time. Reselling Partnerships involve a partner that distributes the product on behalf of the SaaS company.
Go-To-Market Strategies: Recap
Small and Mid-Market SaaS companies need to work with lower marketing and sales budgets due to their product pricing. By crafting a portfolio of sales channels – Direct Sales, Inside Sales, Marketplaces, and Partnerships – and managing the ROI of these by channel, SMM SaaS companies can achieve a high degree of scale for their Sales and Marketing investments.
SMM vs. Enterprise SaaS Metrics
Above, we highlighted the differences in financial profiles and Go-to-market strategies for SMM businesses. This section on SaaS metrics drives home the importance of differentiating between Enterprise and Small/Middle Market metrics.
As we discussed earlier, Enterprise SaaS companies rely almost exclusively on Direct Sales. These companies use other channels, but the Direct Sales team drives unit economics. Chief Financial Officers who master Direct Sales planning and reporting understand the main profitability lever in these companies. This is different than in SMM SaaS companies, which compile and use a portfolio of marketing channels. Typically, an individual channel does not dominate sales activities, so CFOs in SMM SaaS companies need to continually monitor and manage performance across a range of channels.
The GTM strategy for SMM SaaS companies often employs free trials that are self-provisioned by the customer. This means that a CFO needs to track the percentage of users that are paying for the product as well as the rate of user conversions from free trials to paid subscriptions. Return on Investment (ROI) needs to be calculated for each SMM marketing campaign.
At SMM SaaS product price points, companies typically use digital marketing for lead generation. The ROI of these marketing campaigns are tracked with metrics such as email open rates and ad click-through rates. The Inside Sales team may also conduct webinars as a cost-effective way to educate and convert potential users. So, metrics on webinar performance and ROI are also important.
A SMM SaaS Company Example: AVALARA
Avalara is a tax-compliance company which sells software subscriptions that enable companies of all sizes and industries to manage tax requirements across varying tax jurisdictions, thus reducing resource requirements for this function, improving auditing, and lowering the risk of errors in tax calculations. The core product at Avalera is a sales and use tax management platform, but Avalera has added a number of related products to increase functionality and average ACV. For the fiscal year ended December 31, 2019, Avalara served 11,960 customers with an average ACV of $23,700.
Avalera employs a volume-based pricing plan whereby customers purchase a subscription tied to a specific number of transactions. Customers that exceed their subscription-based transaction level can upgrade to higher volume tiers during the contract term or pay overage fees; however, customers cannot roll over unused volumes to future periods. ACV, therefore, can be recognized over the contract term.
Avalara has a number of high-profile customers including Adidas, Bed Bath & Beyond, Box, Duo Security, Pinterest, and Zillow, but the target customer for the company is a mid-market business that Avalara calls a “core customer.” The company defines a core customer as one with an ACV greater than $3,000. For this segment, Avalara reports on Customer Count, Core Customer Revenue as a percentage of Total Revenue, and Net Retention.
The Avalara product is a point solution, which is the term for a product that performs a singular function, in this case tax compliance. Avalara has successfully innovated, adding services including audit services and data storage, and these have increased average ACV. To avoid being “stuck-in-the-middle,” companies with point solutions will seek to grow horizontally by selling to the universe of core customers or vertically by continuing to innovate its product to become an enterprise SaaS solution.
Avalera’s Go-To-Market strategy, similar to many SMM companies, consists of an Inside Sales team, an eCommerce Marketplace, and Partnerships. The Inside Sales team engages marketing leads by phone and seeks to convert them to paid subscribers. The eCommerce Marketplace functions as a site where new customers can self-provision and integrate Avalara’s products. Marketing campaigns generate drive these low ACV customer opportunities to the marketplace for conversion to paid subscribers. Avalara also uses a broad range of channel partnerships with software publishers and developers to resellers, financial services providers, CPA experts, and technology partners. The company does not disclose revenue from channel partnerships but it does report paying commissions in an amount that consists of between 6% and 7% of total revenue. The expenses associated with these three GTM tactics are accounted for in Sales and Marketing.
Avalara’s financial profile is typical of that for SMM SaaS companies. In the fiscal year ending December 31, 2019, revenue mix was 93% subscription and 7% professional services, reflecting a less expensive new customer onboarding process. Subscription gross margin was reported at 72%, which is at the lower end of the range but still respectable. Professional services gross margin was 36%, close to the 40% benchmark that services companies routinely achieve.
The Small/Mid-Market SaaS business model is associated with a key advantage: lower costs, in terms of both time and expense, to launch products. Success in the early stages of these companies requires a light touch Go-to-Market strategy to ensure sales efficiency and preserve operating dollars for continued product development. CFOs must continually monitor the competitive market dynamics to ensure that the SaaS product remains compelling to customers and that the Average Selling Price can be maintained and increased. Tactically, CFOs must also track the key metrics associated with each GTM channel and continually test and evaluate the effectiveness of each individual channel. Insights gained from these analyses enables the SaaS CFO to serve as a powerful business partner to the CEO, the Board of Directors and the C-team.