The definition. ContributIn the first year, your margin is -100%. Generally speaking, the first year of any customer in a SaaS business is an unprofitable one. That’s because the sales & marketing expense to acquire the customer is incurred in year 1. As you can see for Bill.com, for fiscal 2017, the 2017 Cohort represented $6.7 million in revenue billed to these customers, $11.8 million in sales and marketing costs to acquire these customers, and $2.3 million of cost of sales representing a computed contribution margin of -108%.
In the 2nd year, you start becoming profitable. Since you never incur sales & marketing expense again to acquire the customer, the only cost in any SaaS business is just the “cost of sales”. For Bill.com, in fiscal 2018 and 2019, the 2017 Cohort represented $14.2 million and $17.3 million, respectively, in revenue billed to these customers and $3.9 million and $4.2 million, respectively, in estimated costs related to retaining and expanding these customers, representing a computed contribution margin of 73% and 76%, respectively.
The revenue grew. Note that for Bill.com, revenue in year 1 was only $6.7mm. In years 2 and 3, it was $14mm and $17mm respectively, meaning the cohort grew materially. Indeed, good SaaS businesses have cohorts that grow over time, as upgrades in the customer base outpace downgrades and churn. For Sumo, year 1 revenue was $10.1mm, but then grew to $14.6mm in 2019 and $18.3mm by 2020. Confluent’s revenue went from $21mm in year 1 to $40.7mm and $46.7mm respectively. All of these companies enjoy net dollar retention over 100%. For instance, Confluent’s NDR in 2020 is 125%.
Payback is fast. According to Bill.com, “for customers acquired during fiscal 2018, the average payback period was approximately five quarters.” Good SaaS businesses recover the cost of acquiring the customer within 1.5 years.
i) you lose money on the customer in year 1 (about -100% marign); iii) over time, your customers buy more product from you rather than less so long as net dollar retention is over 100%+. Maintain these same attributes in your own SaaS business and you’ll be on your way to joining these companies in an IPO.
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