In the 1981 classic movie Indiana Jones and the Raiders of the Lost Ark, the search is on for the Ark of the Covenant. The protagonist, Indiana, played by Harrison Ford, has uncovered a set of instructions to where the Lost Ark is buried.
The instructions are inscribed on two sides of a medallion. The bad guys have gotten the instructions from only one side of the medallion and therefore they've missed crucial information about the exact location.
When Indy and his partner Belloq realize that, they exclaim, "They are digging in the wrong place!"
Why the Marketing and Sales Funnel Provides an Incomplete Picture
The classic marketing and sales funnel historically provided a simple map for growth with step-by-step directions. It goes like this:
- Identify leads that, over time, turn into opportunities.
- Turn those opportunities, over time, into deals.
- If you want to grow faster, you need to win more deals.
- And to win more deals, you need more leads.
That formula worked for decades, and it has been the guiding principle of B2B marketing and sales teams that sold hardware and software in one-off contracts against upfront payments.
But in a recurring-revenue business such as software as a service (SaaS), growth comes from not only acquiring new customers but also selling more to current customers. Even more so: at around the point of $20M in annual recurring revenue for a SaaS business, the balance of growth no longer comes from acquiring new customers, but from expanding the accounts of current customers!
However, that growth from expansion takes place entirely outside the purview of the classic marketing and sales funnel. And since that growth is not visible in that framework, those who use the framework miss crucial information. As in in the movie, companies keep digging in the wrong place for growth: The ever-increasing demand to grow results in companies' spending more money on leads and hiring more salespeople in the hopes of closing more deals.
That is not an exception. It is the norm.
Not too long ago, I was advising a company that was preparing to go public. Let's call it NewCo. It is a renowned company; by the time it went public, NewCo had an annual recurring revenue stream of well over $100M.
To align all functions, executives of NewCo met once a month to review the company's growth metrics. They used a 48-slide deck, and each slide depicted a specific growth metric along the marketing and sales funnel. Fully 45 out of 48 slides were dedicated to slicing and dicing the growth from acquiring new customers—for example, leads generated per campaign, the on-target performance of salespeople, and average deal size across various channels and segments, such as SMB, mid-market, and enterprise.
Only the last three slides were focused on growth from current customers. Those three slides depicted that the renewal rate was well beyond the market average, and that expansion sales contributed to more than 70% of the growth—at a fraction of the cost.
But when the executives reviewed the deck once a month, they never even had time to review those three slides.
That's what I mean by digging in the wrong place.
Scalable vs. Sustainable SaaS Business Growth
Eventually, NewCo went public, and today its stock is trading at a fraction of the strike price. Why? Because growth from acquisition is scalable, but ultimately unsustainable:
- Scalable growth: Do more and get more
- Sustainable growth: Do more and get more at a lower cost
As its growth rate declined—which is a natural effect— NewCo's leadership team increased the pressure to keep growing, thus spending more money on leads and hiring more salespeople. After all, that was what it could see in the classic marketing and sales funnel. Doing so led to an increase in the customer acquisition cost while the growth rate naturally declined.
Once the company went public, cost became the determining factor of its performance. Had leadership been able to see and understand the origins of growth in a recurring revenue operation, they would have noticed that growth from expansion (current customers) comes at a fraction of the cost of acquisition (new customers), and that the expansion cost is declining. As a result, the company would have shifted some of its investment to customer success and account management functions.
Three Telltale Signs of Digging in the Wrong Place
Having worked with hundreds of SaaS companies, I have noted three telltale signs of companies that have more than $20M in annual recurring revenue (ARR) and are digging for growth in the wrong place.
1. A Maniacal Focus on Winning Deals
SaaS companies grow fast. At first, the growth originates from winning deals. But over time, current customers end up contributing most of the growth.
It is common to run into organizations that develop a maniacal focus on winning new deals at any cost. However, that maniacal focus leads to bringing in too many of the wrong customers, ultimately increasing churn. Once the customers themselves realize that they are not the right fit, they leave. So the more you win, the more deals are lost. That leaves the organization with a feeling of "swimming upstream."
Instead, focus on those customers to whom you have a high probability of delivering real business impact.
2. A Frantic Demand for Leads
Ask sales leaders what they need to double sales. The typical answer is to double the leads. That assumes there is a linear relationship between leads and wins. But that is not the case; the relationship between the two is actually exponential.
Companies experience that phenomenon during a downturn in the economy: As the lead volume and the quality of leads drop, all downstream conversion rates are affected, causing an exponential decrease in sales.
Instead, consider focusing on quality over quantity. Educate your leads as they work with your team, and ensure they are the right fit.
3. Customer Success That Aims Only for Happy Customers
When choosing KPIs for customer success, companies typically pick ARR managed, churn metrics, and Net Promoter Score (NPS).
NPS is a great emotional measure of the point of view of your champion at an account, but it doesn't give a complete picture of how successfully that account is actually using your product or service. Similarly, looking at churn metrics in a vacuum can often paint a different picture and lead to the wrong conclusions.
Instead, consider focusing on net revenue retention (NRR). That shows the true impact that you're having on your customers; if you're continuing to deliver results, they will continue their relationship with you, and over time expand that relationship—which is exactly what the metric sheds light on.
* * *
SaaS startups in their early stages not only need a focus on winning deals but also depend on it. It is what first gets you to $1M in ARR, and then to $10M in ARR.
But when you reach around $20M in ARR, a shift toward retention starts to occur. Once your business hits somewhere between $60M and $80M in ARR, you need to have completed the shift.
Note that the shift takes some of the most progressive companies two full years as a result of company culture and internal politics. And assuming you are approximately doubling your revenue year over year in those early stages, you need to start making the shift when your ARR is between $20M and $30M.
That's why recurring-revenue companies such as SaaS firms must move to a bow tie model. If you do not have a bow tie in place at around $10M ARR, you will likely start digging in the wrong place.
Next week: A look at what the bow tie model is and how it works.
More Resources on SaaS Business Growth
Five PR Strategies for Brand-Building Through the 2022 'SaaSacre'
The Biggest Leakage in a SaaS Marketing Funnel and How to Fix It
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