A slightly revised version of my presentation at SaaStr Annual 2020 which focuses on understanding SaaS business from a metrics viewpoint with a particular focus on the health of the installed base as measured by churn rates and net dollar retention rates

1. Churn is Dead!
Long Live Net Dollar Retention!
Dave Kellogg
Principal
Dave Kellogg Consulting
@kellblog
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2. Quick Self Introduction
Who Is He?
● 10+ years a startup CEO
○ Host Analytics ($8M to $50M)
○ MarkLogic ($0M to $80M)
● 10+ years a startup CMO
○ BusinessObjects ($30M to $1B)
○ Versant ($1M to $15M)
● 10+ years a board director
○ Aster Data, Granular (exited)
○ Alation, Nuxeo, Profisee (active)
● Advisor and angel investor (examples)
○ Tableau, MongoDB, Recorded Future
○ GainSight, Cyral, Cube, Hex, Faros, Plannuh
● Blogger
Why Does He Care?
● Metrics are key to fundraising
● Fundraising is key to success
● Any further questions?
● Valuation impact
● Understanding drivers
● Loathe lack of rigor
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3. Kellblog: SaaS, Metrics, Strategy, S&M, and More
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4. Agenda
● Understanding a SaaS business
● The trouble with churn
● Long live net dollar retention
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5. Why’s It So Hard to Understand a SaaS Business?
The Usual Reasons
● Public companies don’t disclose
the underlying ARR engine
● Revenue is a lagging indicator
● Must impute “billings”
● ARR needs to be implied
● Churn is not disclosed
● Sales commissions amortized
● Et cetera
● These are mostly solvable math
problems
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6. The Other Problem: It’s Really Two Businesses
Look at what happens
when you turn off S&M
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7. What if it grew all by itself?
It doesn’t.
But it does grow at 40% of the cost
of new logo customer acquisition
Source: KeyBanc 2020 7

8. But Back to Private Company-land
We can see the underlying ARR engine and associated unit economics
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9. And We Can Calculate Things Like LTV/CAC
● Customer acquisition cost (CAC) ratio = last-period S&M / this-period new ARR
○ How much you spend to buy $1 of ARR
○ The inverse of the “magic number”
● Customer lifetime (LT) = 1 / churn rate
○ How many years a customer stays a customer
○ Lifetime value (LTV) = LT * ARR (alternate: LT * ARR * subscription gross margin)
● LTV to CAC ratio = LTV / CAC
○ How much a customer is worth versus what you paid to acquire them
○ The Rose Bowl of SaaS metrics
● CAC payback period = CAC ratio / subscription gross margin
○ How many years of gross profit does it take to pay back S&M costs of acquisition
○ A very popular and oft-misunderstood metric
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10. So Are We Good?
No. Churn breaks everything
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11. Agenda
● Understanding a SaaS business
● The trouble with churn
● Long live net dollar retention
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12. The Trouble with Churn Rates
● There are too many ways to calculate churn
● Churn inflicts collateral damage on LTV
● Churn leads down a dark rabbit hole of offsets and timing
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13. Problem 1: Four Ways to Calculate Churn Rates
● Gross vs. net
○ Before expansion or after
● ARR vs. ATR
○ Based on entire ARR pool or the
available to renew (ATR) pool
● Will produce very different results
● The net problem
○ “Other than not knowing the numerator
or the denominator, it’s a great ratio.”
1 3
ATR-based ARR-based
Gross
2 4Net
Ranked in order of my preference if I could only see N of them.
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14. Problem 2: Churn Rates Blow Up LTV
● Lifetime value = 1 / churn rate * ARR
● 4 different churn rates means 4 different LTVs
● Negative churn → infinite LTV
● Very low churn → heavily future-weighted LTV
○ A four-year-old company with a 25-year LTV raises questions
● All this in turn blows up LTV/CAC
○ The would-be, ultimate SaaS metric is collateral damage as well
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15. Problem 3: Churn ARR Itself Can Be Non-Obvious
● Offsetting shrinkage and expansion at renewal
○ Drop 30 units of product A, add 40 units of B: 30 churn + 40 upsell or 10 upsell?
○ Most folks net it out to “account-level churn”
● Upsell along the way: 100 units expands to 140 and renews at 130
○ 30 upsell or 40 upsell and 10 churn?
○ Company wants to call it 30 upsell, but wants the CSM to feel 10 units of churn
● Built-in, multi-year expansion: 100, 120, and 140 units across 3 years
○ Should the CAC be calculated on 100 (initial) or 120 (average) or 140 (terminal) ARR value?
○ Churn treatment needs to be consistent with CAC in LTV/CAC calculations
It’s not just that there are four rates, even defining the numerator is ambiguous
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16. “ARR is a fact.
Churn is an opinion.”
(As was once said about cash and profit.)
Paraphrased from https://mondaynote.com/cash-is-a-fact-profit-is-an-opinion-b90b8fb2d089
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17. The Solution? Zoom Out
I have one word for you, “cohorts”
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18. Agenda
● Understanding a SaaS business
● The trouble with churn
● Long live net dollar retention
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19. This is a Perfect Problem for Cohort Analysis
● Ignores all the details and flows
○ Grab a cohort (typically, all customers)
○ What were they worth in ARR a time-period ago (typically, a year)
○ What are they worth in ARR today
● Net dollar retention = today’s ARR value / period-ago ARR value
○ Easy to calculate
○ Easy to understand
○ Hard to game
● Beware that a few bad apples survivor-bias their calculations
○ “Excluding the customers who chose to no longer do business with us, the cohort (almost
definitionally) expanded by N%.”
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20. Cohort Expansion Charts Aren’t New
But netting them out to a single, benchmarkable, regression-able number is more so
Source: Datadog S-1 via https://medium.com/@sammyabdullah/growing-saas-cohorts-395b44d9d9e1
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21. Net Dollar Retention is Popular
Note: Martin seems to define net as “net of” (i.e., excluding) and gross as “inclusive of” which (1) is nevertheless to saythe metrics are important
and (2) to remind readers that even net and gross are somewhat invertible. I used to refer to them inverted from how I do now, myself.
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22. What’s a Good NDR Rate? About 115%
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23. NDR Not Much of a Valuation Driver (R^2 0.06) …
But it might well be a financing enabler
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24. … Compared to ARR Growth (R^2 0.50) …
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25. … Or Rule of 40 Score (R^2 0.43)
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26. Moving Forward: Three Pithy Quotes to Ponder
Drucker is reputed not to have said this quote, see:
https://medium.com/centre-for-public-impact/what-gets-measured-gets-managed-its-wrong-and-drucker-never-said-it-fe95886d3df6
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27. Building Expansion In
If NDR matters, why not build it into multi-year contracts?
Natural Expansion
● Expanding use / value over the period
● Pays $100K, $120K, $140K
● Drives epic ARR-based NDR
● ASC 606 should not flatten, value not flat
● Creates notion of presold expansion
● Complicates CAC and sales comp
● Good, IMHO, lock in expansion up-front
Price Ramping
● Equal use / value over the period
● Pays $100K, $120K, $140K
● Drives epic ARR-based NDR
● ASC 606 will flatten to $120K/year GAAP
● Price increases, but not really expansion
● Complicates CAC and sales comp
● Bad, IMHO, playing accounting games
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28. The Next Frontier: RPO
Remaining Performance Obligation gets second billing after revenue
Not tracked as much by private companies, but increasingly it will be.
RPO = remaining performance obligation
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29. Takeaways
● A SaaS company is the sum of two businesses (recurring, acquisition)
● SaaS unit economics are great for understanding a SaaS business
● But churn rates can be problematic and often lack credibility
● Flawed churn rates in turn impact LTV and LTV/CAC ratios
● The solution is to do cohort-based analyses which take you above the fray
● Net dollar retention is a cohort-based customer expansion/shrinkage metric
● A good NDR is around 115%
● If NDR is so important, why not build it into multi-year deals?
● Going forward, startups will increasingly track RPO
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30. THANK YOU
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31. References / For More Information
● KeyBanc SaaS study (2019 is latest publicly available)
● Meritech Enterprise Comparables
● Kellblog on LTV/CAC (the ultimate SaaS metric)
● Kellblog on CAC payback period (the most misunderstood SaaS metric)
● Tomasz Tunguz on Redpoint’s 2020 GTM survey
● Alex Clayton on Net Dollar Retention
● Sammy Abdullah on Net Dollar Retention
● Kellblog on Price-Ramped vs. Auto-Expanding Deals
● Asit Sharma on Remaining Performance Obligation
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