This Academy Guide is based on a webinar about the subscription business model featuring Iain Hassall, Controller and VP of Finance for Zuora, and Ben Kwon, VP, Sales Strategy & Operations at Sumo Logic (formerly VP of Operations at Zuora). You can check out the full presentation here: An Operating Framework to Help Grow Your Subscription Business.
Every company has their own set of metrics, their internal framework, that is unique to their business. The commonality we see within our community is the focus on metrics that capture the customer relationship. In a subscription business model, the relationship with your customer – not the product – is the key to your company’s success. And, at the most fundamental level, your customer health is captured through your Annual Recurring Revenue (ARR)
At Zuora, we developed an internal reporting framework that we call PADRE which stands for Pipeline, Acquire, Deploy, Run and Expand. This framework gives us a lens into the customer’s subscription journey, from initial inquiry to their ongoing success. And it serves as a tool we can use to hold internal departments accountable for how they support the customer relationship throughout the customer’s lifecycle.
The first step is to understand what levers drive your pipeline. This is unique to your business, so you have to establish your own foundation by which you measure your results. What are the different phases of your pipeline and how are you measuring the results? Are you a high-touch, assisted sell business that is driven by heavy outbound prospecting activities? Or are you a low-touch (or no-touch!) e-commerce business that is driven by web traffic through brand awareness?
Your strategic initiatives will also shape the way your funnel looks. Are you focused on market share capture? If so the top of your funnel will be fat, allowing your Lead Generation and Sales teams to have as many “at bats” as possible. However, fat funnels are often created at the expense of quality. If you’re a more mature company focused on growth efficiency, you may have a narrower funnel with a higher level of automated qualification and higher conversion rates.
Once you establish the mechanics of your pipeline, aligned with your subscription business model and supporting your strategic goals, how do you know when you’re creating enough – enough traffic, leads, opportunities, etc.?
There are two high level components of pipeline health that we measure to determine whether we are on track to support the revenue targets, a pipeline creation multiple and a pipeline coverage ratio. In both cases we set pipeline goals not at the corporate or even the management layer but we set targets at the account executive level, what we call our “street capacity.” Our goal is to create enough pipeline to allow every account executive to be successful.
Pipeline creation multiple – We have a “creation multiple,” for example 5x your sales quota two quarters out. The creation multiple and what quarter you apply it to is derived from your pipeline conversion rates and your average sales cycle.
Pipeline coverage ratio – We measure coverage ratio based on the amount of active or workable pipeline on day 1 of the period divided by the sales goal for that period. For higher velocity segments the coverage ratio is measured monthly and for slower or enterprise velocity segments the coverage ratio is measured quarterly. Again we measure this at the account executive level.
The pipeline coverage ratio is not a new concept. In fact it’s the most frequently used metric to determine pipeline health. It is however, unique to your business and should be calculated from your company’s win rates. Based on feedback we received from over 100 customers, partners and members of our community, 3.0x is the coverage sweet spot.
When you start looking at customer acquisition, what you’re really looking at is the effectiveness of your sales organization. First you’ll need to examine your sales structure. For example, is your sales organization segmented by vertical, customer revenue, number of employees or a different attribute appropriate for your business? Your internal tools and data management will be heavily influenced by your organizational structure. But there are some key leading indicators that are relevant across the board.
Sales cycle velocity – To measure the effectiveness of your sales organization, as a baseline you should look at your sales cycle. What is the behavior you’re trying to drive and does it vary based on your segmentation. One of the key indicators of sales productivity and efficiency is the average days to close, however you may not necessarily be driving to a shorter sales cycle. For example, if you’re moving up market or launching a new product or entering a new geography you can expect longer sales cycles.
Sales cycle variation measured by segment, by product or even by sales stages can be a powerful leading indicator to identify areas for improvement that are specific for your business. At Zuora we measure our sales process by segment and provide a feedback loop to our enablement team when we spot specific elements of our sales process that are deviating from what is expected.
Sales ramp time – Ramp time is another important measure of sales productivity, or, more specifically, the time required for a new account executive to become productive. This is particularly important for high growth companies that are onboarding a large percentage of their salesforce. This was one of our Sales organizations top strategic initiatives a year ago when over 50% of our account executives were new. The criteria or qualification for an account executive to become ramped can vary by segment, and it can also evolve based on the maturity of your company. We utilize ramp time metrics to drive new sales rep productivity and to accurately model expected revenue generation.
Sales cycle velocity and ramp time metrics help measure your sales organization’s effectiveness, but what about accuracy and predictability? What does your forecast process look like? Most companies have forecast roll-ups at the rep level, manager level, VP level, etc., often with a layer of “management judgement” applied.
Predictive forecast – Consider adding an element of science to complement the art of your sales managers’ forecasts. At Zuora we not only track sales velocity by stage but we also closely track stage conversion and win rates by stage. We are able to produce a “predictive” forecast at every level from individual account executive up to our head of sales. Given that our “predictive” forecast is based on historic productivity, the goal of course is for everyone to beat it. The insights that we gain from these type of productivity and predictability measures help us to model expected achievement across the organization and ultimately tie into our corporate growth model and our compensation models.
Incentivizing metrics – It’s also worth noting that there are useful tools in a subscription business model with which you can incentivize your sales organization, like ACV (annual contract value), TCV (total contract value), MRR (monthly recurring revenue), ARR (annual recurring revenue), and churn. These are all metrics that can be leveraged to drive new logo acquisition, long term contractual agreements and customer retention. Based on feedback from our community, almost 50% compensate on ACV.
Subscription businesses come in many forms these days, with deployment having different meanings for each. However you define deployment, it can be a critical function of your subscription business model, as it’s really your customer’s first extensive interaction with your product. Whether you are a SaaS solution that’s implementing your product in their business environment, or you are a product-of-the-month solution shipping that first box of excitement, how you manage and track that first interaction can determine the success of your business.
Though deployment may differ, the targets are constant: rapid fulfillment and the preservation of cash.
Rapid fulfillment – This can also be considered time to go live. In other words, how long does it take for your customer to start benefiting from your offering? The longer this takes, the greater likelihood of customer churn. If you ship a product of the month, your customer expects the product within days of signing up, not weeks. If you have an IoT product, customers will expect the solution to be delivered and connected rapidly.
Cash preservation – The deploy function can also be a direct drain on your cash reserves. These can be one time costs that you won’t necessarily recover. For example, if you’re a SaaS solution, you might be willing to let your implementation team run at a loss, expecting you can make up the difference on multi-year subscription agreements. Or as an IoT solution, you might be willing to give away the device to chase that recurring revenue stream. But no matter which approach you take, you must keep an eye on the cash reserves you are burning in the deploy cycle.
During the deploy phase, you’ll want to consider a combination of traditional metrics, such as rate per hour and utilization rates, as well as more modern, subscription-centric metrics, like time to go live, and also the rate of customer adoption/attachment. Remember this should always be in the context of how quickly and efficiently you are retiring ARR from your backlog of implementing ARR.
Thinking about how you retain and grow your existing customer base is critical to driving the success of your business. We like to couple “run” with “expand” because this is where subscription business metrics really start to deviate from delivered product offerings.
Churn – You might spend a significant amount of money to acquire your customers – more than you might do with a delivered product offering. Why do this? Because you know the prospect of their recurring revenue stream will be more valuable than if you sold a product to them once, and never heard from that customer again. But is there an acceptable level of churn? We think of churn in comparison to the cost of acquisition. If the cost of acquisition is high, then we need a low churn rate to recover the initial investment. Conversely, If the cost of acquisition is low, then we might be willing to accept a higher churn rate.
Churn can be countered, in part by contract commitments. When talking with our customers and peers, we have found that 1-2 years is the standard contract length because knowing you have that commitment frees you up to focus on continued customer success. However no contract length will ever outweigh maniacal focus on customer success to drive customer commitment.
There are a litany of different ways that companies measure churn (or at least measure for external communication), whether it’s net retention rates, raw % churn, or bifurcation of populations to exclude certain customers. How you are measuring internally should cut through the narrative.
Net retention – One of the best ways we have seen to measure churn is through net retention rates. This is a great tool to identify trends, particularly in your customer acquisition cycle. By measuring net retention, you can see if there is a period of acquisition that was either less or more successful than others, allowing you to focus on the qualities of that period. The expectation is that your install base should be adding to your ARR.
Renewals – Renewals are an important function of your business, and deciding who owns this function is a decision that can ultimately promote or hinder your organization. We’ve found that customer success, which is a relatively new function in the business world, is generally responsible for owning the renewals function.
Upsells – Managing and tracking upsells is critical to your business. Who owns the process, along with how they are compensated, will drive success. You want to manage attachment in your customer base to look for upsell opportunities. Remember, it can be an expensive proposition to onboard new customers, so being able to drive upsells in that customer base will lead to overall efficiencies in your customer acquisition costs. You could even consider bifurcating your acquisition costs between those driven by upsells to those generating new logos. (Note: renewals and upsells are not the same thing. At Zuora, we have a strict policy that straight renewals – and renewals that contain a downsell – are managed by our customer success organization. However sales reps are responsible for driving upsells from our install base.)
As you can see, our pipeline metrics feed acquisition targets, new customer acquisition feeds our backlog, our go-lives feed our run metrics, and our expansion goals loop back into pipeline. And these cascading metrics all feed into ARR growth and can be mapped quarter over quarter.
Regardless of what your version of PADRE looks like, you should always maintain a focus on the customer relationship and focus your operating metrics around growth and preservation of ARR.
You can listen to the full webinar here:An Operating Framework to Help Grow Your Subscription Business