All the hype is about AI, but the real action is in Intelligence Augmentation (IA)

(Original article published on CB Insights)

So much is being said and written about AI. I wrote an article where I attempt to break down what’s here-and-now and what’s not, and what we should do about it.

Machine learning techniques have come of age, and will be harnessed to advance human potential by increasing worker productivity and alleviating mundane tasks. I argue that what we are seeing is an acceleration in machines’ abilities to perform tasks that they have already been better than humans at for decades. However, moving towards the broader vision – and threats – of AI and AGI would require significant additional breakthroughs.

Read the article here: https://www.cbinsights.com/blog/ai-vs-intelligence-augmentation-applications/

Focus on Sales Efficiency as you plan strategy and budget for your growth-stage SaaS company

(Originally published on Medium)

Every entrepreneur, operator and investor active in the enterprise and SaaS space has heard of Sales Efficiency metrics such as Magic Number, CAC Payback and LTV/CAC.

Once at growth stage, Sales Efficiency or Unit Economics is one of the most important quantitative metrics that can help you determine whether you have a viable business, course correct as needed, and help inform various facets of strategy.

Yet, given the many challenges around measuring it consistently, the subjectivity involved, and confusing messaging around so many SaaS metrics, many tend to underestimate its importance.

Some focus only on the unit economics per sales person, which is necessary, but not sufficient.

Subscription oriented businesses lose more money the faster they grow, especially at the scaling stage (~$5M+ ARR, repeatable sales model in place). This, as we know, is because such businesses need to spend a significant amount of capital up front to hire and train sales people, then acquire and set up customers, and recoup value over time as the customer pays the monthly or annual subscription fee. Given the time difference between when the CAC investment (S&M expense) is made, and when the returns (contribution profits) are generated, high growth subscription businesses require significant upfront investment in customer acquisition. The more customers a SaaS business acquires, the deeper the total trough of losses.

The losses typically accelerate as the business grows from $5M ARR to $50M ARR, and looks to add higher levels of ACV each year. A rapidly growing SaaS business could have a rising burn rate for a good reason — the business is acquiring customers fast, and these customers will eventually be profitable for the business. However, a company could also be incurring heavy losses if it has an unviable business, via sub-optimal product/market fit, an inefficient sales or marketing organization, acquisition of marginal customers, operating in unprofitable geographies or inadequate pricing.

Every CEO, management team member and board member of a SaaS or B2B company that is losing money needs to understand very clearly which one of the above it is.

It is paramount to understand whether you would deliver returns on capital invested on customer acquisition — just like any other investment you would make in your personal or professional life. The Customer Lifetime Value (LTV) needs to eventually generate sufficient return on the Customer Acquisition Cost (CAC), to offset R&D and G&A expenses, reinvest into growth, and eventually generate profits. The commonly accepted rule of thumb, especially amongst venture investors and venture-funded companies, has been that of LTV/CAC > 3X for building a sustainable business. This benchmark has a good reason, and we illustrate this with data below. A simple explanation is as follows. For SaaS businesses at scale (~$100m revenues), R&D and G&A together typically average at 30–35% of revenues, down from higher % numbers earlier in the life of the company. CoGS/variable expenses average at another 30–35% of revenues. The predominant swing expense at that point is typically Sales and Marketing. An LTV = 3X CAC (or S&M = 1/3 of contribution margins) leaves about a sixth of revenues as capital for reinvestment into growth, and eventually profits.

Understanding the impact of Sales Efficiency on the viability of the business

To illustrate the impact of Sales Efficiency on business viability and capital intensity, we model a hypothetical SaaS company that ended the prior year with $5M ARR, and targets getting to $100M ARR by end of Year 5 (a commonly accepted threshold for considering an IPO or large M&A). We assume R&D and G&A expense trajectory in line with a basket of public comps, starting at levels consistent with Series B or C stage startups, and approaching an aggregate of 35% of revenues at $100M revenue run rate. We made market-based assumptions for contribution margins (70%) and simple assumptions for annual logo churn (12%) and dollar churn (-5%). Contribution margins adjust for not only typical CoGS items but also any account management and retention related expenses. We use the undiscounted LTV for the purposes of this analysis. We capped the customer lifetime at five years for the purpose of LTV calculation, and modeled various scenarios with different levels of LTV/CAC. We then made assumptions for S&M spend in each scenario such that the company achieves $100M in ARR at the end of Year 5.

The growth trajectory of our hypothetical future unicorn is consistent with that of many successful SaaS companies that have gone public over the past several years:

While each of our scenarios has a similar growth cadence (and hence overlapping curves in the chart above), let’s look at the S&M expenses required to generate this trajectory for each scenario.

With our aforementioned trajectory of assumptions for other expenses, the EBITDA numbers look as follows for this company at various levels of Sales Efficiency.

The difference between scenarios is stark. With an LTV/CAC of 4X, our hypothetical company is close to EBITDA profitability in Year 6 with $116M GAAP revenues, while with LTV/CAC of 2X, the company is still losing $45M a year, or nearly $4M per month in Year 6!

Now let’s look at the Capital Intensity in each scenario. The chart below shows the cumulative losses during the first five years after $5M ARR for this company. This analysis ignores the impact of up-front cash collections/deferred revenue and stock based compensation expense for simplicity. These vary significantly by company, but the trend below will hold after these adjustments.

With an LTV/CAC of 4X, the company requires $80M and gets to profitability in Year 6, while with 2X, the company requires over $180M in Years 1–5, and is still losing $45M per year in Year 6. This difference not only has a significant impact on returns for founders, employees and investors, but also brings to question viability of the company in scenarios where LTV/CAC is under 3X. While many kinds of companies are able to raise financing at preferred terms in bull markets, in normalized market conditions it would be hard for the company to continue raising private financing to fund its large losses during Years 1–5 in the first two scenarios above. On the other hand, in the last two scenarios above, the company may choose to continue to grow faster in Years 4 and beyond if it sees a large market opportunity.

We have used LTV/CAC as the primary Sales Efficiency metric here, and similar analyses can be conducted using other metrics such as CAC Payback and Magic Number. LTV/CAC, while harder to accurately measure, is more comprehensive and predictive.

How should you act on this?

At any given point of time, a business can choose to grow faster by deploying more capital into Sales and Marketing. But this only makes sense as long as this is done while maintaining the right Sales Efficiency. The growth rate and organizational processes (sales hiring, incentivize structures, focus on cross-sells and up-sell, customer targeting, conversion funnels, lead sources) need to be tempered and monitored closely to keep the overall company-level LTV/CAC in a healthy operating zone.

Based on looking at numerous growth stage subscription-oriented businesses over the years, here are my observations and recommendations based on Sales Efficiency, as evidenced by LTV/CAC. The absolute levels will vary by specific nature of business, current stage and other factors.

  • LTV/CAC greater than 5X: If the underlying methodology and assumptions are reasonably accurate, then an LTV/CAC at this level indicates that the business currently has significant immediate growth potential. Moreover, you are possibly leaving some growth opportunity on the table. Consider expanding your sales team, marketing channels or vertical focus more rapidly than you have been doing so far. You have the wind at your back. However, when we see very high numbers for LTV/CAC for high growth companies, it is often due to miscalculated LTV or CAC, e.g. during a company’s early days when the CEO and management team are doing most of the selling those efforts may not be fully incorporated in CAC, or very scalable. Another common pitfall is using an artificially low churn number (rather than renewal rates) at a high growth company to come up with an unreasonably high customer lifetime. I recommend capping the lifetime for the purpose of these calculations at 4–6 years depending on type of customer you serve, and taking a hard look at the underlying methodology if you have a 5 year LTV/CAC that is more than 5X
  • LTV/CAC of 3–5X: This is the optimal zone. Continue executing and find ways to augment your expansion rate without having the LTV/CAC fall below 3X
  • LTV/CAC of 2–3X: The company can potentially build a viable business, but it would be unlikely to generate VC-style growth or returns on total invested capital. These levels may be viable for later stage or public companies which have lower R&D and G&A costs as % of revenues, and potentially lower return expectations on invested capital
  • LTV/CAC < 2X: The business is unviable at present, and cannot continue to grow with current contours and growth rate. Our recommendation is to optimize Sales Efficiency by thoroughly reviewing the sales organization, incentive structure, sales targets, vertical focus, product expansion and partnership strategy; or trim the company’s growth rate to focus only on profitable channels, customers and geographies

In a later post, we will touch upon some of the practical challenges and common errors with measuring Sales Efficiency, and share best practices we have seen around this. Here are is a summary of some key items I recommend — Customer Lifetime Value should be calculated net of all variable costs including customer service, retention expenses, hosting fees and any others; For calculating real churn rates for businesses with annual customer contracts, use renewal rates rather than churn rates, which may artificially look lower; Use customer cohorts for understanding account expansion rates; For the purposes of the LTV/CAC calculation, cap the customer lifetime to a reasonable number, as no business is likely to have a customer lifetime of decades across its customer base in this era of rapid disruption cycles.

Recommendation

Given the aforementioned implications of Sales Efficiency on company viability and returns on invested capital and time, CEOs, management teams and boards would be well served by taking a close look at this metric as they finalize their strategy and budgets for 2017 and beyond.

Investing in the Connected Enterprise and Making Offices Frictionless

(Cross posted from Medium)

The typical knowledge worker spends a third of his or her work day in meetings. With advent of the information, internet and cloud era, we have moved to electronic calendars, virtual meeting tools, cloud-based collaboration software and other tools that increase productivity.

However, the process of finding a physical space to meet or work at has continued to be laden with friction. The move to calendar based booking of rooms and resources has helped, but significant areas of friction remain. This is because enterprise productivity tools have not hitherto had a direct feedback loop with the physical office environment.

Take for instance these recurring situations you’ve likely run into — you book a room for an important meeting, but someone else is in the room when you arrive; or that urgent meeting that you can’t find a meeting room for, yet many rooms appear unoccupied when you walk past the meeting room area; or coming across recurring blocks of zombie meetings on the resource calendar that appear to be there just to hold on to meeting space.

As organizations move towards higher proportions of knowledge workers, move to open office environments, and value employee time and collaboration more, these friction areas are becoming more important to address. Smart organizations have an increasing need to measure and act upon usage patterns of workspace and employee time — think Fitbit for office space. McKinsey expects IoT technologies to manage office spaces could add upwards of $70 Billion of value per year by 2025, including potential for 5% human productivity improvement and 20% savings in office costs.

Today, we welcome digital workplace innovator EventBoard to the Nokia Growth Partners (NGP) portfolio to address one of the most common business headaches — managing meetings. NGP has led a $13.5M Series B round, and the company’s news release provides further details. EventBoard CEO Shaun Ritchie has shared his insights and vision in his blog post. As a long-term investor in the Internet of Things (IoT) ecosystem, we are committed to supporting innovators that will power the next major enterprise shift through connected devices.

Our Connected Enterprise Vision

There has been a surge of buzz around Enterprise IoT. Our Connected Enterprise investment thesis is based on our experience partnering with several successful companies in this space. We look to invest in Connected Enterprise companies that:

Create and capture a bulk of the value in the software platform and actionable analytics rather than proprietary hardware, and monetize via a subscription model. EventBoard’s solutions work with commodity hardware (iPads and Android tablets), integrate with a number of best-in-class third party services and disrupt prior generation solutions that used expensive and cumbersome proprietary hardware. This approach enables a solution that is easier to implement and scale, significantly more usable and cost effective, and one that provides richer analytics & indoor maps

Provide simple-to-use solutions which address clear existing areas of friction, sell to a motivated buyer within the enterprise and easily fit into the natural employee workflow. We believe such Connected Device/IoT solutions will create faster path to Enterprise adoption than solutions that first need to educate customers on need, those that need to move through multiple stages of buyer experimentation, or those that require significant changes to employee workflow

Provide extensible solutions that align with important macro trendssuch as the focus of knowledge economy companies on enhancing employee productivity and fostering collaboration. As companies move to open office layouts and shared spaces, solutions such as EventBoard’s attain further relevance

– Are at a stage where the company has achieved strong product-market fit, has a viable sales model in place, demonstrates strong SaaS/Enterprise metrics, and is at a scale where it is ready to engage with large enterprises

In our conversations with IT and Workplace Resources decision makers at several leading organizations, we found that EventBoard aligns well with these criteria. NGP portfolio companies Digital Lumens and RetailNextprovide other relevant examples of companies that drive business value by leveraging a winning combination of these elements.

Exemplifying our vision and capitalizing on the rise of connected devices in the enterprise environment, EventBoard has a tremendous opportunity to expand as it grows its enterprise productivity analytics stack. EventBoard has demonstrated impressive market traction in a short amount of time. It serves more than 1,800 customers including technology and workplace thought leaders such as Uber, AirBnB, Twitter, Dropbox, GE, Viacom, Rakuten, TripAdvisor and National Instruments. We believe EventBoard is well positioned to become the standard solution for managing workplace productivity thanks to its proven leadership team, category leading product and scalable architecture. Please reach out if you’d like to make your meetings more productive. And EventBoard is hiring!

NGP continues to invest in companies that are actively addressing real pain points in the Enterprise — the innovators that will disrupt the enterprise technology status quo and deliver on the potential business value of the Connected Enterprise era.

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