Forecasting the growth of your enterprise software company is tricky. While most consumer-facing businesses earn money from day one, the average sales cycle for an enterprise software company is six months or longer.
Although setting growth forecasts without sales figures can be tough, it’s essential that you do it well. Think of a growth forecast as a promise, a stake in the ground. You’re staking one of the most important things you own — your credibility and reputation as a trusted leader — on delivering this promise to your investors and your staff.
To help you accurately forecast your company’s growth, here are four essential metrics you should track:
- Monthly recurring revenue: MRR is your most important metric: It’s a measure of your business’s predictable, recurring revenue. Unlike traditional software customers, SaaS customers don’t pay upfront. This is both a blessing and a curse. On the one hand, it means you don’t have those initial injections of cash; on the other hand, it means you’ll have a steady monthly cash flow once you get established.While it’s great to have a record month for revenue, MRR is the metric you should pay attention to. By tracking MRR instead of just monthly revenue, you can keep an eye on the rate at which you’re gaining or losing business. For example, if you gain $100,000 in new revenue but lose $100,000 in existing revenue, MRR will still remain flat.
- Churn: This is a metric to help you understand customer reactions to your business. Churn measures the rate at which customers leave every month. To effectively measure churn, you’ll need to group customers into meaningful cohorts.Are most customer losses newer customers, or are they customers who have been around awhile? At which stage in the cycle are you losing people? Asking these questions can help you identify weak spots in your business. This is a vital metric because you’ll need to manage your customer acquisition cost relative to your customer lifetime value. If your lifetime value falls dramatically, you’ll need to rethink your business model.
- Customer acquisition cost: This goes hand in hand with churn analysis. Many startup leaders are so focused on revenue and growing their customer bases that they ignore how much they’re spending to find new customers. Ignoring CAC can lead to making unprofitable business decisions — you’ll spend so much money chasing new customers that you can’t recoup these costs with the lifetime value of the customer.
- Average revenue per customer: This last metric is by far the simplest, but it tells you a great deal.How much are customers willing to pay for your product? If you notice that the average revenue per customer tapers off around $10,000, you might have hit your price ceiling. If you want to charge more, you’ll need to improve your product. Conversely, if you have continuous growth in average revenue per customer, this might be a sign customers are willing to pay even more for your product.
What to do if you miss your targets
Checking your startup’s growth metrics before setting a growth forecast can help you set realistic targets — but things don’t always go as planned.
Startups often run on tight budgets, so missing your forecast can make it even trickier to meet your next one. You might have to cut your expenses or alter your targets.
Neither act inspires confidence. Your investors might question your credibility or pull back from the company, and employee morale could plummet. It’s important, therefore, to keep both groups from worrying about your startup missing a growth target.
Here are three ways to deal with the problem:
- Build tolerance into your models. You need to be realistic when setting growth targets. For an early-stage company, this means building in a tolerance level of about 20 percent. When your company’s revenues stabilize, this might be as little as 5 percent.Managing expectations is essential to your business’s development. Track your forecasts on a quarterly — if not monthly — basis. This gives you a chance to react before it’s too late.
- Communicate. Investors value open, honest communication. Don’t be afraid to call investors at the first sign of underperformance, but craft your message carefully — you don’t want to set off alarm bells.You should also keep your employees in the loop. They’re far more likely to stick with you if they feel included.
- Conduct a full postmortem evaluation. Finally, ask the all-important question: Why did you miss your growth forecast? Is it because of an internal problem, or is it a reflection of economic problems for the industry? If it’s internal, you need to find a solution.
Look at Apple. The company was worth about $4 billion in 1997 and had just lost $1 billion the previous fiscal year. Steve Jobs then took the lead and staged an immediate inquest. He secured $150 million of investment money from Microsoft, and he took an honest look at Apple’s offerings. Jobs streamlined the company, scrapped unprofitable products, and laid the foundation for the company’s success.
For SaaS startup success, keep an eye on your metrics, and don’t panic if you miss a growth forecast. If you do miss your targets, take a close look at your company. Always keep investors informed of the situation, and don’t quit when the going gets tough.