Metrics that matter for growth & profitability

JC’s Newsletter #174

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Dear friends,

In JC’s Newsletter, I share the articles, documentaries, and books I enjoyed the most in the last week, with some comments on how we relate to them at Alan. I do not endorse all the articles I share, they are up for debate. 

I’m doing it because a) I love reading, it is the way that I get most of my ideas, b) I’m already sharing those ideas with my team, and c) I would love to get your perspective on those. 

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🔎 Some topics we will cover this week

• Sales models and deal dynamics

• Tips and strategies for improving deal size and velocity

• The concept of freemium and how it can be introduced into the distribution model to compress cycle time and drive more top-of-funnel activity.

• Importance of tracking metrics: financial metrics and indicators that are important for startups and scaleups

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👉 The Difficulty Ratio (Bottom Up by David Sacks)

❓Why am I sharing this article?

• Can we be more self-serve / product-led on SMBs? Can AI help there?

• We want to get to the top right by winning the category, we are progressing towards this. 

• The ACV table to time to close is interesting. We should do x5 on ACV due to our gross margin. 

• Good tip: “Make sure that your features appeal not just to end users but to decision-makers who have the budget and authority to buy your product.”

• Do we track cycle time well?

• How to introduce freemium.

• All successful SaaS companies share a trait in common: the size of their deals is commensurate with the time required to close them. We call this the Difficulty Ratio (deal size/cycle time). Larger deals can take longer to close; smaller deals must close quickly.

• Bottom right: Sales cycles are long, but they are rewarded with high annual contract values (ACVs). 

  • This is the classic Enterprise sales model, which typically involves proactive identification of high-value accounts. 

  • Common lead generation strategies include account-based marketing (ABM) and outbound sales.

• Top left: ACV is low, but velocity is high, so lots of small deals add up to a big number. 

  • This is the SMB model, or sometimes selling to individual teams within larger companies. 

  • This model is usually fueled by productled growth (PLG) or inbound marketing. 

  • Targeting SMBs through outbound sales is challenging due to their sheer number.

• Top right: This rare and coveted quadrant features both high deal sizes and high deal velocity. 

  • This exceptional model can occur when a SaaS company has won its category and benefits from order-taking.

  • Or it can be found when a PLG company matures and begins to close enterprise deals. In that case, bottom-up adoption by employees precedes the sale, compressing the sales cycle.

• Bottom left: This is the only quadrant that doesn’t work. Deals are both small and slow. 

  • For example, a startup that takes 6 months to close a $25k deal is not sustainable. 

  • However, during a startup’s first year, closing $25k enterprise deals is acceptable as a proof of concept (POC). 

  • Just understand that a real enterprise deal doesn’t materialize until you renew for at least $100k+/year.

• Push ACVs higher

  • Reevaluate your pricing model: Ensure your pricing model aligns and scales with the value you’re providing. Consider monetizing usage instead of seats (or vice versa), and implement tiered pricing to capture more value from different customer segments.

  • Improve your product: Enhance your product with additional features, integrations, or customizable solutions that address more valuable pain points or that help you engage new budget holders. Make sure that your features appeal not just to end users but to decision-makers who have the budget and authority to buy your product.

  • Target larger customers or verticals

  • Expand within accounts

• Increase velocity

  • Conduct an audit of your sales engine: 

    • Assess your sales team setup, pipeline availability for your reps, lead qualification processes, and the definition of when a lead becomes an opportunity. 

    • Evaluate whether reps can create the necessary urgency to drive deals across the finish line. 

    • Find the compelling event that makes your product an immediate need to some buyer.

  • Track the time a prospect spends in each stage of your sales process. Tracking cycle time will help you identify bottlenecks or inefficiencies that slow down deals.

  • Implement lead scoring to prioritize high-quality leads

  • Consider how you might introduce PLG into your distribution model: Freemium offers can compress cycle time and drive more top-of-funnel activity.

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👉 Metrics That Matter – Three Analyses for Startups and Scaleups to Track on the Path to Profitability (Index Ventures)

❓Why am I sharing this article?

• Interesting financial metrics (we already follow most of them)

Pre-S&M Profit Margin:

• Technology companies typically group Operating Expenses into three categories: Sales & Marketing (S&M), Research & Development (R&D), and General & Administrative (G&A). If you have a highly retentive product, S&M could be considered an investment in future growth and a variable expense as opposed to a fixed expense. R&D and G&A are typically considered more fixed in nature and related to maintaining your current revenue base and customer relationships. 

• Given that S&M is an investment today for future growth, one helpful metric to analyze cost structure is Pre-S&M Profit, which takes Operating Profit Margin and adds back Sales & Marketing Expense. This tells you how much margin you have before making the decision to invest in Sales & Marketing. A Pre-S&M Profit Margin of approximately 20% or higher can be considered quite healthy because it means your company has adequate budget to invest in S&M. 40% or higher would be considered best in class.

• We’ve also found metrics like Magic Number, LTV to CAC, and Rule of 40 to be helpful financial indicators.

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👉 Guide to Growth Metrics (Andreessen Horowitz)

❓Why am I sharing this article?

• Should we track our Gross dollar retention, net dollar retention more often?

• Compare your Free Cash Flow.

Gross dollar retention:

• YoY ARR growth is a leading indicator for both customer demand for your product and future topline growth.

• To account for different drivers and predictability of ARR growth, we will also usually evaluate logo growth and percentage of ARR derived from expansion vs. new customer sign-ups. 

  • For bottom-up companies, we also look at conversion to paid metrics, and for top-down companies, we look at sales pipeline, historic pipeline coverage, account executive capacity, and historic attainment—among other metrics.

• We like to see a healthy balance between ARR added from expansion of current customers and ARR added from new logo growth.

• GDR essentially measures renewals, and it’s often a good indicator of how mission critical your product is to your customers. As a company scales, your existing customer base becomes a larger portion of your business and retaining these customers is key to sustainable long-term growth.

• GDR is especially important to track for businesses with top-down sales motions.

• GDR can vary depending on the customer base. For companies focused on SMB and midmarket customers, GDR is typically 5–10 points lower because these customer bases have inherently higher churn.

Net dollar retention:

• NDR helps founders evaluate how good their company is not just at retaining customers (i.e., GDR), but also at securing additional revenue from their existing customer base. Since it’s usually cheaper to expand an account than acquire new logos, expansion is one of the best growth levers founders have, particularly in scaled businesses with larger existing customer bases.

• NDR tends to be much higher in usage-based or bottom-up businesses. Usage-based businesses can expand contract values without negotiating new contracts, while bottom-up businesses typically start with a smaller base of users that can expand virally. With a few exceptions, NDR eventually evens out as companies scale and accounts expand to a saturation point.

Free cash flow margin:

• This metric is primarily affected by a company’s scale—not go-to-market motion or type of software (i.e., application or infrastructure)—so benchmarks displayed are based on ARR.

• You should consider free cash flow margin alongside your company’s growth rate (see rule of 40) because there’s often a trade-off between investing in hypergrowth and achieving profitability.

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