Not All Revenue Is Created Equal
Transcript
Hi. I want to talk to you about one of my favorite topics which is revenue. But not all revenue is created equal.
When I talk to software companies that have enterprise software SaaS based platforms and I ask them where the revenue comes from.
It's always SaaS based but it's not consulting services. I ask them why.
I say, well the VCs. VCs really like SaaS but they don't like consulting services.
And that's a true statement.
We do prefer SAS-based models because they're
predictable recurring revenue models,
and that in an exit, we'll have a higher multiple,
that we'd be valued higher.
But that said, let me tell you a quick story.
I was on the board of a cybersecurity company
in the Valley that was selling enterprise software.
And the company had a who's who of VCs,
one smarter than the next.
I loved being on that board.
learned so much from everybody but one day we started we noticed a trend that
the customer retention rate was appropriated it was in the low 90% and
all of a sudden it started to drop a couple quarters go by and the customer
retention rate was about 70% and the board got really concerned the
management team got concerned and the management team did a deep dive and
here's what they found out the problem wasn't with the software software worked
fine. The problem wasn't with competition. They weren't being displaced by somebody else.
The problem was staffing at their customers. What happened, this was a complicated product. It took
some training. So the company would go in, they would do some training, they would train one or
two people, and time would go by. And what happened is there was churn. So the company's
staff would sometimes they would leave and take another job or sometimes they'd
be promoted or sometimes they'd be assigned a more urgent task and what
happened is over time the product wasn't being used because nobody didn't have
anybody else to replace them and my partner Troy has a saying that I really
like which is what's the problem to be solved and so the problem in that case
to be solved was a staffing problem, even though that you were an enterprise software
company.
So here's what the company did, which I thought was really smart.
They offered up a monitoring service.
So it was a service.
They charged an annual fee.
They charged a high margin for it.
And what it did is it monitored the utilization of the software.
And if the company noticed that the product wasn't being used at the same levels as it
been historically they would step in and they would discover that maybe somebody
had left and they could either provide training to train somebody new if the
company had somebody new to train or they would actually do the work
themselves it was hugely successful a couple quarters go by a year goes by and
sure enough their customer retention rates went back up into the 90s where is
is appropriate. So it may be true that VCs don't like consulting services, but it's even more true
that VCs really don't like customer churn, and you shouldn't either. And so as I gave this some
more thought, I started thinking about this as business continuity. Could you set up a services
program, maybe it was on an annualized basis, that was business continuity software, business
continuity services, so that you are completely aligned with your customer and whatever the
customer needs to make sure that your software is being appropriately used, you can charge
the fees necessary at decent margins to make sure that you and your customers are completely
and totally aligned.
And so I would say to you, as I would say to other VCs, while you may not like service
revenue, you're really going to like higher customer retention rates.
Every SaaS founder has been told that investors want recurring revenue and not consulting services. It is a true statement — recurring models are more predictable and earn a higher multiple at exit. Treated as an inviolable rule, though, it can cost you the customers underneath the revenue.
The story here is a cybersecurity company selling enterprise software, with a board full of first-rate VCs, that watched customer retention slide from the low 90s down to about 70%. The deep dive found the product was fine and no competitor was displacing them. The problem was staffing at the customer: a complicated product, one or two trained people, and then those people left, got promoted, or got pulled onto something more urgent. Nobody replaced them, and usage quietly died.
The fix was a paid monitoring service that watched utilization and stepped in when it dropped — high margin, annual fee, and precisely the kind of services revenue the rule says to avoid. The point is to find the problem to be solved first, then decide which revenue actually solves it.