How the Economics of Professional Services Have Changed in Software

A founder asked me recently if there were any trends in professional services across public SaaS companies. I had examined the gross margins and share of revenue from professional services about 3 years ago. Professional services are consulting fees software companies charge to customers for software configuration, customization and education. What has changed over the past 3 years?

First, we have more comprehensive data set, since many more companies have gone public. Second, many newer software companies generate substantial fractions of their revenue from PS. Appian is close to 50%; Pegasystems is at 37%; Horton is at 24%; Mulesoft at 20%.

In the past, companies with higher professional services components to their revenue have been valued less highly because PS revenue isn’t recurring and is lower margin than software revenue.

In addition, the gross margins from professional services look different than three years ago. The variance is much higher. One

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Elastic S-1 Analysis – Another Open Source Monster

Last week, Elastic filed their S-1 to go public. Elastic is a Dutch company founded in 2012. Just five years later, the company generated $159.9M in revenue. Elastic commercializes open source software called the Elastic Stack, a set of different products that enable users to search and store data in many different sources and formats. This software is used for application search, website search, enterprise search, application performance monitoring, and analytics for business and security data.

To put this company’s exceptional success in context, I plotted their metrics alongside Mulesoft, another enormously successful open source company that Cisco acquired the day before their IPO for $6.5B. In the charts that follow, I have plotted Elastic’s metrics the two years before their IPO, marked as -2 and -1. I have plotted Mulesoft’s metrics from 2015 and 2016, which was -3 and -2 years before IPO, but the companies were

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Tomasz Tunguz 1969-12-31 17:00:00

Baumol cost disease explains the increase in salaries without productivity gain. In a classic example created by the former Princeton professor who taught luminaries like Burton Malkiel, the number of people required to play a Beethoven symphony today is equal to the number hundred years ago. But the wages of a classical violinist have increased despite no productivity gain. Baumol also cites this phenomenon in nursing. But, from the cursory research on nursing salaries, I found this isn’t true in g3452ffy1that field.

Tomasz Tunguz 1969-12-31 17:00:00

.— title: How to succeed despite your every effort to fail layout: post excerpt: Startups are discovery teams - they venture into the abyss, like Shackleton, aspiring to cross the Antarctic, plant a flag and live to tell the tale. Because every expedition is unique, no one knows what will work: product features, marketing tactics, sales pitches, fundraising stories. Nor can the team fully anticipate the precipices and risks: competitive, legal, hiring, market timing and management risks.

Tomasz Tunguz 1969-12-31 17:00:00

The power to transcend paradigms: disruption The mindset (goals, structures and rules): culture The goal of the system: mission The power to evolve the structure: organizational growth; self-organization; moving fast Rules of the system: how to engage inside and outside the company Structure of information flows: Positive feedback loops

Tomasz Tunguz 1969-12-31 17:00:00

Advances in machine learning are transforming the software world. One of the most exciting applications of machine learning is speech recognition and natural language processing. After researching the space for more than a year, we are thrilled to announce our investment in and partnership with Chorus, a pioneer in speech analysis for sales. Chorus has a unique technology that enables it to listen to inside sales phone calls, and provide real-time feedback to salespeople while they are speaking on the phone.

Tomasz Tunguz 1969-12-31 17:00:00

.— title: Building A Money Machine layout: post excerpt: Successful startups are money machines: they ingest a dollar of investment and produce more than a dollar in revenue. There are three steps to build a money machine: Find or create a product many people will use. Convince customers to buy the product. Mechanize the two processes above, reducing costs and increasing profitability to finance growth. Startups repeat these three steps many times during their lifespans.

Psychology for SaaS Startups

All the while, this brand building effort is a substantial investment in reducing cost-of-customer-acquisition. Dale Carnegie’s seminal book How to Make Friends and Influence People introduced the powerful notion of social proof to millions. Social proof is the psychological phenomenon behind the power of word-of-mouth marketing. The old trope “No one gets fired for buying IBM” is a manifestation of social proof in an enterprise sales process. Social proof is an incredibly powerful force.

Access is the Scarcest Commodity in Startupland

The SEC announced last week that it wants to find ways to let Main Street investors access stage private venture companies. This news item underscores an important trend that is reshaping the industry. Today in Startupland, startup access is the scarcest commodity. Everybody wants an allocation, an opportunity to invest in the very best companies. The SEC story highlights how much has changed in Startupland. In this post, I’ll touch on three.

First, public market investors can’t access high growth companies at the stages they once could. Second, shares in the private market trade at a premium to public market shares. The public market liquidity premium of the 90s has been replaced by a private market access premium. Third, this confluence of factors creates an opportunity for vertical integration in venture, where VCs provide capital at every stage in the company’s lifecycle: from seed to A, B through to pre-IPO Continue reading "Access is the Scarcest Commodity in Startupland"

How SaaS Companies are Valued

In a post earlier this week, I argued 1% of Salesforce’s revenues creates a unicorn. More broadly, I said that the biggest SaaS companies are so large, that they must have underserved customer segments. And there is an opportunity for a startup to identify that underserved segment, build a product to serve it better, and build a unicorn. I received a lot of comments about this post, but not the kind that I expected.

Many people wrote me to say that 1% of revenues does not equal 1% of market capitalization. In other words, even if start of were able to win over 1% of Salesforce’s revenues, it would not equate to a $1B valuation. Also, one person accused of clickbaiting: writing an article with a misleading headline, which is something I try very hard not to do.

Given that feedback, I thought it important to explain in more detail Continue reading "How SaaS Companies are Valued"

1% of Salesforce’s Revenue Makes a Unicorn

Salesforce is worth $113 billion. 1% of $113 billion is $1.13 billion. ServiceNow is worth $34B and Workday is worth $33B. 3% of $33-34B is $1B. Atlassian is worth $20.5B. 5% of $20.5B is $1B. Why am I doing all this simple math you might ask?

We have reached a point in SaaS where a small fraction of an incumbent is a billion-dollar company. If you start a business tomorrow that is able to cleave 1% of revenue from Salesforce, you will have built a billion-dollar business.

1% is not that much.

For every one of the 23 software companies listed in the chart above who are worth more than $5B, there is an unhappy customer segment. A customer segment that perhaps was initially well served by the company. A customer segment whose needs have changed. A customer segment that can be identified, targeted, and better served. Continue reading "1% of Salesforce’s Revenue Makes a Unicorn"

Why Fast Learning Curves are So Important to Startups

Startups are business machines engineered to grow quickly. The forces of hypergrowth exert enormous strain on every aspect of the company. Internal break all the time as the company moults into a new skin. This is one of the most important things to keep in mind when hiring. Every lead hired today, whether marketing , sales, engineering or product, will have a very different job nine months from now, much less two years from now.

Imagine you work at a startup that is growing headcount 125% year over year. It’s 25 people going to 56 going to 126. You hire a head of engineering. The engineering team is 17 people.

The org chart will look like this: one engineering lead with 17 engineers reporting to them. 17 direct reports is unsustainable. It’s at least one full working day of 1/1s. Plus, the engineering lead must double the size of the

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How Long Should Your SaaS Software Trial Period Be?

How long should you let a customer use your software before they sign a contract? You could offer them a 7 day free trial. Or 14 or 21 or 30 or 90.

Longer trials might be better. The customer could delve deeper into the product, become more committed and sign a larger contract. Shorter trials drive urgency, weed out the uncommitted, and result in shorter sales cycles. Both sides have compelling arguments.

Unfortunately, most SaaS startups don’t have enough samples to reach a statistically significant answer. Anecdotally, I’ve heard from many marketers shorter trials are better.

The team at MadKudu analyzed 9 companies with different customer acquisition and sales strategies. Their data showed conversion rates for most of these businesses follow an S curve. I’ve copied their chart above. Two have freemium plans (A & G); three have 14 day trials (D, E & F); four have 30 day plans Continue reading "How Long Should Your SaaS Software Trial Period Be?"

Are We Investing Enough in Our Managers?

I met a seasoned executive recently. He made a bold claim. “Management is an art, and one that is overwhelmingly undervalued in Silicon Valley.” I wondered, are we investing enough in our managers?

Talent is the largest investment of an early stage company. 80%+ of startup operating expense flows to compensation. Retaining these employees is good business. Especially in such an expensive and competitive talent market.

Research shows employees leave their jobs because of poor leadership and poor management. All managers in a company influence employee retention - from the C-level to the line manager. This is why investing in each creates a competitive advantage.

Suppose the average manager has a span of control of seven. Seven people’s compensation might total an annual budget of $1.5M to $3M. That’s a quite an investment for an early stage company. A manager influences a significant fraction of an early stage Continue reading "Are We Investing Enough in Our Managers?"

Jacob’s Ladder in the Startup Fundraising Market – How Startups Today Skip a Round of Fundraising

Jacob’s Ladder is a toy of thin wooden blocks attached by ribbon. If you hold it in your hand and rotate it to touch the second block, it seems to set off a cascade of blocks falling from the top. The blocks haven’t changed positions, though they do rotate. It’s a moving optical illusion. When I watch this toy, I’m reminded of the current state of the fundraising market.

Long-term trends in the start of fundraising market have been consistent over the last 10 years. Median round sizes have increased from 2009 dramatically across seed and Series A-C.

As these round sizes have grown, there is a Jacob’s Ladder effect. In the chart above, I’ve drawn dashed lines from the values in 2009 across the graph. The dashed blue line is the median series A from 2009. Seed rounds have not surpassed 2009 Series A levels. That part of the Continue reading "Jacob’s Ladder in the Startup Fundraising Market – How Startups Today Skip a Round of Fundraising"

Why Your Startup Doesn’t Invest Sufficiently in its Differentiators

There are three types of product features, a seasoned head of product told me recently. MMRs, neutralizers, and differentiators. MMRs are minimum market requirements; basic features that every customer expects and demands. Neutralizers mitigate competitive threat. Differentiators are your startup’s competitive advantage. As a product manager, I’d never thought about this type of roadmap segmentation before. But it made a lot of sense to me.

When a startup has established product market fit, the differentiator is clear. This feature set distinguishes the company. It is the reason customers prefer the product to alternatives. The very first buyers buy irrespective of deficiencies. The differentiator is enough to overlook those faults.

As the product team talks to customers, they are likely to hear feedback encouraging more investment in MMRs and neutralizers. “Your product is missing this feature. We need this capability that exists in another piece of software in yours.”

This Continue reading "Why Your Startup Doesn’t Invest Sufficiently in its Differentiators"

The Startup Founder’s Almanac

I first met Elad Gil when I became an associate product manager at Google. Back then, he had an unusual habit I noticed right away. Most people carry their laptop in the same way. The laptop is closed, in hand, between the hand and the hip. Elad carries his laptop open, powered on and by the top or bottom corner. He’s so smart and has so much cognitive bandwidth, he simply doesn’t have time to wait for the computer to wake from sleep.

I’ve admired the way Elad decomposes problems and proposes solutions from those early days in Building 42. High Growth Handbook shines as a straightforward manual for startup founders. It explains the theory and the practice of building a company from his point of view and that of many luminaries.

There are a few passages from the book that struck me.

Marc Andreessen: “In fact, the general model Continue reading "The Startup Founder’s Almanac"