You may also want to view our webinar “Financial Metrics for Cloud Companies”
The Cloud business model has a dramatic effect on cash flow making every expense you incur more visible and more painful.
So many start-ups underestimate their customer acquisition costs and overestimate their sales projections. It is the main reason so many of them go broke – they simply run out of money. The same is true for traditional software companies that are expanding into the Cloud – they may have cash flow from their on-premise sales and they may have people and resources that can be shared across product groups, but if they aren’t measuring their customer acquisition costs properly, it will take much longer before their move to the Cloud starts to pay for itself.
We affectionately refer to this as the cash flow chasm. It’s the gap in timing between spending money to come on board, to actually making a return on a relationship. The gap will vary greatly based on the factors – how much you spend, the level of revenues you get from a contract, and how long the customer stays with you.As illustration, let’s look at the economics of having one full-time salesperson.
A salesperson represents a cost that has to be absorbed before they generate a single dollar of revenues, and a monthly expense that will exceed the revenues they produce while they are ramping up.In this model we are assuming that the salesperson brings in $5,000 of new monthly recurring revenues every month, and it takes 3-to-4 months to ramp up to 100% sales efficiency. It takes an average of 11 months before one salesperson reaches their break-even point.
They were actually incurring a loss every month before they reached break-even, and they have to keep selling for you to make that money back. Some estimates are that it can take 23 months to make that money back. Now, consider the average tenure of a SaaS salesperson is 26 months.The good news is that you will continue to collect the recurring revenues from all of the accounts they sold to, which produce a great margin for you – IF you have the cash flow to bridge that chasm.
This is why so many SaaS companies are moving to contracts with annual payments up-front. It is the best way to eliminate the cash flow chasm. In the enterprise space, there is almost never a problem with annual payments. The companies have the cash to make the payment, and in many case they would prefer to make one payment per year instead of having to set up monthly payments.