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10 Tips for Building a Successful Software Business

10 Tips for Building a Successful Software Business
Image credit: MiBSi | Flickr

As more and more businesses warm up to cloud-based services, the software-as-a-service industry continues to grow fast. The Gartner CRM Guide, published in March predicts, for example, that by 2015, for the first time, more than 50 percent of customer-relationship management deployments will be deployed as SaaS, and that by 2025 that number will surpass 80 percent.

As Mark Andreessen would say, “software as a service is eating up the world.”

Related: Considering 'SaaS'? What You Need to Know

Consider these 10 tips to create a successful business in this expanding industry:

1. Follow KISS (keep it simple, stupid)

SaaS products are often self served, and as such need to be self explanatory, simple, clean and highly intuitive. Sales and marketing collateral need to highlight value, return on investment and use flows, not features and technology.

2. Offer several packages

The entry-point SaaS offering should almost always be free, but limited in usage volume, functionality and/or time. It is recommended to then offer two to three paid packages fitted to different customer segments with different usability, ROI and willingness to pay.

3. Define, measure, analyze, improve, control

In their actions, SaaS users share with us invaluable information about their use of our products, and their needs and behavior. Data reveals what functionalities are popular or aren’t being used (and should therefore potentially be omitted per the KISS principle), and also helps to segment users and define packages. It’s important to continuously define tests (wherever possible with A/B testing) and monitor the effective improvement after making changes.

4. Cultivate an ecosystem

Successful products are wrapped with open and flexible APIs that enable easy integration with third-party software. The better ones also amass around them a community of developers, and/or offer a plugin marketplace that enables the development and promotion of third-party plugins. Interoperability increases the value of the product, and also introduces an ancillary source of revenue from referrals, resale opportunities and equipment manufacturer deals.

5. Offer the right amount of professional services

Professional services are a double-edged sword. On one hand, they increase revenue and stickiness and reduce churn rates. On the other hand, they increase deployment time and cost of sales, and reduce margin.

Related: Want to Join the 'Unicorn Club'? Here's What 3 Companies Did to Get There.

Professional services typically make up for between 10 to 20 percent of new annual contract value (ACV), and their gross margin is typically 20 percent (vs. 80 percent for the recurring revenue). These proportions usually add up to a blended gross margin greater than 70 percent, which is an important threshold for maintaining good valuation multiples.

6. Be committed to your customers’ success

In addition to signing up new customers, the main goal of a SaaS company is to defend and grow its recurring revenue from existing customers. Typically, the goal is for up-sells to constitute between 10 to 25 percent of new ACV booked, and for the company to maintain a gross monthly churn rate under about 1 percent (without taking into consideration up-sells), and a net monthly churn rate that is negative (up-sells greater than gross churn).

To achieve this, a customer success team needs to continuously monitor their customer’s usage levels, send them product updates and satisfaction surveys, and invite them to customer-advisory board sessions, among other things. The customer-success team should also be trained and capable in selling.

7. Monitor your dashboard

SaaS companies need to constantly monitor their key performance indicators (KPIs). The most important measurements are monthly recurring revenues (MRR), churn rate, cash flow, customer acquisition cost ratio, customer lifetime value, ACV/MRR pipeline and average ACV/MRR per salesperson.

8. Align incentives

It is crucial to create incentives and set compensation plans aligned with KPIs. For example, salespeople need to be compensated differently depending on the type of customer (new vs. up-sell), type of booking (recurring vs. nonrecurring), contract term, terms of payment, etc. Similarly, customer-success managers need to be compensated for reducing gross churn and maximizing up-sells (or combined, reducing net churn).

9. Growth is king

For a SaaS company with typical gross margins of greater than 70 percent, valuation is mainly dependent on annual revenue growth rate. The average SaaS Company is growing at about 25 percent year over year and is generally valued at around four to five times its forward revenues. Conversely, a company with similar revenues growing at about 50 percent year over year would be valued at around twice that.

The message is clear: if you have the means to do it, you should invest heavily in growth.

10. Show a path to profitability.

Most SaaS companies are not profitable because they invest their resources to fuel growth. That said, good SaaS companies must show a path to profitability -- essentially prove the business model is fundamentally sound (per KPIs above) and that they plan to be profitable in the next one to two years, or can at least do so while maintaining at or above average growth rates. The best way to demonstrate this is for companies to hit profitability every couple of years before investing more once again toward higher growth.

Related: Want to Stand Out From the Crowd? Know Your Unique Value Proposition.