I enjoyed the recent Saascribe interview with Jason Lemkin. He is always worth reading on SaaS topics. Around the same time, I also found a Huffington Post article quoting Jason on critical SaaS metrics interesting. It reflects a common view that growth is the defining measure of success for SaaS.
So why do some other analysts stress the importance of lifetime value (LTV)? Take this deck from ChartMogul for example. This is an example of a long established clash of investment philosophies. Growth Investing v Value Investing. Stock market gurus and big money investment managers have argued about the benefits of these approaches for many years. There are strong advocates on both sides. Although the world’s most famous investor, Warren Buffet, argues that the two are the same in theory.
Growth investors choose companies based on future potential. They look beyond traditional measures of financial performance. VCs have to be growth investors. It is essential to their business model.
But growth investing carries big risks. The future size of markets is uncertain. And some companies may not be able to turn growth into value in the long term. Recent results from Apple are a great example of the effect of this strategy. The world’s biggest company by market capitalisation reported record results. Revenue, margins and profits were all at new highs. Yet the share price dropped 5% when they were announced. Growth investors expect even more than Tim Cook and his team are able to deliver.
By contrast value investment is all about financial fundamentals. Conventional finance theory asserts that a company is worth the discounted value of its future cash flows. If an investment shows revenues, profits and cash flows that amount to more than its share price this is a value opportunity.
Of course not everything can be predicted. But investors who focus on value also look for businesses with predictable future earnings. This makes for low risk investments although they can be hard to find. The biggest problem is incomplete information. An investment may appear attractive. It may not look so clever if a major product problem is revealed for example.
For SaaS LTV is a good proxy for this concept of value. In simple terms LTV is the sum of the future value from each customer. Multiply by the expected number of customers and you have a rough measure of business value.
It is clear to see the value in both growth and value measures. For a SaaS company it is not as simple as making a choice. Both need to be balanced:
- Startup investors including VCs and angels will always be looking for growth. It is at the heart of their business model. You need to convince them to raise money.
- You start with nothing so growth is essential to build a business.
- Current investment conditions will not last forever. When times are hard, shareholders will look for value. LTV will become fashionable real fast.
In the real world growth will be the every day focus. At an early stage you have no company without customers so there is no option. Finding paying customers and building that base is the day job.
But as a leader, you need to step back from time to time and look at LTV. Get underneath the numbers and understand what you can learn about your business. Look at adjustments which can improve LTV in the future. Have those answers at your fingertips and you will impress investors and analysts. Build LTV over time and you will have a sustainable business. You will also have a tremendous edge if market conditions turn down.
by Kenny Fraser @Sunstonecomms