Metrics & Operations

Is it SaaS? Is it ARR?

echojason@gmail.com'

Jason Lemkin

A lot of us SaaS old timers feel like it may almost be time to retire the SaaS acronym.  Isn’t everything SaaS now?  No one is building on-prem software from scratch anymore, are they?

It’s a fair point.  I remember when Salesforce used “No Software” as their tag line.  I was at a Salesforce event, seated next to a VP from Microsoft.  He learned over to me and said, “Enough with the No Software.  You won [nodding to Benioff].  It’s all on demand.”  Salesforce had a good run with that tag line, but mostly retired it with good reason.  No one wants to buy packaged software anymore.

Screen Shot 2016-04-05 at 9.32.30 AMBut fast forward to ’16, and once again, things are confusing.

Is a subscription delivery service “SaaS”?  Is free software, with services attached, like Zenefits or Weave “SaaS”?  Is a 100% API-based service like Twilio or Checkr or Algolia “SaaS”?  Or what about marketplaces and other software with a human component underlying them?  Was Zirtual SaaS?

Even more confusing is — what is “ARR”?  If you attend Demo Days of any sort these days, you’ll see every start-up now talks about ARR, not revenues.   Including e-commerce companies.  Including hardware companies. Are all recurring revenue subscriptions “ARR”?  Are razors “ARR”?

I get a headache, and want to make a few simple observations and suggestions.

  • Screen Shot 2016-04-05 at 9.49.14 AMFirst, it’s only SaaS and software if the gross margins are > 65%.  Maybe 60% if you push it and have a lot of onboarding costs.  Ideally > 70% if you aren’t really enterprise-y and are easy to deploy.  More on gross margins here in a strong post by Tomasz Tunguz.  The beauty to software is you write a few (million) lines of code, compile them, upload … and then it cost $0.02 to ship those bits anywhere in the world.  The more you ship, the more you make, at almost no variable cost.  If your variable cost is high — if it’s > 20-30% of revenue — it’s not software.  It’s something else.  It’s a service.  And services are great.  But they usually are valued much, much less than software.

Screen Shot 2016-04-05 at 9.38.35 AM

  • Second, it’s only ARR if the gross margins are > 50%.  Gross and net revenues are very confusing terms in software.  Confusing in that they shouldn’t exist.  Gross and net revenues, GMV, and all that make a lot of sense I guess in ecommerce, adtech ad sales, etc.  But again, not in software.  The appeal to recurring revenues, the whole point, is that they are sort of a cash annuity.  You do have to nurture these customers, maintain them, enhance the service.  But do it right, and they stay for years at very low cost after the initial acquisition. If that’s not the case — it ain’t ARR.  And your revenue doesn’t deserve ARR multiples.

If you use these terms and don’t meet these criteria, it’s a confusing game.  You may be building a decacorn.  It just may not be a SaaS decacorn.

And just as importantly, if this is confusing to you — you’re not alone.  It’s confusing to almost everyone.  Get good financial help here.  This stuff isn’t intuitive.  And you’ll almost certainly get it wrong if you hack it.

Published on April 5, 2016
  • Frank Bruno

    So never once did the author spell out what the acronym “ARR” stood for. Can I get a definitive on this please?

  • performancecentreau

    “it’s only ARR if Gross margin is > 50%”. Wouldn’t that be more like 90% ?

  • Cloud native building block startups are changing the as-a-service landscape.
    “SaaS vs XaaS: 10 Distinctions for Growth Marketers”
    https://medium.com/@Platformula1/xaasify-your-startup-7b01e2885102#.xnnqvgnpb

  • Olivia V Bond

    awesome read!

Share This
[i]
[i]