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In the software world, a growth at all costs mindset has given way to profitable growth. Building a venture-backed business was easier when only growth mattered. But now CEOs need to drive both growth and profitability. In the public markets, the companies with the highest growth efficiency (which we define as ARR growth rate + free cash flow margin) command the highest multiples:

In this guide, we unpack a software profit and loss statement (P&L) into its component parts. Much has been written about how to drive growth, but here, we provide tactical steps for CEOs to follow in order to drive more efficiency and profitability.

Gross margin acts as the limit to the ultimate profitability of your business and has an enormous impact on your valuation. Its a great place to start because improving gross margin rarely comes at the expense of investment in growth.

The median gross margin for high-growth public cloud companies is 77%.

Case example: Take two identical software businesses. One is an 80% gross margin business that operates at 40% profit margins at scale. Holding all other factors constant, that same business with 60% gross margins will have only 20% profit margins. The difference between 80% gross margin and 60% gross margin cuts the value of the business by at least 50%.

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Implementation

Customer Success and Support

The median amount of ARR that an Enterprise CSM manages is $2 million to $5 million.

Customer Profitability

As a guiding principle, we suggest you use CAC Payback benchmarks to assess your GTM efficiency. CAC payback benchmarks range by scale of the business and whether you are selling into an SMB or enterprise customer base, as sales cycles differ across segments. Here are the good-better-best benchmarks we have aggregated from private cloud companies:

At scale, one of the most powerful drivers of S&M efficiency is improving retention. It is always cheaper to retain and upsell existing customers than to acquire new customers. Moreover, if gross retention is low, refilling a leaky bucket makes it tough to maintain profitable growth.

Sales

Marketing Efficiency

Research & Development (R&D) is the most fraught area to cut spending to drive profitability: overcutting in R&D can lead to short-term wins but degrade competitive advantage over the long-term. Management teams should apply discretion when looking at R&D benchmarks given unique factors such as product complexity and market competitiveness.

The median R&D as a % of revenue is 20% for high-growth public cloud companies.

G&A is a ripe target to drive efficiency given that it is a cost center.

The median G&A as a % of revenue is 12% for high-growth public cloud companies.

Throughout your company, people-related costs tend to be the biggest area of expense. Making sure you are staffed appropriately across the entire organization is critical.

Pricing is one of the most important drivers of revenue growth and profitability. It is one of the most efficient ways to drive margin because any price increase drops straight to the bottom line. If youre a SaaS leader looking for new levers of revenue growth, take our B2B SaaS Pricing course.

The benchmarks we leverage for this article do not include stock-based compensation. However, it is important for founders to understand the impact of stock-based compensation. Although it does not immediately impact cash flow and profitability, it will inevitably at a future point. Further, looking at benchmarks inclusive of stock-based compensation also mitigates any noise resulting from different stock vs cash compensation structures across companies (e.g., the same company that gives 70% stock and 30% cash will look much more efficient than one that gives 50% stock and 50% cash). Lastly, the role of stock-based compensation is becoming an increasingly common topic of discussion for public market investors and has an increasing impact on valuation. We recommend benchmarking your business by including stock-based compensation or benchmarking against companies with a similar equity burn to fully understand relative cost structure and profitability.

As a CEO, it is important to remember:

In this article, we tried to be as comprehensive as possible in ideating tactics CEOs can implement to drive efficient growth. As we wrote the piece, I wondered if it might be helpful to share how I applied at least some of these 40 different tactics to a real business. The case study below shows that these ideas are very actionable. They changed the trajectory and outcome for SendGridand can for you, too!

Fortunately, I worked with a very talented and mature team at SendGrid. Creating alignment on our need to drive to a healthier rule of 40 was like pushing on an open door, and our whole company (not just the leadership team) got behind this goal.

Ultimately, it was a collective effort from across the organization that enabled SendGrid to drive profitable growth. A few examples of notable initiatives included a finance leader branding a company-wide Save to Reinvest campaign, a vice president of support helping us create and monetize new customer support tiers, and a customer success leader helping us launch new add-on services

Focusing on profitable growth isnt just the job of the CEO. Invite the smart and hard-working teammates of your company, who know your day-to-day operations best, to be part of the solution.

Our Save to Reinvest'' campaign was one of the best examples of internal marketing Id ever seen. We demonstrated to everyone in the company that we werent cost-cutting for its own sake, but rather so that we could afford to reinvest in growth levers for the business. This framing is what allowed us to both slash our burn and reaccelerate growth, what we later called the SendGrid smile; in other words, the graph that illustrates our growth rate over time which went down, then flat, then up and to the right.

Over the course of six quarters, we took action on the following tactical steps throughout the organization. Incrementally, we moved from -30% to roughly breakeven, and then reaccelerated our growth as we scaled in 2016, ramping toward our IPO in the fall of 2017.

SendGrids Gross Margin was in the 60s at the time I joined, and was mid-70s by our IPO, and mid-80s when I left Twilio. Unquestionably, some of that improvement was simply due to economies of scalecosts held flat as we increased our output. But it also was the result of many intentional, cost-focused initiatives across a number of areas, including:

General and administrative (G&A) expenses:

a. Vendors: We found it helpful to align the whole team on being more disciplined about vendor costs and negotiations. I personally helped renegotiate our renewal for a event and data analytics platform, which had reached $1 million per year when I arriveduntenable for a $30 million ARR company like ours. This saved us a boatload of money each year. Importantly, it also showed the company that the CEO cared a lot about cost containment.

b. Real estate: When SendGrid expanded from its roots in Boulder to a larger presence in Denver, our CFO and COO championed the consolidation of our two Colorado-based locations. Economies of scale, again, saved us a lot of money as we hired more people into the same physical footprint.

The biggest takeaway for CEOs is to remember that there are opportunities to drive better margins and profitable growth in every aspect of the business. If youre a SaaS leader fundraising in the near future and looking for ways to drive profitable growth, reach out to Brian Feinstein (Brian@bvp.com), Caty Rea (crea@bvp.com), Janelle Teng (jteng@bvp.com), or Sameer Dholakia (sdholakia@bvp.com) to learn more.

Read the original here:
A CEOs tactical guide to driving profitable growth - Bessemer Venture Partners