Category: Analysis

LOVESPACE: Scaling a 5* Service

Every year at LOVESPACE we collect hundreds of thousands of boxes from thousands of customers nationwide. We want to be the first choice for people and businesses needing help looking after their things. LOVESPACE is currently doubling in size year on year and with this comes the challenge of simultaneously maintaining the quality of our service whilst delivering improved marginal economics as we scale.

We approach the challenge of scaling in three main ways. First, we understand the relative value of different customers through cohort analysis. Secondly, once we have identified our main target segments we understand their needs in detail via customer journey mapping and thirdly we ensure we have an underlying product roadmap that allows us to deliver a scalable operation to meet the needs of these customers.

We have been analysing cohort economics for some time. The discipline is well understood in the SAAS environment (see this excellent series of articles by Joe Knowles) but is also relevant to subscription businesses like ours. We now have the ability to track customer acquisition costs versus life-time value for each of our core segments (SMEs, Students, Movers and Declutterers). The insights from this work are critical in driving investment, pricing and product development decisions; and drive much more clinical interventions than merely looking at segment P&L as a whole. We look to “engineer” value from each of our segments by, for instance, differentiating our prices depending on whether a customer is booking at the last minute or in advance, or whether the location we return their boxes to is the same city or a completely different one.

Customer Journey mapping is the tool we’ve used to identify pain points and opportunities to improve our service in a way that matches customer needs and expectations. We take the data we collect from customers after they’ve used the service, and map their experience and interactions at each of the stages in our service. By doing so it becomes clear where in the service we can make changes to improve customer experience. For example, as a result of this process we made significant changes to our onboarding emails and welcome pack, to improve the rate of customers that are ready for their collections and deliveries.

Once we have understood the needs of our customers in some detail we ensure that our product roadmap will deliver against those needs as we grow.  At LOVESPACE we’ve invested in developing our own technology, which allows us to manage all our warehouses, drivers and customers in real time, whilst integrating with partner warehouses, drivers and materials suppliers. Our warehouse and driver management app allows us to keep costs down through automation and is the key to our ability to scale. It means we’re able to set up new sites across the country within a few days and we aim to replicate this when we expand internationally. And with the upcoming launch of our consumer app we will be able to provide customers with an enhanced experience by allowing them to track their driver and manage their orders straight from their phone.

We’re always happy to talk about cohort analysis, customer journey mapping, and building technology that delivers a five-star service, so please do feel free to get in touch. But if what you’re looking for is a better way to manage your belongings, where you can get them collected and delivered anywhere in the country, with storage in between, then look no further. LOVESPACE.

Industrial Strategy-reasons behind the proposals

In January the government published a green paper on “Building our Industrial Strategy”. The report lays out 10 pillars consisting of wide reaching measures with implications for the whole economy. In my previous post I pulled out the proposals which I think are most relevant to the UK early stage tech sector.

In this post I wanted to discuss in more detail the report’s reasons behind those measures, some of which I agree with, some of which I don’t.

The macro problem: low productivity

The strategy is principally concerned with improving the productivity of the UK workforce.

It reports that despite strong GDP growth since 2010 (second only to the United States among advanced economies), and the lowest un-employment rate for 11 years, real wages have struggled to recover from the decline during the 2008 recession.

The paper points to the ‘productivity gap’ between the UK and its ‘competitors’ as the major cause of this stagnation in real incomes. Whilst the UK had started to close the gap in terms of output per worker (middle chart, below) with France, Germany, and to some extent the US, much of this progress was reversed during the recession.

More importantly, the UK remains far behind all three countries in terms of productivity per hour worked. As the right hand chart below shows, workers in the US, France and Germany produce as much in 4 days as UK workers do in 5.

As well as improving overall productivity, the strategy aims to correct stark regional disparities. As the chart below shows, productivity in London is now 72% higher than the national average with all other UK regions except the South East having productivity below the national average.

According to the paper, this is more pronounced than it is for our neighbours, although it is difficult to compare apples with apples given the differing geographies of different countries.

So what does this have to do with tech start-ups and investors?

Well the report rightly highlights technology innovation by early stage businesses as an important driver of productivity improvement and it specifies two main barriers holding this innovation back.

1. Insufficient access to R&D funding.

2. Lack of support for ‘scale-up’ businesses.

As I explain below, the report makes a good case for the first, but I’m not so sure about the second.

Access to R&D funding

The green paper concludes that there is a need for increased government R&D funding, highlighting a correlation between government support and business investment in R&D (BERD) as shown in the chart below.

The UK invests 1.7% of GDP in public and private R&D which is below the OECD average of 2.4% and far behind leading backers of innovation (e.g. South Korea, Israel, Japan, Sweden, Finland and Denmark).

This is a function of lower government spending but also a below average ratio of private to public investment.

The report also emphasises that whilst the UK has a strong record of early stage research, we are relatively weak at turning those innovations into commercial successes.

The UK has 3 of the world’s top 10 universities and 12 of the top 100 and it has the “most productive science base of the G7 countries”. However, the report claims that we have a long standing weakness in translating research into commercial outcomes and have “too often pioneered discovery without realising the commercial benefits”.

This may be partly due to the way we distribute funding across the different stages of R&D. Whilst our distribution is not hugely out of line compared to other European countries, we have a striking skew towards early stage research (basic and applied research rather than experimental development) compared to innovative countries such as Israel and many Asian countries. Notably China spends 80–90% of its R&D funding on later stage experimental developments compared to 30–40% for the UK (see below).

You can read about the proposed measures to boost R&D in my previous post.

Support for ‘scale-ups’

The paper highlights that whilst the UK has done a great job of creating a world class start-up environment, it has done less well at fostering those start-ups to reach ‘scale’.

The UK ranks 3rd for business start-ups but only 13th for scale-ups according to OECD research, and whilst 2015 was a record year with 5.4 million small businesses in the UK, a “lower proportion of UK start-ups grow into standalone businesses than in the US”.

According to the paper “some observers say we have an under-supply of late stage venture capital compared to the US” and this is presented as the main cause of our ‘scale-up’ under performance.

However, the report provides no evidence to support this, and as a ‘scale-up’ investor myself I haven’t seen any evidence of it in the market. Of course, it depends on how you define ‘scale-up’, but in the £2–15m range that we invest at Smedvig Capital, its doesn’t feel like there is a shortage of capital.

According to Beauhurst (a data provider) there are 76 funds who can invest up to £25m in equity finance in the UK, there are 112 that can provide up to £15m, and 247 than can provide up to £5m. So that’s somewhere between 76 and 247 funds chasing roughly 200 deals per year (I acknowledge there is a certain amount of ‘chicken and egg’ in this relationship).

Yes, the UK is far behind the US in terms of scale-up successes but I am not sure that this is down to a lack of funding. I don’t have any strong evidence to say what the underlying cause is, but let us not forget that the UK is a fundamentally smaller market than the US (which is 5–10x bigger in most cases). For UK businesses to reach anywhere near the scale of similar US competitors they either need to go to the US or to multiple other markets. Given the challenges of entering new markets this must make it harder for UK businesses to reach ‘scale’.

Some of the current and proposed work by the Department of International Trade (including expansion of export finance) may well help with this by making it easier for UK businesses to scale internationally.

The paper also suggests that fund management incentives weaken long-term decision making in Europe as “funds are expected to deliver short term returns versus industry benchmarks”. At Smedvig Capital, we are lucky to have a very flexible mandate and we certainly see that many successful investments take longer than the 3–5 years that many companies are forced to aim for (our average hold period is 7 years).

The report also singles out lower levels of fixed capital investment for UK listed firms compared to other OECD countries as a possible symptom of short term incentives in public markets holding back long term investment (we have been in the lowest 10 per cent for 16 of the last 21 years).

If you have a view on this topic, the government has launched its business scale-up inquiry and is looking for feedback by May 3rd.

You can read about the proposed measures to help UK businesses scale-up in my previous post.

Conclusion — good proposals, not sure about the reasons

Whilst I definitely support the measures laid out by the report, I’m not sure I fully agree with all of the reasons behind them. In particular, I haven’t seen any evidence of a lack of ‘scale-up’ finance in the UK.

Industrial Strategy-implications for tech start-ups and investors

In January the government published a green paper on “Building our Industrial Strategy”. This week I got round to reading it and although it is long (132 pages) and far reaching, it does have some proposals relevant to the UK technology ecosystem.

I don’t necessarily agree with all of the report’s conclusions, but below I have summarised the key proposals that start-ups and investors should be aware of.

In my next post I discuss the main reasons behind these measures, some of which I agree with, some of which I don’t.

The government is looking for feedback on the strategy so if you have any, I would urge you to respond to its request for input by 17th April.

Proposed changes — 10 pillars

The strategy outlines 10 ‘pillars’ (copied below) aimed at increasing productivity and driving growth across the UK. The pillars are far reaching but several of them present potential opportunities to boost the UK’s early stage tech sector. Pillars 1 and 4 are particularly relevant.

There are many broad implications for business, but I will highlight the three main implications for early stage tech.

Implication 1: increased access to R&D funding

The first ‘pillar’ of the strategy aims to boost R&D investment and help drive commercialisation of research. There are many approaches discussed with varying levels of rigour, but the key proposals are:

 – Increase government investment into UK R&D by 20% — a further £4.7bn of funding by 2020–2021. Start-ups should keep an eye out for how to access this funding.

 – This will be coupled with efforts to optimise the funding and tax environment to drive up the ratio of private to public investment. Again, an important area to watch for start-ups and investors alike.

– Creation of UK Research and Innovation (UKRI) which brings together Research Councils with Innovate UK to develop a strategy for how to optimise spending of the additional R&D funding. The government seeks initial views which can be submitted here by 17th April. Start-ups and investors should have their say.

 – One project that is already underway is the Industrial Strategy Challenge Fund which creates a new funding stream for UKRI to back technologies where: the potential market is large, the UK has research strength and business capacity to meet the market need, there are significant social and/or economic benefits, and there is evidence that government support can make a difference. Start-ups should consider whether their sector might be applicable for Challenge Fund support.

 – Sectors that have been suggested are smart energy (including batteries), robotics and AI (including autonomous vehicles), satellites and space tech, healthcare, manufacturing and materials of the future, biotech, quantum technologies, and ‘transformative digital technologies’. But again, the government seeks suggestions.

Implication 2: increased support for ‘scale-ups’

Pillar Four is focussed on measures to help businesses scale-up, with the following proposals being of particular interest:

 – A Patient Capital Review will be launched in Spring 2017. Scale-up companies should follow how this review could help them.

 – Increased backing of institutions to catalyse private sector investment including an additional £400m for the British Business Bank. This could be a valuable source of finance for scale-up companies.

 – The government will ‘explore’ how its data (such as VAT returns, other HMRC data, or companies house data) can be used to help investors identify potential scale-up targets. Growth investors should input into what data could help spot potential targets and how this could best be accessed.

The government has launched its business scale-up inquiry and is looking for feedback by May 3rd.

I should say that whilst I’m absolutely in favour of increased support for scale-ups, as a scale-up investor myself, I’m not sure that I agree with the conclusion that there is a shortage of scale-up venture capital in the UK. More on this in my next post.

Implication 3: investment in tech infrastructure

There is a whole section focused on improving the UK’s infrastructure given our poor relative ranking vs other developed countries (ranked 24th globally on transport infrastructure quality by the IMF).

A wide range of infrastructure investments are planned, but most importantly to the tech-sector is a new £400m Digital Infrastructure Investment Fund to boost fibre broadband providers and a further £740m “earmarked” for:

 – “Full fibre broadband roll-out” for businesses and the public sector.

 – A “coordinated programme of integrated 5G and fibre projects to accelerate and de-risk the deployment of future digital technologies.

Conclusion — funding opportunities for R&D commercialisation and scale-ups

The government clearly acknowledges the early stage technology sector as an important part of the solution to the UK’s productivity problems. It proposes increased R&D funding (particularly aimed at later stage commercialisation) and support for ‘scale-up’ businesses as key steps to boost the sector, as well as improvements to the UK’s digital infrastructure.

There are many other implications for business more broadly, but I have chosen to focus on those which specifically effect technology start-ups. One example of a broader proposal is an expansion of export finance and the Department of International Trade (DIT) in an effort to boost exports and make it easier for UK businesses to scale internationally. If you are thinking of international expansion, I would recommend that you find out how the DITcan help.

Start-ups and investors should keep an eye on how these new measures evolve as they could present valuable opportunities for funding and support.

Importantly, the strategy is presented as work in progress and the government welcomes input from industry, you can respond here if you have any feedback.

In my next post I will look at some of the reasons behind the measures discussed in this article.

SaaS Metrics – how to improve?

In my last two posts I explained why LTV:CAC and CAC Payback are the two most important metrics for SaaS startups and how to use them to interpret the health and potential of your business.

But what do we do if we need to improve either of these metrics?

Unfortunately there is no easy answer. There are limitless tools and tricks, but with imperfect information there is rarely an obvious ‘right’ answer. Even if there was, the right approach would be specific to each individual business situation, so there is no generic playbook for how to improve.

In practice you have to be constantly testing and adapting, seeing what works and what doesn’t. It is a on-going tactical and strategic battle.

However, in this article I will discuss some high level steps that may help you to forge an informed path and give yourself a fighting chance of making the right moves.

Step 1. Measure

It sounds obvious, but it’s amazing how many businesses don’t track their LTV:CAC and CAC Payback. We have already discussed why these metrics are important, and if you are not tracking how they evolve on a monthly or quarterly basis, you should be.

Of course for an early stage business you can expect metrics to move around quite a bit as you make changes and your business evolves. But by measuring LTV:CAC and CAC Payback, you can see how the changes you make impact the fundamental unit economics of your business.

More on the specifics of how to actually calculate key metrics in a later post.

Step 2. Measure some more

LTV:CAC and CAC Payback are nice, concise metrics that give you an academic read on the overall health and potential of your business. But they are not actionable. To understand how to act to improve either of these two key metrics, we first have to measure their constituent components.

CAC Payback is a function of sales and marketing spend, new Monthly Recurring Revenue (MRR)landed by the sales team, and gross margin.

LTV:CAC is a function of average MRR (sometimes referred to as Average Contract Value, or ‘ACV’), gross margin and gross churn.

The simplest way to track these components is using a Monthly Recurring Revenue bridge (‘MRR Bridge’) as laid out below.

Here you can see what your opening MRR was at the start of the month and what closing MRR you finished the month on. You can see how the change between opening and closing was driven by new MRR from new clients, expansion or contraction in MRR from existing clients, and finally gross churn, which is MRR lost due to clients who have left.

It is important to track your gross margin for the month and your sales and marketing spend. I also like to track the total number of customers.

More on the MRR bridge and how to use it to actually calculate your key metrics in a later post.

Step 3. Segment your metrics

Sometimes you can improve your key metrics just by shifting your mix of customers, products or channels, without having to think about driving change in any given component.

For example, you may find that the unit economics don’t stack up when serving customers below a certain size. You may decide to change your approach by cutting sales and marketing spend to that segment, or reducing their account management. In some cases, you could decide to just stop serving customers below a minimum threshold altogether – saying no can be a powerful tool.

But to make decisions about your segment mix, you first need to be able to measure the key metrics and their components at a segment level.

Segmented metrics is probably something I would only consider for later stage businesses (post Series B) because it only really makes sense if you have enough customers and use cases to segment meaningfully and if your product, and sales teams are sufficiently structured.

There are three common axes of segmentation.

1. Customer segments

The most common type of segmentation. Typically broken down by size (e.g. small, medium, enterprise), but sometimes by vertical or use case.

2. Channel segments

It can be useful to see how your key metrics vary by channel. For example, inside sales vs field sales vs re-seller partnerships, or online marketing vs direct mail. Also up-sell vs new sales.

3. Product segments

This is less common, but in some cases where you have different sales teams selling different products, it may be worth considering the economics of each product individually.

If you measure LTV:CAC and CAC payback for each segment you might find that one customer segment, or one channel, or one product group is pulling the rest of the business down. Conversely, it might be that you have one or two star segments with stellar economics where you should be focusing all your resources.

Step 4. Get tactical

You may decide that tweaking your segment mix is not the right approach and that you need to take corrective action to drive improvements in a specific component of your unit economics.

There are too many options, and the answer too dependent on the specifics of the commercial situation, to go into detail here. But below I have laid out some of the questions you might consider when trying to improve each component of unit economics. These suggestions are by no means exhaustive.

How can we increase average MRR (‘ACV’)?

– Is our product suite and pricing optimised to encourage cross-sell, up-sell and volume increases from our clients?

– Can we add functionality or features to drive more value for, and spend from our clients?

– Is our account management team properly structured and incentivised to deliver maximum value from our clients?

– In particular, how do we recognise and compensate up-sell vs the initial sale?

How can we increase gross margin (reduce variable cost to serve)?

– Can we streamline our processes or use technology to reduce delivery and support costs?

– Can we productise further to make the delivery and operations teams more efficient?

– How can we make our account management and support more scalable? Can we productise these services?

– Can we encourage more ‘self-help’ customer behavior?

– Are we offering too much support too cheaply to certain customer groups?

How can we reduce churn?

– Can the proposition be adapted to better serve high churn customer segments?

– Are there common reasons for churn and can they be fixed?

– Are there early warning signs of churn such as falling Net Promoter Score, or usage metrics?

– If so, can we implement processes to flag these signs before it is too late?

– Can we create more ‘sticky’ functionality and features or can we do more to become more embedded in our customers’ workflows?

– Can we see a high churn ‘bedding in period’ after which customers tend to stick around?

– If so, what can we do to increase engagement during this bedding in period to maximise the likelihood that a client becomes ‘bedded in’?

How can we increase sales efficiency?

In other words, how can we deliver more new MRR for the same or less sales and marketing spend?

 – Is the sales team structure and compensation mechanism optimised to match our desired customer and product segments?

– Can we tweak the sales process and compensation structure to shorten the sales cycle and increase sales cadence?

– Can we adjust our terms to shorten the time from landing a sale to revenue recognition?

– Can we improve our training and recruitment processes to reduce the ramp-up time for new sales reps?

– What is the variability in sales rep performance, what can we learn from this?

– What does our marketing funnel look like and where can we improve conversion?

– Which marketing channels are most effective, how can we optimise for this?

– Can we unlock attractive new customer segments with pricing and proposition adjustments?

Over the last three articles we have seen the importance of LTV:CAC and CAC Payback and how they can be used to indicate the health and potential of a business. Finally we have considered ways of improving these key metrics.

In reality it is a constant tactical battle which is never over. There are limitless tools and options and no easy right answer. But a good starting point is to at least measure your key metrics and their constituent components so that you understand what is driving performance. If you have sufficient scale, it can be useful to segment your metrics to see if certain customer groups, channels, or products are holding you back or driving you forward. Finally, there are a whole range of levers you can pull to try to boost the different components of unit economics.

SaaS Metrics – What am I aiming for?

In my last post I presented LTV:CAC and CAC Payback as the two most important metrics for SaaS businesses.

LTV:CAC tells us how profitable a business will be at maturity and CAC Payback tells us how much cash it will take to get there. Therefore, these are the two most important metrics, and entrepreneurs should monitor them religiously.

Management should strive to improve these two metrics. But founders often ask us “how good does my LTV:CAC and CAC Payback need to be?”

In this second post of three, I will explain why for SaaS businesses to ‘work’, they need to have LTV:CAC of at least 3x. I will also show that for capital efficient returns, CAC Payback should ideally be less than 12 months.

I will then demonstrate unit economics in action through a worked example.

LTV:CAC must be at least 3x, ideally 5x.

In a previous post I explained that LTV:CAC is a great predictor of profitability at maturity.

As it turns out, there is a direct mathematical relationship between LTV:CAC and ‘steady state’ contribution margin.

By ‘steady state’ we mean once the business has stopped investing in growth and is just spending enough on sales and marketing to replace churn and maintain a constant revenue.

‘Steady state contribution margin’ is the percentage of revenue that is left after taking off variable cost of sales, and sales and marketing costs (churn replacement only). It is what is left over to cover fixed overheads before getting to ‘steady state operating profit’.

The chart below shows how for a given gross margin, steady state contribution increases with increasing LTV:CAC. This improvement is steep at first, but as LTV:CAC increases, the rate of contribution improvement starts to slow.

So, what can we learn from this?

Well, below 3x LTV:CAC it’s going to be almost impossible to make a highly profitable business. Benchmarks (such as those published by Pacific Crest) tell us that even the largest SaaS companies have an overhead base of at least 30% of revenue. Therefore, to leave enough room for a ‘meaningful’ profit margin (say 10%) we need contribution margin to be greater than 40%. Unless LTV:CAC is at least 3x, this will be tricky.

Between 3x and 5x there is a steep improvement in contribution margin (roughly ten percentage points improvement). At 5x LTV:CAC, contribution margin is high enough that a very profitable business should be possible.

Beyond 5x, there are still benefits to be had, but we start to see diminishing returns. Doubling LTV:CAC from 5x to 10x only yields a further ten percentage points improvement in contribution margin.

So in conclusion:

LTV:CAC needs to be at least 3x for a business to have a chance of profitability, but really management should be aiming for 5x to make a great business.

I will explain the maths of this relationship in a later post.

Ideally CAC Payback should be less than 12 months.

CAC payback is an indicator of how much cash a business will need to spend on sales and marketing to reach a certain size in a certain time.

Again there is a mathematical relationship here, although it is more complex than the LTV:CAC rule. I will delve into the maths in a later post, but the rule of thumb that we apply at Smedvig Capital (and has been written about by various other commentators) is:

CAC Payback needs to be less than 12 months for a business to have a good chance of capital efficient growth. But for enterprise SaaS businesses with high value clients, this can probably be stretched to 18 or even 24 months.

This is a slightly more nuanced, less objective rule than the LTV:CAC rule because the amount of cash one is willing to invest depends on the expected size of prize and appetite for risk.

For most SaaS businesses, CAC Payback needs to be less than 12 months to provide the capital efficient growth that attracts investors to SaaS in the first place. But for enterprise SaaS companies with high value, low churn customers (and thus high LTV:CAC), a higher CAC Payback period (18–24 months) can work.

So that’s the theory, but to demonstrate the impact of unit economics, let’s do a worked example.

Thought experiment: unit economics in action

Imagine we have three SaaS businesses with identical P&Ls. Each is raising a £7m Series A round to invest in sales and marketing acceleration.

Three ‘identical’ P&Ls.

All three are run rating £2m Annual Recurring Revenue (‘ARR’) and growing 10% month on month. All three have a gross margin of 75% and all three are spending just under 50% of revenue on sales and marketing and a further 50% on overheads (tech, product, finance, admin). They are all loss making to the tune of -£0.5m. They look like three good, early stage businesses.

But with different underlying unit economics.

Company A has low CAC, quick CAC Payback, small contract values (Monthly Recurring Revenue, ‘MRR’), high churn, low LTV. This is the sort of profile we might expect from a consumer subscription business for example.

Company B has very high CAC, long CAC payback, large contract values, low churn and high LTV. This is more like the profile of an enterprise SaaS business selling large, bespoke, contracts into blue chip companies.

Company C is somewhere in between. Perhaps the metrics of a SaaS product aimed at small and medium sized businesses.

It’s tricky to disentangle all the individual metrics to get a read on how the three businesses will perform overall.

But, they all have the same P&L so should all be pretty similar… right? Well, let’s see where they end up five years after the investment.

Very different outcomes five years later.

Company A: Disaster

To be fair, Company A has grown to a respectable £13m ARR. However, growth has all but stopped now. It burnt through the £7m investment in just over three years and had to raise another £2.6m. It is still not through break even. More worryingly, even if we strip out growth costs, the company would still be loss making (steady state EBITDA ~ -£1.3m).

Company C: Solid investment

Let’s jump to Company C. This has been a great investment. It is now at £22m ARR, growing 11% per year and has reached break even without needing any more cash. It is dropping £1.7m EBITDA whilst still growing, and if we strip out growth costs, its ‘steady state’ EBITDA is £3.5m.

Company B: Big win… eventually

Company B is a really interesting one. After 5 years it is smaller than Company C at £17m ARR. It burnt though the £7m investment in 23 months and needed to raise a further £4.6m — much worse even than Company A. However, it has reached break even (just). More excitingly, it is now growing the fastest at 18%, and if we strip out growth costs its steady state EBITDA is £4.1m. So it is poised to become a more profitable business than Company C and is arguably a more exciting business (depending on your risk appetite).

So, could we have predicted this outcome?

We should have seen this coming.

Well Company A had a LTV:CAC ratio of 2x which should have been a pretty clear warning that it would struggle to become profitable.

Company B had a super high LTV:CAC (15x) which highlights its potential to be a ‘big win’. However, its long CAC Payback period (24 months) was a warning that it would take a lot of cash and a long time to get there.

Company C had a solid LTV:CAC of 5x and a similarly strong CAC Payback of 12 months. This should have told us that it would get to a good level of profitability without burning too much cash. A nice, lower risk, investment even if Company B ends up being the bigger win.

So despite all three businesses having the same P&L, we could easily have predicted their divergent outcomes, just by looking at two metrics.

Avoiding traps: when to invest and when to hold back.

Finally, let’s look at how Company A and Company B evolved over time. This will demonstrate how unit economics can help us to avoid traps when deciding whether or not to invest in sales and marketing. We will ignore Company C for now because it is straight forward — a good investment from the get-go.

Take company A (red line) first. Because it has such a quick CAC Payback (6 months) it was able to acquire new customers and revenue very fast. It grew faster than the other two companies initially and after twelve months it had grown ARR 5 fold to £10m (left hand chart). Consequently its burn had come down the most, to about -£2.5m after 12 months (middle chart), and it had burnt through the least amount of cash, just under £4m (right hand chart).

However, because churn was so high (hence low LTV:CAC at 2x), as soon as it reached any scale, it had to invest huge amounts in sales and marketing to replace churning customers just to tread water. By 24 months, almost all of its sales and marketing spend was going on churn replacement rather than new growth and so growth all but stopped (left hand chart). EBITDA never got to break even and plateaued at -£1m (middle chart). The business continues to lose money today and will never become profitable (dotted line).

The trap: in the first 12–24 months, management could have looked at the stellar growth rate and decreasing burn and decided that everything was going smoothly. It would have been easy to make the mistake of investing further to accelerate growth when in reality they needed to do the exact opposite — cut sales and marketing spend and focus on fixing churn. A quick look at LTV:CAC would have told them this.

Company B (orange line) has a long CAC Payback (24 months) so it took a long time and a lot of money to get going. After 12 months it had only reached £5m ARR (left hand chart) and after 3 years it was still the smallest company despite spending the most on sales and marketing (right hand chart).

However, because it has such low churn (hence high LTV:CAC at 15x), as it began to grow it gathered momentum. The customers it acquired (at high cost) stuck around and spent lots of money. By the end of 5 years, it has a large, stable, base to build from and almost all new investment goes into growth. By year five it is growing the fastest (left hand chart) and is through break even (middle chart). Importantly, because it has a stable base of revenue, it can chose to ‘turn-off’ growth spending at any time to increase profit (dotted line, middle chart).

The trap: management may have lost their nerve and chosen not to invest further when confronted with sluggish growth and high burn early on. This would have been a mistake. Now is exactly the right time to accelerate sales and marketing to win market share and push through the cash trough (right hand chart). Armed with CAC Payback and LTV:CAC numbers, management could have seen what was going on and had the confidence to press on.

Over the last two articles I have demonstrated the importance of LTV:CAC and CAC Payback. Management teams need to be totally focussed on keeping LTV:CAC above 3x and driving up towards 5x. Almost as important is keeping CAC Payback down, ideally below 12 months.

I will discuss various approaches that management can take to improve LTV:CAC and CAC Payback in my next post.

Note: this analysis assumes that the addressable market is large enough, and the competitive environment stable enough, to maintain constant metrics. This is a simplification designed to isolate the impact of metrics from other important factors.

SaaS Metrics — What really matters?

At Smedvig Capital, one of the most common topics we end up discussing with entrepreneurs is metrics.

Investors obsess over metrics because they provide an objective measure of the current and future health of a business. But for the same reason, they should also be an essential part of the entrepreneur’s tool kit.

However, with so many metrics out there now, choosing and making sense of the most important ones can be a daunting task.

When we discuss metrics with founders, they usually ask three questions:

  1. Which metrics are the most important?
  2. What do ‘great’ metrics look like?
  3. How can I use those metrics to add value to my business?

Last week we gave a presentation to a room of SaaS CEOs at Silicon Valley Bank where we tried to answer these three questions from an investor perspective. Over a short series of posts, I will lay out our answers one at a time, starting with “which metrics are the most important?”.

Ultimately, only two questions matter.

The ‘value’ of your business will be driven by two specific questions:

By ‘maturity’ we mean, once a business has reached a ‘fair’ share of its potential addressable market and has stopped investing heavily in growth.

These two factors will eventually define the financial return to the founders, the management team, and the investors.

So how can we go about answering these questions for an early stage business?

These questions are tough to answer.

Sadly, this is easier said than done. Most early stage businesses are investing heavily in growth, growing really fast, and losing lots of money. This makes it difficult to answer these two key questions simply by looking at the P&L.

With SaaS companies, the problem is exacerbated because value is realised through recurring revenues spread over a long period of time. Businesses typically have to spend a significant amount of sales and marketing budget upfront to acquire a customer (Customer Acquisition Cost, or ‘CAC’) and then receive regular, relatively small payments over a long period of time.

This means that high top line growth can mask a fundamentally flawed underlying business, and conversely, many great businesses may need to burn through a lot of cash before realising their potential.

So how can we assess the potential of a business if the P&L can be so misleading? The answer is unit economics, and in particular, two ‘killer’ ratios that tell us everything.

Luckily, two ratios tell us everything.

By looking at the economics of a single (average) customer, we can get a sense of how the economics of a businesses will unfold as it scales.

There are many different metrics of unit economics, which can tell us about different aspects of business performance. But there are two specific ratios, which tell us how all these different aspects aggregate up to answer our two fundamental questions.

These two ratios are ‘Lifetime Value to Customer Acquisition Cost’ (LTV:CAC) and ‘Customer Acquisition Cost Payback Period’ (CAC Payback).

LTV:CAC is the ratio of the total gross profit we expect to receive from an average customer during its total lifetime, versus the average cost of acquiring a customer (sales and marketing spend).

LTV:CAC is a powerful metric because it tells us how profitable the business will be at ‘maturity’. High LTV:CAC means high profitability.

CAC Payback is the number of months of recurring gross profit from an average customer, that it takes to payback the average cost of acquiring a customer (sales and marketing spend).

CAC Payback is an indicator of how much sales and marketing spend will be required for a business to reach a certain size. It is therefore a great proxy for how much investment the business will need in order to reach its next milestone. High CAC Payback means high cash burn.

I will discuss in more detail how these metrics are calculated in a later post.

So the answer is…

LTV:CAC tells us how profitable a business will be at maturity and CAC Payback tells us how much cash it will take to get there. Therefore, these are the two most important metrics and entrepreneurs should monitor them religiously.

These two metrics are not only vital for proving the potential of your business during fundraising but should also be used as a constant barometer of business health.

In my next post, I will demonstrate the impact of these metrics through a worked example and will try to answer the question “what is a ‘great’ LTV:CAC ratio and CAC Payback?”.

Making a call on calls; why Smedvig Capital has invested in call tracking


Article written by Smedvig Associate, Joe Knowles:

Smedvig Capital recently invested in Infinity, a leading UK provider of call tracking solutions. You have probably never heard of call tracking. So in this article we aim to explain why we believe that call tracking is hugely under utilised today, with vast amounts of value still to be created for marketing, sales and operations teams and why we are excited to be investing in this area of marketing technology.

As digital advertising spend continues to rise, the ability to track and optimise campaigns is increasingly important 

Digital advertising spend has grown at 19% per year since 2010 and is expected to accelerate. As digital gains share of advertising and marketing budgets, it becomes increasingly important for companies to accurately measure the return on investment (ROI) from their digital advertising spend and to optimise campaigns.

Fig 1: Digital advertising spend continues to grow

This may not be news to you. But what many are not aware of is the growing importance of inbound sales calls in a multi-channel world and the difficulty this creates when it comes to measuring ROI from digital advertising.

Inbound sales calls are an increasingly important part of the multi-channel customer journey

Inbound telesales is an increasingly important sales channel for digital businesses. In today’s complex multi-channel world, a prevailing customer behaviour is to research a product or service online before ultimately calling a business to make the purchase. A Google commissioned report found that 60% of consumers think it is very or extremely important to be able call a business during the purchase process. This is particularly true of considered purchases involving high value transactions or complex products. For example, Infinity has seen rapid traction in sectors such as holidays, autos, healthcare and business to business services and we believe this has not even scratched the surface.

“60% of consumers think it is very or extremely important to be able to call a business during the purchase process”

The rise of mobile devices has boosted the volume of inbound sales calls to businesses. Customers (both individuals and businesses) are relying more and more on their smartphones to identify, research and connect with potential products and services. The convergence of online research and voice connection onto a single mobile device has boosted ‘research online – call to buy’ behaviour which has ultimately driven higher call volumes.

Fig 2: Mobile call volumes to businesses are growing 16% per year  

Furthermore, an inbound call is a strong signal of intent. According to BIA Kelsey, inbound calls are 10 to 15 times more likely to convert to a sale than web leads. This makes calls even more valuable to businesses.

“Inbound calls are 10 – 15 times more likely to convert than web leads.”

With more and more customers starting their research online before calling a business when they intend to buy, it is clear that being able to track how a customer arrived at and behaved online before making a call is critically important to marketing teams. But herein lies the problem. Most businesses are not able to connect the dots between what they spend on digital advertising and the inbound calls they receive as a result.

The problem is that many businesses are not able to link digital behaviour to inbound calls

In a fully digital world, the effectiveness of marketing spend is tracked from the first time a user is attracted to a website through to the final sale online.

However, for the many businesses who rely on inbound calls to convert journeys that start online, the link is broken. These businesses have to decide how to spend their digital advertising budget with no visibility on how this spend converts to calls and ultimately to sales. They are at a disadvantage compared to pure online-only businesses.

Fig 3: Calls disrupt the ability to measure and optimise marketing spend

The solution is visitor level call tracking

With visitor level call tracking, every visitor to a clients’ website is shown a unique telephone number on that site (or page on a site, or position on a page). Thus, when a call is received to that unique number, the call can be linked back to the specific online journey of the caller. The ‘click stream’ is tracked at a visitor level and identifies the exact search term / advert that the caller clicked on to reach the site, and what pages on the site they viewed prior to making the call.

Fig 4: The solution is visitor level call tracking which connects online and offline activity through a unique telephone number on the website

Call tracking completes the loop between digital advertising spend and sales calls, allowing spend to be tracked to calls, and ultimately to sales. This has profound benefits for marketing, sales, and operations teams.

Marketing teams: optimise digital ad spend based on true ROI

Call tracking integrates online and offline marketing which enables teams to monitor channels, sources and location.

This allows marketing teams to track advertising spend through to results, optimising sources (down to the keyword level) that are the most profitable and most likely to convert in order to maximise ROI.

Sales teams: armed with context, increase conversion

Call tracking enables telesales teams to increase conversion rates of calls as well as the rate of up-sell to the caller.

Based on the customer ‘click stream’ before the call, a call tracking system can ‘whisper’ lead information to the salesperson which helps to tailor the sales pitch to the individual.

Operations teams: automatically route callers based on intent

Call tracking can increase efficiency within a call centre by automatically routing calls based on onsite and search behaviour.

Customers can be pushed to the front of the call queue, prioritising those that are higher value or more likely to convert based on indicators in their ‘click stream’. Similarly, calls can be automatically routed to the most relevant team.

Call analytics software can recognise, investigate, and block calls that have suspicious patterns to prevent wasted telesales time with fraud or spam calling.

To Infinity and beyond

The actual market for call tracking is nascent today with so much untapped potential. Any business which spends more than a few thousand pounds a month on digital advertising and makes some of its sales via inbound calls, should be using call tracking. Yet very few actually are. This is why we are excited and why the market is starting to listen. According to data from Datanyze, the number of call tracking installations is growing at more than 60% per year.

“Any business which spends more than a few thousand pounds a month on digital advertising and makes some of its sales via inbound calls, should be using call tracking. Yet very few actually are.”

Even more exciting is the opportunity to expand from core call tracking insights into other areas of marketing technology. As marketing technology and advertising technology continue to converge, call tracking is uniquely placed to create actionable insights across departments with increasing layers of rich data. It has huge potential to amplify all areas of sales, marketing, advertising and operations. The opportunities are infinite.

Smedvig Capital recently invested £10m into Infinity. You can read more about the deal here.

This article referenced the following reports: Google; ‘The role of click to call 2013’, BIA / Kelsey; ‘Calls too businesses 2015’

The VC’s winding road from investment to exit

Rob Toms shares the story of Smedvig Capital’s investment in Tusker

When Smedvig were first introduced to Tusker back in 2000, we were immediately impressed by their innovative web-enabled approach within the UK vehicle contract hire market.

The founding team at Tusker had spotted that the cumbersome and principally manual process for specifying, requesting and approving a company car could be moved online – so optimising the process and generating superior management information for corporate customers. Amongst other innovations they had built a sophisticated web-based customer quote engine from scratch, which remains at the core of the business today.

Back in 2000, we saw a great opportunity to put capital to work in a high potential company, and looked forward to working closely with management to scale the business. However the initial thesis was ahead of its time: internet speeds were still slow; fleet managers saw the approach as a potential threat to their jobs; and the business struggled to execute against its business plan – making slow progress towards breakeven. Other investors in Tusker were losing patience and began lobbying for an exit.

As with many start-ups, Plan A wasn’t smooth. We are lucky that our funding model allows us to continue to back businesses over the long term, and not be tied to specific exit timelines. We are also fortunate that we have a large enough fund to continue to back businesses which may be struggling for a while, but which we believe have an exciting long term future.

In 2005-6 we injected additional capital into Tusker, and took the opportunity to buy out all of the other institutional investors. We promoted David Hosking from Sales Director to CEO, and worked with him and new FD David Brockwell on a mandate to accelerate growth. A much stronger culture of customer service excellence was driven into the business, using external benchmarks. Initial progress remained slow, with Tusker just making it through breakeven before the financial crisis hit. During the credit crunch, vehicle finance for Tusker and its non-bank competitors became expensive and difficult to obtain – Smedvig worked with advisors to strengthen the balance sheet with a capital reorganisation that helped maintain banking lines. Encouraged by the non-execs, David started spending more time thinking what the Plan B growth strategy could be.

This thinking time out of the business resulted in the launch of Salary Sacrifice for Cars (SS4C) – an innovative product giving the opportunity for employees not normally entitled to a lease car to drive a brand new car for a fixed monthly amount that includes all servicing, maintenance, insurance etc. at prices that typically substantially beat high street options. Tusker continue to be market leader in this area, which is now widely regarded to be the biggest single growth engine in UK contract hire.

A new growth phase

Tusker’s innovative new proposition SS4C, its focus on customer service, and award winning technology drove rapid growth over the subsequent few years.

Smedvig worked closely with management, providing hands-on support and strategic advice as they continued to develop the SS4C proposition. It was agreed that the profits the business was by then generating would be reinvested in improving capabilities and securing growth. Smedvig worked with the team and external advisors on an internal and external rebranding exercise, and on building B2C capabilities which are new to contract hire when packaged as salary sacrifice.

In 2012 Smedvig invited Sir Trevor Chinn to take the chair at Tusker. A leading figure in the automotive industry, having built Lex Vehicle Leasing and later chaired both the RAC and Kwik Fit, Smedvig had previously worked with Sir Trevor on their investments in ITIS and Streetcar.

Tusker has now reached almost £100m revenue, with a fleet size of over 11,000 vehicles from over 200 corporate customers. Over 370,000 employees are now covered by a Tusker SS4C scheme, and rapid growth has led to strong profitability as the business reaches scale.

We are delighted with Tusker’s success to date, and to have been able to provide the long-term support which the business needed during its growth years. Tusker has been acquired by ECI, an investor that both Smedvig and the Tusker team hold in high regard, and we wish both the team and their new investors all the best with the next phase of their growth story.

The deal environment

Whilst we are very pleased with our return on the Tusker investment, there are always mixed feelings about letting go of strong businesses with proven teams. Finding new places to invest capital effectively is never easy and particularly in earlier stage growth capital opportunities.

There are a few reasons why this is the case. First, the universe of companies that fulfil the sort of criteria most VCs look for is not huge. Second, many of these transactions are not intermediated so having visibility of a significant portion of those companies is not straightforward. Lastly, whilst at one time there was felt to be a ‘funding gap’ for development capital, there are now a number of credible possible capital partners in the marketplace.

Fortunately there are a few mitigants to these challenges.

There is understandably a strong correlation between the state of the entrepreneurial market, and the number of capital providers. Hence one of the drivers of the increased number of VCs in the London market is the thriving early stage market place here. Over the last few years there has been a dramatic growth in the community of early stage businesses in many sectors and in some, such as fintech, London is genuinely one of the global leaders. This means there are many more businesses that are attractive to the VC community. This relationship is clearly self-reinforcing. Moreover, the strength of the different entrepreneurial hubs makes it easier to connect with a greater number of relevant companies than in the past.

In terms of the number of capital providers, the important thing for getting deals done is a legitimate point of difference. Different companies, quite rightly, look for different things when seeking a capital provider over and above the basic economic deal. Chosen well, the right partner can materially improve the chances of, and scale of, success – and that may well dominate any basic economic differences in financing offered. In Smedvig Capital’s case, unusually, we seek only to do 3 or 4 deals a year. This allows us to get deeply involved in investee companies providing hands on support in multiple areas, in a way that is not possible with much larger portfolios. Not all entrepreneurs want that level of involvement from their capital partner but where they do it provides us with a compelling proposition.

So whilst we are sad to let a great company like Tusker go, we are excited about our remaining portfolio – including our recent new investments such as Quill, Vive Unique and Profile, along with what lies ahead.

B2B sales: Not just about great salespeople (though it never hurts!)

By Johnny Hewett, CEO Smedvig Capital, originally posted on

Creating a successful sales team goes beyond simply finding those that can sell fridges to Eskimos.

Inevitably, and correctly, there is a lot of focus in earlier stage businesses on the nature of the product or service.

Is it better, different, cheaper, easier etc than its incumbent competition and/or is it truly disruptive? Equally importantly does the customer agree, or as Rob Ryan puts it in his book on entrepreneurship, ‘Does the dog like the dog food?’.

However, even if some or all of the above attributes turn out to be true and the dogs do indeed love the dog food, the success of the company will be critically dependent on its ability to introduce effectively the product or service to its potential customer base – this is where sales and marketing need to earn their spurs.

Whilst marketing has an equally vital part to play, particularly in defining clearly what the core company message is and ensuring that every element of communication and collateral reinforces it, for the purposes of this piece, I am going to focus on sales.

We have all met great salespeople with the magical ‘can sell fridges to Eskimos’ skill, and they are very valuable. However, finding them is non-trivial and even if found, they and all other merely mortal salespeople can be made vastly more effective by the correct preparation, structured approach and data driven oversight and support.

There are a number of steps in that process that represent a lot of work, but is time very well invested. Many of these things will sound obvious but it is surprising how often the desire to ‘get out there’ dominates comprehensive sales force planning. It is also interesting to note that the best person to deliver this analysis and implement highly effective sales force management is often not the best salesman, and may even be non-revenue generating directly – a tough decision for an earlier stage company.

The first step is developing a full understanding of the optimal target customers. In essence this is an exercise in understanding the trade-offs between the scale of the opportunity and the likelihood of winning business. The former is generally easier to assess than the latter and should be done initially at an appropriately high level – such as by industry vertical and geography rather than individual company basis.

Likelihood of winning is harder to assess in most situations given the large number of elements to consider including, but by no means limited to: relative product/service attributes; nature of competition; relative price position; brand sensitivity and ease of switching – but a structured and thoughtful exercise allows some bucketing of likely success.

The output of this exercise put simply: the key target universe provides the core data for the subsequent routes to market analysis to establish the best way to approach those targets. This in turn helps define the appropriate sales structure both in terms of number, role and relevant experience. Even with this in place, there is much to do in system terms to drive the team’s effectiveness.

Ensuring all the relevant data is collected to allow clear KPIs to chart performance by individual beyond simply revenue generated will help identify early who and what is done well with appropriate focus on, or change for, what is not. It will likely include number of leads generated, ratio of meetings held, sales generated, sales growth from existing clients over time and so on.

With the right metrics established, it is then important to review the compensation system to ensure that it drives the desired behaviour. This may be as simple as sales revenue booked – but margin achieved may be relevant as will other factors such as how revenue involving more than one salesperson is handled, as this will be vital to deliver strong team dynamics and mutual support.

None of the above replaces the need for careful hiring of the right sales personnel, marketing delivering the right materials or indeed having the right product, but it will go a long way to making any sales force more effective – even if they can sell fridges to Eskimos.

Enough already? There is an alternative to selling out

By Johnny Hewett, CEO Smedvig Capital, originally posted on

Rather than labour on or grasp at an attractive offer for their business, entrepreneurs can choose a middle ground.

There are many things for an entrepreneur to worry about, often dauntingly so. Indeed one of the things that distinguishes entrepreneurs from other mortals going to work each day, is an apparent ability to see past the challenges to ‘what could be’.

So with so many things to worry about, perhaps one that for many falls into the ‘nice problem to have’ is when a business has been successful enough to attract a trade offer; whether or not to sell.

Whilst it may indeed be a nice problem to have, the decision is often far from straightforward and is certainly worth detailed consideration over and above the obvious questions such as whether the price fairly reflects value.

Let’s leave the price and value question for another day as, fundamentally, I believe it should be about state of mind of the entrepreneur. Have they been toiling away for 20 plus years? And well, enough already: ‘let’s just take some money and move on.’

There is no shame in this. People’s lives move on with other desires that creep in, changes of health, family circumstance, freedom to travel, etc…

But if the desire to drive the business really no longer exists, and it is more trial than fulfilment or there are other agendas that have become more important, then clearly if the offer is fair (and maybe even if it isn’t), selling out to trade is very possibly the right answer.

Conversely, if the desire to drive the business forward is still vibrant and providing the stimulus running a venture should, then unless the offer significantly over values the business (and maybe even then not), it likely does not make sense to sell.

Whilst the cash might be nice, in most cases the role and feeling of ownership will change absolutely or, at least, very significantly and the fulfilment being gained will be substantially diminished.

The reason the decision will likely be a difficult one is that things in life are rarely as neatly black and white as painted above. There are some things that are going well, but some areas are frustrating and need new impetus.

Having all or a large percentage of net worth tied up in one ‘basket’ is worrying. The lack of available finance either for the business or for things outside the business is a cause of tension. There are multiple owners and some want to sell out and some don’t and so on.

In the more commonplace ‘grey’ situation, it maybe that there is an interesting ‘middle ground’ – that of taking some money from a development capital firm.

This potentially can solve many of the concerns created by the more black and white decision of sell or not. Certainly, it can address the eggs in one basket position in which many entrepreneurs find themselves.

By selling some part of their holding, the founder can create some liquidity for other agendas, whether school fees, new house, etc – and by doing so release the tension either personally or within a relationship caused by lack of available cash.

There is a widespread belief that capital providers don’t like ‘cash out’ but only investing into the business. Whilst this may be true of some providers, at Smedvig Capital it very much is not. We often feel that far from creating misalignment, freed from the burdens of excessive capital concentration, many entrepreneurs perform even better.

There are many other areas in which it can help such as dealing with different liquidity agendas amongst owners and of course the traditional benefits of a new financial partner if well chosen, including fresh ideas and expertise, connections and additional capital to fund growth.

So if faced with this quality problem of an offer for your business, it may be there is a better solution than the binary alternatives of soldier on or ‘enough already’.

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