White lies to yourself about revenue may make you feel good, but the end always sucks

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Revenue: It’s what CEOs are judged by. But all too often CEOs give white lies about revenue to themselves, their staff and investors.

I’m not talking about criminal stuff. It’s just, well, not being totally honest about the state of the numbers.

Let’s look at a few that I’ve seen.

Reporting new license revenue and recurring revenue as one number.

This is so common, it’s almost a joke. I routinely talk to CEOs who say “our numbers are up”, and then I ask the question: “Is the new license revenue up?” and get the real answer.

New license revenue is what’s new. A new customer, and it is the single most important revenue number.

Recurring revenue is from customers renewing a subscription or a software maintenance plan.

Recurring revenue is driven by three things, in order of importance:

  1. product quality, price and relevance,
  2. quality of technical/customer support and
  3. renewal sales activities.

If you focus on these three key drivers, recurring revenue chugs along happily. For enterprise software companies, typically 75–90% of your customers will renew their subscription (or buy a maintenance plan). 85% is a good goal. I’ve experienced as high as 100%. But that’s an outlier, and if you have 100% renewal rates, you’re not as smart as you’re lucky. Customers do drop off in a normal world.

In consumer software companies, the number is typically lower, perhaps in the 65%–70% range.

(Of course, if you’re a pure SaaS/subscription business, you’ll focus on churn.)

The biggest mistake a sales manager can make is to confuse these two revenue sources. Recurring revenue reps should not be compensated as highly as new license reps (and they often are, because the numbers are so large). They should be compensated on a good base plan, with commission tiers or bonuses tied to the percentage of existing customers who renew their license subscription, with the total dollars booked being less important.

That’s not to minimize the revenue role of a renewal rep, as they should be compensated for aggressively selling add-on licenses, additional plans, and other revenue opportunities. The point here is to put the picture into perspective.

Focus on your new license billings as your number one priority.  Have that number as a KPI that everyone knows.

Then have a separate KPI for total recurring revenue dollars and the percentage of customers renewing.

Don’t hide poor new license billings by merging the number with recurring. That’s just lying to yourself and your investors.

How to calculate renewal revenue

Companies are all over the place in terms of how they calculate renewal revenue. And, you can play with the numbers to make yourself look better.

But again, we’re looking at an honest number to run your business. In the above link, Carbonite is a company that has a good approach.

To make it simple, keep two statistics:

Renewal Count

How many customers are up for renewal in a given period?  (a)

How many of those renewed? (b)

And you get:

b/a=renewal rate

It doesn’t matter if they renew in that month, or in a different month. One simply keeps track of the rolling average of renewal rates.

Renewal Dollars

What is the dollar value of the renewals in a given period?  (a)

What were the renewal dollars (including upsells, crossells, additional licenses, etc.) in that period (b)

And you get:

b/a=renewal dollar rate

 

The point is to separate thinking in the organization from existing customers and new customers.

Incorrectly calculated subscription revenue

Subscription-based revenue is another method that’s often incorrectly calculated, often completely innocently.

As you probably know, there are two key calculations in subscription revenue: MRR (Monthly Recurring Revenue) and ARR (Annual Recurring Revenue).

The formula for MRR is dead simple = Total # of Paying Customers  x  Average Revenue Per User.

Now, MRR/ARR metrics are commonly used in reporting, but they are not included in GAAP or other reporting schemes. But they are very important to investors, and to the management of a SaaS company.

So here are some common errors in SaaS reporting. Some of these are surpassingly common.

  • Including quarterly or annual contracts at full value in a single month. Even if someone pays you a lump-sum quarterly or annually, you still need to divide the numbers up to match the MRR figure. (I know, it seems obvious, but I’ve seen this mistake done all too often). Bookings are different than MRR.
  • Underreporting by including fees in the MRR number. Don’t under-report the number by discounting, from the MRR number, credit card charges, delinquency, etc. It will throw off the true number. Instead, break those out separately.
  • Including one-time payments. Don’t bundle in one-time payments into your MRR. These are just that: one time payments, whether NREs, or license fees, or whatever. Report them separately.
  • Including free trials. Don’t include free trails in your MRR numbers. It’s fairly idiotic, but it does happen surprisingly more than one would expect.
  • Not netting out discounts. Net out your MRR net of discounts. In other words, if a customer gets 20% off per month for prepaying, then report the number net of discounts.

(Hat tip to Profitwell — and a shout-out, as they have a great free tool for SaaS reporting.)

Under-reporting can be almost as bad as over-reporting.
Under-reporting revenue (to be “conservative”) can also really kick you in the teeth, as I’ve learned first-hand.

Just get the right number, don’t play games and be completely honest with yourself and with your team and investors. You may not be popular in the short-term, but in the long-run, you’ll be running a better business.

And that, in the end, is what counts.

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