Friday, November 1, 2013

Metrics that matter (or why great info businesses are essentially SaaS businesses)

In a previous post, we talked about what makes a great information business.  In a sentence: great information businesses (1) have proprietary data or insight, (2) embedded within a business process, and (3) delivered through software.  The combination of those three factors tends to yield defensible, profitable, scalable businesses.

But how do those factors translate into the financial statements and metrics that we use to operate and value information businesses?

First, a bit of a primer on accounting in subscription-based businesses.  After all, who doesn't love an accounting lesson?

Wait - come back!  I promise, it won't take but a moment.  

Let's say you've got an information business which sells a subscription-based product.  When a customer signs a non-cancelable contract for, say, 12 months of service for $120k, no revenue is generated up-front.  Instead, the revenue is equally recognized over the life of the contract - in this case, $10k per month.

Until recognized, the revenue remains on the balance sheet as deferred revenue.  Remember that metric - it's the single most important thing to look at in an info business.

Now, let's presume that the customer pays up-front - which is typical in info businesses.  The cash balance of the business, therefore, is enriched immediately - allowing the further re-investment of that cash into the business.

OK - enough accounting.  Let's back back to the metrics that matter.

If you were able to look at only three metrics to assess an information business, what would they be?  Here are mine, in priority order:

1. Deferred revenue.  Did you skip over the accounting section above?  If so, go back and read it.  For those still with us, deferred revenue growth is the best forward-looking indicator of revenue performance.  Want to know whether an info business is trending upwards or downwards?  Don't make the mistake of looking at past revenue performance - deferred revenue is all that matters.

2. Operating cash flow.   Great info businesses shouldn't need ongoing injections of capital. Instead, customers fund the growth of the business with up-front payments.  Therefore, operating cash flow should be growing in lockstep with the growth of the business overall.  

3. Renewal rates.  A growing deferred revenue balance is terrific - it means customers are continuing to invest more and more in their relationship with you.  But which customers?  Renewal rates - on a dollar basis, in particular - are the best indicator of client satisfaction with the offering.  And satisfaction = stickiness = goodness.

On to my final point.  If you've spent time looking at SaaS businesses, some of these metrics might look familiar.  In fact, very familiar.  

To put a fine point on it: great info businesses look, act, smell, and taste just like great SaaS businesses.  The physics are the same, the business dynamics are the same, the cash generation abilities are the same...etc etc etc.

So that's it.  Of course, there are hundreds (thousands?) of other metrics we could consider - especially when we start talking about valuing information businesses.  But for my money, deferred revenue growth, operating cash flow, and renewal rates are the right place to start.

What do you think?