Are you looking to optimize your technology company’s business model? TSIA specializes in helping businesses like yours achieve peak performance. We constantly develop data-driven frameworks that you can use to assess and enhance the health of your business operations. In this report, we introduce three essential frameworks designed to evaluate the efficacy of your company’s operations, including:

• Rethinking SaaS Success Metrics: The Rule of 35 for XaaS Companies
• Evaluating XaaS Company Success: The Four Zones of Growth and Profitability
• Measure Your Revenue Growth Efforts: Revenue Acquisition Cost (RAC)
• Your Key Takeaways
  

Are you curious to learn more? Read the full report in the TSIA Portal to discover how these frameworks can transform your business.

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Rethinking SaaS Success Metrics: The Rule of 35 for XaaS Companies

Understanding the right metrics is crucial to optimizing your SaaS company’s performance. Traditionally, the Rule of 40 has been the gold standard for measuring the balance between growth and profitability. This metric suggests that your company’s growth rate plus profit margin should total at least 40%. While this rule rewards growth, it allows some leeway to sacrifice profitability for expansion.

However, many companies need to catch up to this target. For instance, firms in the TSIA Cloud 40 Industry Quarterly Review spend around 37% of revenue on sales and marketing, achieving a growth rate of 22% but ending up with a -7% operating income. This equates to a “Rule of 15,” far from the ideal Rule of 40.

Recognizing this challenge, some investors have introduced a weighted version of the Rule of 40. This new metric gives more importance to growth over profitability, particularly for smaller companies:

Weighted Rule of 40 = (1.33 * Revenue Growth) + (0.67 * EBITDA Margin)

Rather than loosening the original Rule of 40, TSIA proposes a complementary metric specifically for XaaS (Anything-as-a-Service) businesses: The Rule of 35.

Defining the Rule of 35

The Rule of 35 is all about scalability. To achieve sustainable growth, your company’s revenue minus the cost of goods sold (COGs) and sales and marketing expenses should equal at least 35% of total company revenue. In other words, your business can scale effectively if you keep your COGs at 30% or lower and your sales and marketing expenses at 35% or lower.

The Rule of 35: Revenue – [COGs + Sales and Marketing Expenses] ≥ 35% of Total Company Revenue

Focusing on these metrics can help your company achieve a scalable, sustainable business model.

Related: Is Sustainability Driving Revenue Decisions for Businesses?

Evaluating XaaS Company Success: The Four Zones of Growth and Profitability

Are you curious about how your XaaS company performs in terms of growth and profitability? At TSIA, we regularly assess companies in the T&S 50 and TSIA Cloud 40 to see how they measure up against the Rule of 40 and the Rule of 35. Our findings categorize these companies into four distinct success zones.

Zone 1: Meeting Both Rules

Companies in this zone are the top performers, managing to grow while effectively controlling costs. They meet the Rule of 40 and 35, making them profitable and steadily growing businesses.

Zone 2: Meeting Only the Rule of 40

These companies demonstrate strong growth but can improve cost management by reducing COGs or cutting down sales and marketing expenditures.

Zone 3: Meeting Only the Rule of 35

Companies here are profitable but need help with growth. They manage costs well but need to find ways to accelerate their expansion.

Zone 4: Missing Both Rules

These companies face the most challenges. They could be more profitable and could grow more effectively. They need to catch the targets for the Rule of 40 and 35.

Understanding Valuations and Market Trends

Our assessment provided a snapshot of companies’ positions within these zones in Q1 2024. More companies are crossing the Rule of 35 thresholds, and only 26% are satisfying either the Rule of 40 or 35.

Understanding which zone your company falls into can help you identify areas for improvement. Whether focusing on cost reduction or finding ways to boost growth, aligning with these frameworks can significantly impact your company’s valuation and market position.

Related: The Year of Profitable SaaS

Measure Your Revenue Growth Efforts: Revenue Acquisition Cost (RAC)

Understanding the cost of acquiring new customers is essential for your XaaS business’s growth and efficiency. While customer acquisition costs (CAC) is a critical metric, not all companies track it diligently. To simplify this, TSIA introduces a practical proxy: revenue acquisition cost (RAC).

What Is RAC?

RAC measures the efficiency of your revenue growth efforts. It’s calculated by dividing the annual percentage of revenue spent on sales and marketing by your yearly revenue growth rate.

RAC = Annual % of Revenue Spent on Sales and Marketing / Annual Revenue Growth Rate

For example, in Q1 2021, Cloud 40 companies spent an average of 37% of their revenue on sales and marketing, achieving a 22% growth in top-line revenues. This translates to a RAC of 1.69 (22% * 1.69 = 37%).

Why Is RAC Important?

A lower RAC indicates more efficient growth. If your company is paying more for growth compared to your industry peers, it’s time to rethink your strategies. There are two main levers to reduce RAC:

• Increase revenue growth: Boost your growth rate while maintaining or lowering the percentage of revenue spent on sales and marketing.
• Reduce sales and marketing expenses: Lower the percentage of revenue spent on sales and marketing while keeping your revenue growth rate the same or higher.

Benchmarking Your RAC

TSIA captures the RAC ratings for companies in the T&S 50 and TSIA Cloud 40 each quarter. This allows you to see how efficiently your company generates revenue compared to industry peers. In Q1 2024, the average RAC for these companies was 1.79.

Related: X-as-a-Service Everything You Need to Know to Start the Journey

Your Key Takeaways

• Embrace the Rule of 35 for scalability: Focus on maintaining your cost of goods sold (COGs) and sales and marketing expenses at 30% and 35% of revenue, respectively. This metric will help you scale your XaaS business effectively and sustainably.
• Identify your XaaS success zone: Regularly assess your company’s performance against the Rule of 40 and Rule of 35. Understanding which success zone your company falls into can highlight areas for improvement, whether it’s reducing costs or accelerating growth.‍
• Optimize Revenue Acquisition Cost (RAC): Track your RAC to measure the efficiency of your revenue growth efforts. Lowering your RAC by boosting revenue growth or reducing sales and marketing expenses can lead to more efficient and sustainable business growth.