SaaS Economics

September 24th, 2017

I give a new hire talk at Sentry, going over over growth engineering, our self-serve funnel, and basic SaaS economics. Everything here may be “common knowledge”, but it was new to me. Writing this down, I hope this is useful to other engineers.

To understand a product, follow its code. To understand a business, follow the money. At its simplest abstraction, a business is a function that takes two inputs (time and money) and (usually) returns more money[^1]. As a mathematical function, it might be represented as such:

\[f(time, money) = money * (1 + IRR) ^ \frac{1}{time}\]

…with IRR being the internal rate of return, the amount of money returned by the business for every dollar invested. For a business to be considered a good investment, they should return more than the market rate…

\[f(time, money) \geq money * (1 + market\ return) ^ \frac{1}{time}\]

For instance, a business has $100. Investing in the market returns 10% a year. Investing in the business returns 5% over 6 months. A little math tells us the business is the better investment, because the IRR is $0.25 more than the market rate.

\[$100 * (1 + 0.05) ^ \frac{1}{0.5} \geq $100 * (1 + 0.1) ^ 1\\ $110.25 \geq $110\]

For a more detailed dive into SaaS economics, I’d highly recommend reading David Skok’s article on LTV. For our purposes in discussing funnels and cash flow, we’ll value each customer at 1.5x ACV.

I’m going to discuss separately each of the types of input in our function: money and time.

  1. Money: Funnels
  2. Time: Cash Flow

It’s worth nothing that while I borrow accounting nomenclature, it’s not remotely close to GAAP. This is mostly geared around understanding how businesses invest their resources to achieve lasting value.