The Three SaaS Growth Qualities of Qualtrics

Qualtrics filed its  S-1 on December 28, 2020, and went public on January 28. The filing provides a good opportunity to showcase three key SaaS metrics: Revenue growth, the ‘Magic Number’ as a proxy for sales efficiency, and the ‘rule of 40’ as indicator of how fast-growing SaaS companies balance growth and profitability.

In fact, much has been written about the definitions of various metrics. There is broad consensus in the investment community that GAAP principles are not suitable for SaaS companies, and that a different set of metrics is needed to actually run a SaaS company and to benchmark performance against a peer group of competitors on a quarterly and annual basis. 

It is important to note that no definition is ‘better’ than the other but it rather matters to pick one definition and execute against it. Scale Venture Partners in Silicon Valley has probably most extensively used, benchmarked, and written about SaaS metrics, and they have defined ‘Four Vital Signs of SaaS’. 

30+% year on year revenue growth

Revenues increased by 39% between 2017 and 2018 in the run-up to the planned 2018 IPO, 47% between 2018 and 2019 in the first year after the SAP acquisition, and 31% between 2019 and 2020 for the first 9 months where the second and third quarter of 2020 were fully affected by the uncertainties brought on by the Coronavirus.

This compares to 17% revenue growth at Medallia and 20% revenue growth at Surveymonkey, Qualtrics’ two main competitors, based on data from the BVP Nasdaq Emerging Cloud Index.

The share of international revenues steadily increased from 23% in 2018 to 26% in 2019 and to 28% in the first nine months of 2020. 

Magic Number >1 is a proxy for sales efficiency

For a recurring revenue business, the most intuitive way to measure the ‘Magic Number’ is by dividing the New ARR for the quarter by the fully-loaded Sales & Marketing spend for the previous quarter. A Magic Number greater than 1x tends to be a compelling business investment, and a sample of public SaaS company benchmarks can be found here. 

Public companies don’t report ARR, but Scale has found a nifty way to approximate new ARR by multiplying the intra-quarter difference in GAAP subscription revenue by 4 to annualize it.

Qualtrics’ has generated steady annualized ARR growth of about $35 million in each quarter. The net retention rate (NRR) has consistently been above 120% in each of the past eight quarters.

Applying this math to Qualtrics results in a Magic Number of 1.0 in 2019, and 0.9 for the last seven quarters. 

There are lots of reasons why this metric is way too simple, and some important assumptions have to be made around the revenue accounting* and the sales and marketing expenses**. But as Scale Venture notes: ‘However the Magic Number has one redeeming virtue that in our view outweighs all the negatives. Because it is a GAAP based number it is freely available for all public companies and it is comparable between companies’.

Rule of 40

SaaS management teams are often driving towards either rapid growth or increased profitability, and the Rule of 40 has become a construct for framing the balance of these two phenomena. The Rule of 40 (‘Ro40’ or ‘efficiency score’) states that, at scale, a company's revenue growth rate plus profitability margin should be equal to or greater than 40%.

A ten-year look at the data shows that the Ro40 has remained quite consistent among public SaaS companies, suggesting that the measure is a useful barometer of the balance between a business' expansion and profitability, and by extension, the general sustainability of company performance over longer intervals of time.

In 2019 Qualtrics clocked 47% revenue growth at a negative -4% FCF margin to yield a 43% efficiency score. This was slightly down from 2018 50% efficiency score based on 39% revenue growth and 11% FCF margin. During the first nine months of 2020 revenue growth slowed to 31% and the FCF margin dropped to -13% to yield a 18% efficiency score. 
Medallia is sporting a 14% efficiency score and 17% and SurveyMonkey 34% based on data from the BVP Nasdaq Emerging Cloud Index .

_______________________________________________________________________

* Qualtrics’ professional services were included in the Magic Number calculation. They are comprised of research services, implementation services, and engineering services. They are non-recurring and account for approximately 25% of total revenues. Qualtrics’ professional services typically increase proportionally to subscription revenues and account for approximately a quarter of total revenues, but took a downturn in 2020.

** Sales & marketing expenses: Qualtrics had significant stock based compensation expenses and amortization expenses in 2019 and 2020 which have been stripped out. Sales & marketing expenses generally increase sequentially primarily due to headcount growth in connection with the expansion of the business, and small bumps in those expenses have been smoothed out.