Small Companies, Big Growth: Why SaaS Companies Under $1M are Booming with Ray Rike

Randy Wootton (00:04):

Hello, everybody. This is Randy Wootton, CEO of Maxio and your host of SaaS Expert Voices, where we bring the experts to you to talk about what’s happening broadly across the SaaS marketplace and what could be unfolding tomorrow. It is my pleasure to welcome a friend and colleague, Ray Rike, CEO of Benchmarkit to join us. This is the second time Ray has been on board the SaaS Expert Voices train to talk about our growth report that we produced at Maxio and how it intersects with a industry benchmark report that he produces. Ray has a great background, started at GE, worked his way up, and then has had multiple roles as president, CEO, and COO. So been an operator mostly on the go-to-market side, but obviously has overseen all functions and started at Benchmarkit about four years ago. Welcome, Ray.

Ray Rike (00:52):

Thanks, Randy.

Randy Wootton (00:53):

Great to have you.

Ray Rike (00:53):

I’m so happy to be here, and a topic that I love talking about, which is benchmarks and growth.

Randy Wootton (00:59):

Yes. So maybe before we get into the actual reports, talk a little bit about the founding of Benchmarkit and your passion around metrics. What led to you to dedicate your life to this? It’s just a really interesting calling.

Ray Rike (01:12):

Yeah. Well, my first, almost 10 years out of undergrad, I worked at GE as you mentioned, and I went through their executive leadership development program for about five of those years, and you did not make a decision without understanding your financial performance metrics inside and out. And if you were asking for additional budget or doing a forecast, it had to be backed up with a lot of great data metrics and critical thought. And then, I came out to Silicon Valley with Netscape, and that was in 1996. And I went from amazing financial discipline and rigor to move as quick as you can. And I tried to introduce five-year planning and they looked at me and it’s like, “Yeah, let’s do five-month planning, best case, right?” So I realized very quickly that a lot of the financial discipline and rigor that I had learned in large, more traditional corporate America was in Silicon Valley.

(02:08):

So I wanted to try to introduce and bring that as we scaled companies, because when I was brought in, it was typically in that 5, 10 as high as 20 million, and how do you get to 100 million? And that required more repeatability, scalability, and predictability. So that’s why I did it. And then, even though I was a devout reader of the KeyBanc Capital Markets annual SaaS benchmark report that David Spitz did, it didn’t have the context I always required. I need to know what my customer acquisition cost ratio should be for a company at this stage with this ACV and selling to the enterprise market versus selling to the SMB market. And you just couldn’t do that with the KeyBanc Capital Markets.

(02:50):

So I sat on this goal four years ago to provide the industry’s largest, now 18,000 companies have participated in our benchmarking research and the most contextualized benchmarks out there. So you can go to benchmarkit.ai and say, “I’m a company with 5 million with a 25K product and I’m selling to the enterprise market,” and you can see the median for NRR or the 25th percentile. So that’s my goal is to give operators benchmarks, not as religion, but as guidance to where they should be striving to achieve.

Randy Wootton (03:21):

And I know we’ve really benefited from the insights you’ve provided. We’ve used it as part of our strategy process and our financial planning process, because to your point, I too tend to be one of those database operators having grown up in the military, but also just at Microsoft and at Salesforce. And they were very strong on the whole idea of you got to have database decisions, and so you got to trust the data or understand where the data is coming from and then use it to inform that decision making. And I think your Benchmarkit report has been immensely helpful.

(03:49):

I think the other thing, what you are alluding to is it’s not just a report that gets produced on a quarterly annual basis, it’s live via the website. And so, people can go interact with it, put in their information and then see where do they fit in those different cohorts, which is what is so important is a $10 million company selling small ACV deals versus a $10 million company selling large ACV deals is very different. And all the metrics that play out are different. And so, having enough companies in each of those cohorts is one of the things, if you have 18,000 people participating, you’re starting to get it at scale and you’re able to really provide context for people to understand cohort benchmarking.

Ray Rike (04:32):

Exactly.

Randy Wootton (04:34):

And so, then, you say, “Oh, well why are we partnering with you?” Well, the thing that we do at Maxio is your surveys is a survey. It requires people to input the information and most people are honest, and that’s great. It requires a lot of compilation. One of the things Maxio has, we have north of 2,000 customers and we have their actual billing and invoicing data. So we’re looking at it a slightly different lens, which is what’s happening with those customers. We split it similarly, not as robust as your segmentation. We don’t have the 18,000, but we do split it and we’ll get into the details around small companies, large companies. Our data set is primarily private companies, VC or PE-backed. We are able to draw the distinction between how they invoice, how they price, and then we’ve been layering in industry insights. And so, what are we seeing broadly across that?

(05:24):

And so, I think that’s what we’re going to talk about today is what we’re hoping to do is I’ll outline the five key takeaways from the Q2 Maxio growth report. We publish it every quarter, and some of these have continued throughout this year or over the last eight quarters, which we’ll talk about. And there’s been some interesting new developments in Q2 versus Q1 or previous years. So we’ll talk about those. And then, we’ll have you, Ray, talk a little bit about how does that correlate or correspond with what you’ve seen in the Benchmarkit report. And so, this is a way to bring these two things together. We’re looking at different data sets, but there’s a lot of overlap in terms of the insights we’re bringing to the broader SaaS landscape.

Ray Rike (06:05):

Perfect. Boy, some of the growth reports you had in the Q2 2024 Maxio growth report, really good so let’s start there.

Randy Wootton (06:15):

Let’s go in. All right, so the five key takeaways, I’ll go through them quickly and then we’ll come back to them, touch on them individually is one, private B2B companies are growing quickly. So this is good news for all of us. It sat through the, or suffered through the B2B SaaS recession, which wasn’t publicized, but I think a lot of us in the market saw it with the pullback from VCs and PE companies. And so, now, we’re starting to see a shift there. The first half of 2024 has been great for small businesses. And so, when we think of companies lower than $1 million in revenue where a ponderance of the startups are, there seems to be a resurgence. We’ll talk a little bit about that.

(06:54):

Pricing model matters, and this is one of the things that’s very interesting for us at Maxio where we support companies who both do subscription-based invoicing as well as fixed rate term subscriptions. The nuance is subtle, we’ll talk a little bit about it, but it is interesting. It does have an impact in terms of your growth rate and there’s some drivers for that.

(07:14):

Number four is businesses are spending on infrastructure and essentials. So when we look at the broader industry landscape, we’ll talk about some of the industries that are growing and some of those are contracting, but it’s interesting to see where people are spending the money and you, Ray, have some data on that. And then, finally, you can’t get through any of these types of talks without talking about AI. And it is interesting to see what’s happening. AI, I don’t know if we’re over the hype cycle or not. They’re growing, but not as quickly as they were in 2022.

(07:43):

So those are the five. Let’s dig in. So on the private B2B companies are growing quickly, what we’ve seen is that there’s an average annual growth rate of 17% since the beginning of 2022. And I think this is interesting because prior to that, right at the end of 2020, 2021, you saw the growth rate at 30%, and that was where a lot of investors were making investments. It became the expectation that you’re going to grow 30% per year. And if you didn’t have a plan that supported that, you were a dog. And I think what we’re finding is it’s starting to normalize more to a mean of 17%, and this is the second or third quarter where we’ve seen that across all customers that we have, it’s about a 17% increase.

(08:27):

And look, to put it in broad perspective, a 17% growth rate would be awesome. I mean, the members of the S&P 500 have an average annual growth rate of just under 7% over the last 5 years and are projected to grow at 5.5% in 2024. So we’re still talking about an industry B2B SaaS in particular is throwing three times the average. What have you seen with that, Ray, and how have you thought about the drivers of growth of these companies that might be different than the broader S&P 500?

Ray Rike (08:57):

Well, first of all, because all I follow is B2B SaaS and cloud. So you mentioned that 17% growth rate for the private companies across your end of which is 15, 65, public SaaS and cloud companies have a median growth of 12% right now. So private companies are definitely beating those. And what’s interesting is I really like the segmentation because we did research about four months ago what’s your planned growth rate? And the planned growth rate across about 1,000 private SaaS companies was 35%.

Randy Wootton (09:33):

Sorry, when was this? So it was 35% at the beginning of 2024?

Ray Rike (09:36):

Yeah, we did this research February through March, so their plan was 35%. And every segment of company size planned to have higher growth in 2024 versus 2023, except the less than a million, the less than a million size companies did a bloodbath in 2023. And they were more conservative. And actually, what your then shows is companies below a million are actually growing faster. I believe the max year growth report showed in Q2 ’24, under a million’s at 21%, and above a million’s at 16%.

Randy Wootton (10:19):

Yeah, that’s right. You nailed it. So I think that’s really interesting. So let’s go to those board meetings. You come out of November, December of 2023, you lay out your growth plans for the next year. Look, I was one of those guys. I wasn’t as aggressive as 35% growth in 2024, but was certainly up in that range. And so, February, we input our data to your survey and say, “We’re all going to grow 35%.” Now, fast forward to June of this year, and what we’re seeing is an average of 17% growth. People are flipping out at the board meeting. What’s happening? When you’ve been talking to all these people in your surveys and going around and getting context, the qualitative context around the quantitative numbers, what are you hearing is happening?

Ray Rike (11:06):

Well, there are two major ends of the spectrum. For those companies who had higher growth rate plans and aren’t coming close to achieving them, they are being ruthless and ripping out expenses, because they’re trying to preserve their cash runway, which as an investor, I want you to go from 12 months to 18 months if you’re not meeting your growth expectations. But at the same time, Randy, what our research shows is that companies are spending less than 25% of revenue on sales and marketing are growing 50% slower than a company’s investing 45% more.

(11:43):

So the question here is cause and effect. Is the cause of the higher growth because we’re spending more or is the effect I’m growing more so I can spend money? Now, usually, it’s companies that are in a good market, they have a highly repeatable and efficient customer acquisition, retention, and expansion process. They’re being to step on the gas because you’re killing your competition. So that’s the real thing. So that’s number one. So the fast-growing companies are investing more and growing faster. There’s much lower growth. It’s that middle that’s so hard. And that middle, they still are really focused more on efficiency and unit economics than growth. They will sacrifice some points of growth to get to at least break even, whether that’s EBITDA or free cash flow margin. But once you’re at 50 million above, Randy, right now, what most companies are targeting is about a 10% free cash flow margin.

Randy Wootton (12:45):

Got it. And very, I mean, relatively few companies that get to 50 million. But I think what you’re describing is this dynamic of, to your point, is don’t want to get caught in the middle. You either need to be solving for EBITDA, controlling your own fate. We talked about with this, our friend Todd Gardner about the dolphin strategy where you get profitable every once in a while, where you can show your investors you can do it, you start to generate a little bit of cash and then you can say, “Okay, where am I going to invest next?” You can go unprofitable, but you’re in control of your fate. And so, I think getting the EBITDA positive, critical, important, maybe not at a company that’s less than a million bucks, but certainly as you get to that %10, $20 million, if your growth starts to waver, like they’re going to come after you and say, “Cut people cost, cut internal software, cut investments,” and then you’re behind the ball and it’s super hard to be in front as the CEO running the company.

Ray Rike (13:34):

And one of my favorite metrics, and I may derail this, but I love this thing called the CAC ratio.

Randy Wootton (13:40):

Oh, well, that’s what I was going to go next. So tell us about the CAC ratio.

Ray Rike (13:44):

This measures your sales and marketing expenses divided by your new ARR, which is new name customer and expansion customer ARR, but then be more granular and look at your sales and marketing investment expenses allocated to the pursuit of new logos and the ARR, divide that by the new logo ARR. What I do with a lot of our customers is I actually build a matrix and I say, “Okay, let’s say the median for a company like yours should be spending $1.50 of sales and marketing to get $1 of new ARR.” And there’s a, “But if you’re growing at 5 points higher, you can spend 5% more. If you’re growing 5 points lower, you can spend 10% less. So then, your entire go-to-market team knows there’s a direct alignment between how fast I grow and how much I can spend,” if that makes sense.

Randy Wootton (14:39):

Yeah, totally. I hear you. And I think that is a powerful distinction of CAC ratio, specifically new CAC ratio. You have to be able to allocate the expenses and then understand by revenue streams, so you could split it out by product, by region as well if you get to that next level of granularity in terms of what are you spending to acquire that type of revenue, which is very different than I think the view where you look at total sales and marketing as a percent of revenue. I think the CAC ratio is the one that Battery beat me over the head over the last two years is to really focus on have that dialed in. And to your point, it’s got to be balanced. And this is what I tell my team is if we’re not seeing the growth we want, we got to ensure we at least we have the model set up so that we put more money in, we know what’s going to get the payoff.

(15:25):

The question for you, Ray, on this, and we’ve talked about this before, is it does seem like CAC ratios broadly have gone up, especially on the new front, meaning it’s getting more expensive. So sometimes in the board meeting, they’re like, “Well, last year you were spending only $1.05, why are you spending $1.20?” So how have you seen that dynamic play out in terms of it is getting more expensive? Is it more expensive in specific verticals or specific size companies that you’re seeing?

Ray Rike (15:50):

So three things. Number one, a lot of people call this the valley of death, and it’s that 20 to 50 million, it may even go up to 75 million. You grew really well with one or two primary targets, customer segments, but you want to try to retain some growth endurance so you have to go to a new market. Maybe you’re going from SMB to mid-market, or maybe you’re going from mid-market in the US and now you’re going to other English-speaking countries. And inherently, your customer acquisition cost is not as efficient. It’s going to go up. So that’s why you got a major CAC ratio by segment, very important.

(16:31):

But Randy, here’s, I’m going to blow your mind on point number two. So everyone knew with this cautious buyer capital environment and looking to consolidate, it was going to be harder to get new logos as customers. So yeah, you’ve seen new logo CAC go up in 2023 versus 2022 and went up 22%. So it was 22% more expensive over the entire population to acquire new customer logos in associate AR.

(17:01):

But listen to this, there’s something that I love called expansion CAC ratio. Now, it requires some discipline and some work to get this in place, but it’s how much sales, marketing, and customer success operating expense is allocated to the pursuit of expansion AR, and you divide that by the expansion AR you get from existing customers. Historically, and by the way, KeyBanc has done this measurement for eight years. I think David Spitz invented it. It was around 61 to 69 cents. So I spent 61 to 69 cents at median of sales marketing and CS expense in the pursuit of upsells and cross-sells. So heading into 2023, everyone knew it was going to be hard to get new customers, so they reallocated sales and marketing investment to retaining, but then expanding existing customer relationships.

(17:51):

In fact, if you look at percentage of growth ARR coming from existing customers, it went up from 30% to 35%. So it went up 5%, and larger, like 50 million above, it’s almost 50%. But listen to this, the cost in 2023 to get $1 of expansion ARR went to $1. It went from 69 cents to $1, a 42% increase. And by the way, only 18% of the companies we conduct research with actually major expansion cap ratio. So this was a pretty small population, well it was only about 100 companies, but 69 cents to $1, and the common wisdom was it’s cheaper to sell to existing customers, but no one knew how much. So when you’re the CEO going to your head of CS or sales say, “Well, we need to go from 5 million to 8 million of expansion ARR, what’s it going to take?” Most companies don’t know.

Randy Wootton (18:47):

The wisdom was, hey, it’s easier to sell to current customers, not just cheaper, but easier because you already have an MSA in place, you’ve already gone through the procurement, you’ve got a sponsor. If you’re doing well, you’ve got a value relationship where they’re valuing you. And so, if you roll out a new product, or even if you introduce a little bit more pricing, which is what a lot of B2B SaaS companies did in terms of just brute force increased prices, you thought that there was going to be room to move with your current customers. But I think what you’re showing is that everyone was locking down. People were, I know for us, for example, we had a focused effort on reducing internal software from a percentage that was too high to, I think, in what I’ve heard broadly, and this isn’t COGS, this is internal software, like 2 to 3% of your revenue.

(19:33):

And so, we just went after everything. And we had, as Battery would tell you, it wasn’t a good thing that every company that came and talked to him said that Maxio was a customer. We were customers of every single internal software that was out there. We had all the great stuff, we had all the Porsches, and we had to go back and cut. And I think, so even though we were current customers of many software, we were not just not going to expand, we were going to cut. And I think we saw that broadly across the stack. And so, that’s probably why those costs went up as well is because now you’re competing for trying to attack the walled garden. So any other thoughts on that before we shift to number two about what’s happening in the small company segment?

Ray Rike (20:14):

No, I’d love to go to that because there’s some data in the Maxio Growth Institute report that I really want to talk about.

Randy Wootton (20:19):

Yeah, no, super interesting for us, and this is another one of these counterintuitive, “Wait, the small companies aren’t growing?” What we saw is these are companies with less than $1 million in annual revenue, they’re growing significantly faster in 2024 than what they had been doing in ’22 and ’23, which is what you were alluding to. It was two years of anemic, single-digit revenue growth for $1 million and smaller customers. Their growth rate has now skyrocketed to 26% in Q1 of this year and continue to 21% in Q2, which to your point that you made earlier, significantly outpaces the growth that we’ve seen in the companies that are above a million bucks, which in Q2, it’s only about 16%. So I’ll be interested in hear what your thoughts are in terms of why do you think that’s playing out that way?

Ray Rike (21:07):

One of the things unfortunately that data doesn’t show is are any of these AI companies? Because I’m finding a lot of companies are experimenting with early stage AI companies, the Clays of the world, the STR AI systems, et cetera. So that’s one hypothesis, Randy, is we’re seeing a lot of investment going on in these AI products, which are small companies. Makes sense to you?

Randy Wootton (21:36):

Yep. I think we’ll talk a little bit about that as the fifth trend is what’s going on in the AI. I was thinking, Ray, if we look at our churn data, again, we have about 2,000 customers, 2,400 customers skew more to S, SMB, and mid-market. So have a couple 50-ish public companies that use us. We have a couple hundred that are greater than 100 million, but our core is in this space. So if we look at our smallest segment, our number one churn reason over the last year, 18 months has been declining or going out of business for small companies. And so, I do think there was a lot that just were running and they weren’t getting exit velocity and the VC said, “Hey, wrap it up or tuck it in.” And we’ve had a bunch of companies that were acquired. We had a much higher percentage of those companies that were acquired into other companies, and they were either ours, so we were able to extend it or they were acquired and we didn’t keep them as customers.

(22:31):

So I do think there’s been a bunch of churn at that low end. I think though there is still a lot of capital in the market. And so, to your point, I don’t think it’s all going to AI companies, but a lot of the early stage venture are putting money in now, but they’re smaller bets, they’re small companies, and the growth rate on a small number is, you know better than I do, can look great, even though it’s only, “Hey, I grew from $50,000 to $100,000 in ARR.” So when we’re working with those small companies in billing space and they’re just getting up and running, they have a product, they’re putting out their billing a little bit of dollars, it looks like a lot of growth.

Ray Rike (23:03):

One of the most illuminating things from the Maxio Institute report was you segmented by fixed rate pricing, i.e. traditional subscription pricing and usage based pricing. Now, you did that for small companies below a million and then above. So below a million, the fixed rate pricing companies were growing. They hit 44% in Q1 and 41% in Q2 of ’24. Compare that to usage-based pricing companies, Randy, same timeframe, they only grew at 24% in Q1 and I believe it was 18% in Q2. So off a smaller number, less customers getting some of that subscription booking upfront, so you get the cash in the door, you’re growing much faster.

(23:50):

But then, when you look at the company’s over $1 million, Randy, with that same filter lens, your companies with usage-based pricing are growing faster and much faster than traditional subscription-based pricing. So as an entrepreneur out there and as a CFO, it’s like, okay, reduce friction, upfront is good, but I also need cash to prove this model works. But as I grow, when do I introduce usage-based pricing and how does that change my processes and even my measurements? So I think that’s enlightening.

Randy Wootton (24:25):

Enlightening is completely counterintuitive to me because looking at early stage companies, startups, you think a lot of them are running a PLG model. A PLG model is often a usage-based construct. It’s a technologist who’s built this company. They’ve got, “Hey, come get access, my product sells itself.” And, “Oh, I’m going to sell it based on value.” You buy something, you pay for it. But I think the insight that you have is one of those that seasoned CEOs, CFOs, and or investors say, “Hey guys, you need to have contracts. We need to get paid upfront because the whole model is you got to hire people then to support it.” And so, I do think focusing in, getting product market fit, getting some customers on board, having the contracts, the annual contracts enables you to a set of foundation, and then you can introduce usage-based pricing.

(25:10):

I think usage-based pricing has a lot of volatility. We see that about half our customers are what we call usage-based customers. Depending on how their metric, the widget is going up or down by month and it can change from month to month, we see it just play out havoc in our financials and we have to isolate it and focus on it, understand what’s happening. We have growth there, but if you’re looking at it on a single month basis annualized by 12, which what you do often for ARR, it can totally go wackadoodle. So we’ve had to do things like look at the trailing three months of usage by customers, and we have to look at every single customer at the level of customer. And with 2,400 customers, it’s really hard to understand what’s happening and try to pattern match. Is it seasonality? Is it business model? So there’s a level of complexity once you introduce usage-based pricing. But to your point, for the bigger companies where you have that stable term subscription base, which we also have the platform fee, you benefit with the growth of your customer base.

Ray Rike (26:06):

So in fact, I just did a lot of research and did a couple sessions, training sessions on this, Randy. So in the Maxio Institute report, it was a great early indicator of the correction coming because the usage-based pricing companies, you started seeing in Q1 and Q2 of ’22, their growth rates came down. Subscription companies remained stable for two or three quarters. But then, when it became renewal time in January of ’23, that’s when the subscription companies came down. And now, starting two quarters ago, the usage-based companies started to grow faster than subscription on whole. So interesting data.

(26:45):

Now, here’s the thing for people to think about though, because sometimes, number one, they think PLG and usage-based pricing are synonymous. They’re often correlated, but not always. PLG is an acquisition motion and it can have subscription pricing. So don’t confuse the two, but the forecasting process with usage-based pricing is so hard, because during the good times, it grows faster. During the bad times, it shrinks faster, but then it grows faster again when we start to reinvent ourselves as an economy. So just be careful of thinking that usage-based pricing is a magic elixir. It’s not.

Randy Wootton (27:27):

Amen. And I think that understand the nuances of that and making sure you have the systems. I mean, advertisement for Axio, this is what we offer, is the ability to do that complex billing both in the billing and in the reporting is making sense of the madness. And as you add more customers, your Excel sheet breaks. So I pulled out from the report just a couple of data points to make this real. If you’re a fixed rate B2B company and your zero to $1 million, you’re in the top 10% of our cohort if your growth rate is 137%. For a usage-based company, zero to million bucks, your top 10% if you’re 106% growth rate, so significantly higher in that zero to 1 million.

(28:11):

At the other end of the spectrum, if you are a fixed rate B2B company and you are 20 to 50 million bucks, you’re in the top 10% if your growth rate is 39%, if you are usage-based, so this is the flip that we were talking to you, usage-based B2B company, top 10%, $20 to $50 million cohort, it’s 111% growth. So almost three times the growth by having usage base included in the pricing model. And honestly, I mean, Ray, I think it’s not a matter of either or, this isn’t like the Jets versus the Sharks. It’s what we’re, our green I think or advocating for is a hybrid approach, but being very disciplined and understanding how to do that. And so, you’re going to have some platform fees or more term subscription. You’re going to have some professional services, you’re going to have some statement of work stuff and you’re going to have usage. Usage is the future, but be super careful as you go down that path and try to incorporate it into your business model.

Ray Rike (29:13):

Yeah, a couple things we highly recommend, don’t go to your existing customer base and do the initial experimentation of usage-based pricing. Maybe it’s the new segment you’re going after or it’s a new product, but start without impacting your existing customers. That’s very, very important, Randy.

Randy Wootton (29:30):

Cool. Maybe this is a great segue to the fourth point around industries. So if you’re going to start a new industry, for example, that could be a place where you could introduce a new pricing model. Last year, we introduced the end of 2023. We introduced our first industry analysis to break out the growth metrics by industry. We had the aperture pretty tight at that point, specifically around B2B companies. We do have more than just B2B companies in Maxio. We have food beverage and tobacco, we have media and entertainment. And so, we saw this time we were able to double click down and provide more insights in terms of the broader set of industries and had some insights in terms of the ones that are doing well, the top growing ones are really the infrastructure and essentials.

(30:18):

And our idea is that in an inflationary market where funding is hard to come by, companies are tightening their belts and spending on the essentials. Infrastructure industries like transportation, supply chain, cybersecurity, and healthcare are growing aggressively. Discretionary industries like media and e-commerce are growing much more slowly. And I think that is in line with what I’ve seen broadly. I’m an old MarTech guy and you’re seeing MarTech just continue to get crushed.

(30:44):

Now, that’s part of supply and demand. There’s 20,000 MarTech providers, and part of it is CFOs going to heads of marketing and saying, we’re not going to support this very complicated MarTech stack that you have. You need to get down to the essentials, which is going to be the CRM used across marketing and sales, but it’s also going to be some sort of email. It’s going to be some sort of website. It’s going to be by search, but all this other whiz bang cool stuff, you’re going to have to cut. What have you seen in terms of industry trends from your data, and we’ll get to AI as the last thing? But before we go to AI, just broadly across industries and people’s appetite to buy.

Ray Rike (31:20):

Well, this is of course common sense, but anyone who had their primary customer base and B2B technology, especially in the SMB, really have had a tough last six to eight quarters, and I’ll use ZoomInfo as your poster child, 40% of their revenue as a $1.2 billion public company was from the SMB market in tech. They currently have a net revenue retention number of 85%. Why?

Randy Wootton (31:54):

Wow.

Ray Rike (31:54):

Because so many of those small tech companies either stop buying or are no longer here. Carta’s data, which is an equity platform, shows that twice the number of even $10 million and above SaaS companies are going out of business in 2024 compared to 2023, which was twice as much as 2022. So if you’re selling into the software industry, it’s still hard times. At the same time, if you look at infrastructure, especially when I say infrastructure, I’ll talk about technology infrastructure like cybersecurity and that and hyperscalers, cloud infrastructures like the Microsoft Azures, Google, and AWS in the world, they’re doing really well, Randy.

Randy Wootton (32:41):

Yeah, well, I think that was what we were pointing to a little earlier. We’ve seen that in our data as well as those small companies and we sell primarily B2B tech, we’re the ones declining or going out of business. And to your point, just what I talk about is a B2B SaaS recession. I think there’s just been this contraction. It’s driven by, you can point at inflation, but just I think VCs and PE companies just press pause and they said, “Hey, we used to be, we’d give you money for 12 to 18 months, now it’s going to be 36 months.” And all those CEOs of those little companies went, “Wait, what? I thought I was going to raise and spend 12 months executing, and then you spend the next 6 months of doing the next raise.” So I think the whole funding dynamic has really changed.

(33:20):

Now to earlier point, we’re starting to see that turn a little bit in the SMB space and what you were making a comment on was about the AI companies are the ones that are getting invested in. What we’re seeing, and so it’s interesting, I think with AI, there’s three different models of AI companies. There’s those that are wrap around GPT 4.0 type construct. And so, do they have real value or are they just augmenting a model? The other one is they have real data, system of record data that then they are aggregating and providing insights and intelligence in a way that is unique in the marketplace. And then, the third one I think of is augmentation of current tools that are already supporting end markets. So like Zendesk with their AI solution or Salesloft or Outreach with their AI solution, it’s tied into what they’re currently offering that you’re going to pay for.

(34:12):

So if you say broadly across those three types of AI companies in the marketplace, why that’s relevant is there is not, and we don’t have an AI vertical. What you have is a lot of companies that have AI that are supporting other verticals. So it’s an AI company supporting manufacturing or AI companies supporting retail. And so, we’ve gone through and we’ve aggregated all the companies from the data who are AI first to come up with an AI cohort, and what we’ve seen is they’re going fast, but not as quickly as 2022 when there was the hype cycle around AI. What have you seen in terms of the broad market trends for AI, either how the business models are being articulated or the investments are being made?

Ray Rike (35:01):

Well, let me start with investment because it’s data that you can easily get from the Crunchbases of the world, et cetera. So first of all, let’s look at US and I’m going to go US VC backing. So in Q2 of ’24, it hit about 42.9 billion, which was an increase from 33 billion in Q1. So that’s a nice 29% increase. So we’re starting to see some wakenings of VC, but now let’s look at how much of that VC investment in the US went to AI. 29% of that investment went to AI companies in first half of ’24. 29% went to AI first companies, 71% to non-AI companies.

(35:53):

If you compare that to two years ago, 2022 Randy, only 12% of VC investment went into AI. So it’s went up 2.5X over the last two years. So that tells me that the AI hype from an investor perspective is still going strong. Now, one more data point for you is how much of that is going into the foundational models versus application? The foundational models, the companies that have data and they’re going to train that large language model, foundational models got over 60% of total VC investment in AI companies in 2023. Application companies only got about 20%. So the investment in AI companies right now is way over-indexed in the foundational models and not in the, I’ll call them thin veil of applications writing on top of foundation models. So a lot of data there. Any questions?

Randy Wootton (37:02):

Well, I’m an English major, 60% plus 20% equals 80%. Where’s the other 20% going? Foundational models?

Ray Rike (37:10):

Technology.

Randy Wootton (37:10):

Applications.

Ray Rike (37:11):

Technologies and tools that enable AI, developer tools, et cetera, but not business applications.

Randy Wootton (37:18):

Got it. Yeah, no, I think those are the three categories. You said it much better than I did, but I think that’s super interesting in terms of the data is the gold or the data is the oil, and then you can wrap models on top of that that then allow you to do really bring value into the marketplace. So I think that’s interesting. I mean, if we take all this together, we pull this, all these little threads, what we see is, I think the broader theme is we saw a downturn in SMB over ’21, ’22, ’23, we saw that blow up. We’ve seen that increase significantly. There seems a direct correlation to be with where VCs are putting their money. To your point, we’re seeing investment in both. It’s up 20% from Q1 to Q2, and the way the mix is over the last year, it’s really in AI. So the hype cycle’s not over yet, but you better, I guess the takeaway is you better have a foundational differentiated offering as AI versus being a wraparound.

Ray Rike (38:22):

Definitely. And I also want to give one other variable there. So of that increase in Q2 over Q1, which I mentioned it was, if you look at it on a dollar basis, it was about $9 billion more was invested in AI. $6 billion of that $9 billion increase went to one company, one deal, and that was Elon Musk and xAI.

Randy Wootton (38:48):

Oh, gosh.

Ray Rike (38:49):

So that’s why-

Randy Wootton (38:50):

Well, that’s skews the data.

Ray Rike (38:52):

It skews the data. That’s why with all these metrics and benchmarks, you want to peel back one or two layers of the onion to really understand what’s under there. That’s why I had to mention the $6 billion deal at xAI.

Randy Wootton (39:05):

Well, Ray, every time I talk to you, I learn something. It’s so much fun to talk about metrics. I mean, you just talked to so many different people and you have all this data at your fingertips. What are you telling CEOs of companies that are less than $10 million? What are the things they need to focus on? What are the most important things to get right over the next 12 to 18 months?

Ray Rike (39:24):

Really understand your ideal customer profile and make that as narrow as you can. Yeah, you think you need to grow by extending your target customers. If you’re $5, $10 million, I’m sure hope that your primary ICP can let you at least become a $20 to $50 million company. And what I saw in the last 12 months for companies that really focus on ICP, that I’m seeing increased pipeline conversion rates from, and I know these are old school, but MQL, SQL, SQL to close one and demo to close one.

(40:01):

So the better you narrow and focus your ICP the better, and use your gross revenue retention and net revenue retention metrics as an input to your best ICPs. Because a lot of times we get hung up in, I closed these two or three new accounts in this new industry segment or new customer segment and it made my quarter and we’re all celebrating. But number one, how repeatable and economically repeatable is that? Number two, do they stick around 2, 3, 4 or 5 years? So if you’ve got a core that you know is profitable and you got good unit economics and double down on it.

Randy Wootton (40:41):

All right, I’m not going to let you off the hot seat. You said two things, which really I think I want to underscore, the idea of using gross retention and net retention to inform your ICP. I think a lot of companies think about why are we winning and so they do the analysis on the new logos and these are the types of customers we’re winning and we need to go get more of those. But I think to your point, why do we keep winning? Those are the customers that renew and they bought the product a year ago or two years ago, and so they’ve gone with you on this journey, you’ve been adding new features and new capabilities.

(41:14):

Are you still able to speak to the needs of the people that bought you? It’s like we went from dating to getting married. Is your wife sticking with you, or your husband sticking with you? Are they renewing? Are they upping again? Because that is then taking that information to go back to the ICP. I think it can also really help you nail the use cases, the value paths that inform the messaging that you use to go out and win more in that narrow ICP.

(41:38):

We’re north of, we’re big, call it series D. One of the things I’ve talked to my team when I first came on board was we needed to narrow the ICP and get it right to get the [inaudible 00:41:49] sales engine down and they said, “Gosh, Randy, we have all these other customers.” To my point, we have all these verticals outside of B2B SaaS. I was like, “No, no, no. We got to focus our energy and effort.”

(41:59):

But there is a point at which you want to be able to introduce multiple products, multiple ICPs. Where do you find that inflection point in terms of company size where now you got to be able to broaden a positioning and messaging to be able to say, “For us, we have an ICP, which is a B2B SaaS, but we have two personas, we speak to the early search founders, technical founders, and then we speak to series B, series D CFOs, those are two very different personas. We could be selling just billing or just FinOps, but the combination of the two companies means we have to speak to both.” Where do you find that inflection point in terms of company size or how executive teams need to think about broadening the ICP to continue to drive growth?

Ray Rike (42:40):

Of course, the answer is going to be, it depends, but some broad level, if your primary ICP stops performing before 20 million, God help you, because either you have a product category that is not big, your product market fit has went away, or you’re very ineffective in selling, so 20 million at least. Best in class companies, those growing at 45% and faster above 20 million typically are still in their same ICP until 50 million. So 20 to 50 million, you should focus on that primary ICP.

(43:25):

Now, at that point in time, I do see natural need, if you’re going to keep your growth endurance at that 80 to 85%, that means year-over-year growth is at least 85% of what it was the year before. Then, you’re going to need to expand. And then, when you do expand, you need to make sure that you break out your performance metrics. I’ll use CAC ratio we talked about earlier. If my CAC ratio for new customers is $1.40 and we’re celebrating and you’re now going from mid-market to enterprise, make sure you segment that out. Know what dedicated resources are going after enterprise, how much you’re spending in your marketing programs, and be prepared that those first two to four quarters is going to suck. Your CAC ratio may look at $2, $2.50, $3, but don’t let it taint your investors and board meetings that they think your entire CAC ratio is getting worse, it’s because I’m investing in this market. Right?

Randy Wootton (44:20):

Amen. I think that is a great way to end as we think about it’s August when we’re recording this. I think a lot of companies, if they’re smart, they’re starting to do strategy conversations with their board in September, which then informs our financial planning from November, December. They can lock it down and drop an operating plan. In that strategy, you want to be talking about your three-year growth plan. What are the growth drivers? And I think to your point, Ray, being able to isolate those different growth drivers and understand what the investments are and what are the metrics you’re going to use.

(44:49):

So for example, we’re looking at enterprise. Enterprise is a super interesting segment. It’s really expensive to go to enterprise. And so, if we’re going to do that, we need to be aligned with board in terms of this is like a year, 18, 24 month payback because the sales cycles are usually a year. And so, do we have the appetite to take that on right now or is there a different way to do it? And I think if you use that NPV, ROI analysis, the metrics aligned with the investment, you can have a clear-eyed conversation about it, and then you got to be able to hold the reins. And then things start getting tough, you don’t want to go into a market and then pull out of a market either, and that’s either by region or by segment. It’s you invest all that mental capacity and energy and then you put all these dollars in it and then you pull back because you got cold feet. So the job of the CEO and the executive teams make big bets. You got to be clear-eyed about how to frame those up.

Ray Rike (45:42):

And this might be heresy to some investors, but let’s say you’re going to enterprise, because I have had the opportunity to do that several times. My number one measurement is customer acquisition logo velocity. I want to know how many logos in the enterprise market or in the automotive industry and enterprise or healthcare, whatever, that I need to get over the next 1, 2, 4 quarters. And I will sacrifice ACV and ARR for logos. Because often if you can get 10 versus 2, but you get 40% less that muscle memory of what their buying criteria are, what the value proposition is, and their referenceability 6 to 12 months down the road, then you can start getting more value and charge higher prices. That’s my recommendation in that environment.

Randy Wootton (46:36):

Awesome. Ray, you just keep dropping wisdom and I think people can find you on LinkedIn. You have several podcasts that you’re hosting. Is there other places you’d like people to track you down or just follow you on LinkedIn? You’re always posting, putting out good stuff.

Ray Rike (46:51):

Yeah, LinkedIn, it’s just Ray Rike. I was user number 256. That tells you how old I am of LinkedIn.

Randy Wootton (46:57):

Wow.

Ray Rike (46:58):

So I’m on LinkedIn. That’s where I post every day. Two podcasts, I do one with Dave Kellogg, one of the OGs of the SaaS industry called SaaS Talk with the Metrics Brothers and the Metrics that Measure Up. It’s a great complement. So download the Expert Voices, SaaS Talk and Metrics that Measure Up. And then anyone can email me anytime, ray@benchmarkit.ai because every interaction I have with someone in the industry is a learning opportunity for me. So I’m not that smart, but when you talk to hundreds of people every year who are really successful, I learned so much.

Randy Wootton (47:30):

Great, Ray. Well, thanks for sharing your wisdom. Always enjoy our conversations and look forward to the next time and see you in person.

Ray Rike (47:36):

Cool. Thank you, Randy.