From Xero to a Billion in How Long – Part 2

Posted by on May 4, 2018 in Growing with Confidence

The truth is in the cash flow

From Xero to a Billion in How Long – Part 2

When we last met, we’d determined that you needed 1,795,000 new subscribers to reach your target 2.9 million subscribers which, based on your current Smoothed ARPU of $343, will generate $1bn in annual Revenue.

In Part 2, we’ll look at how quickly, and what it’ll cost, for you to achieve this outcome.

We’ll be balancing a matrix of key business drivers to achieve the best outcome for your business:

  • Market Share and the need to grab it as quickly as you can.
  • The risk of new technology rendering your business obsolete.
  • Sticky subscribers will underwrite your profit.
  • Shareholders with deep pockets to fund growth.

Let’s start with taking a look at your current growth rate. The graph below shows the growth in subscribers on a 6 monthly basis.

It is clear from this graph that the rate of growth in subscriber numbers dropped significantly in the 6 month period between March 2017 and September 2017.  We’ll need to reverse this as quickly as possible.

What happens if you increase Average Revenue Per User (ARPU)?

Building on the work already done, let’s take a look at what happens if you increase the subscription payable for using your software.

First though, we’ll start with the position if we do nothing.

The graph below shows the nexus between the compound rate of growth and time needed to reach your target of 2.9 million subscribers.

It assumes there is no change to the Smoothed ARPU of $343 as at September 2017.

It’s a Speed graph, which tells you the compound growth rate needed to reach 2.9 million subscribers in a specified number of years – for example, if you grow your annual subscribers at a compound rate of 21%pa it will take 5 years to reach your target number of subscribers.

Ok then, now what happens if we increase the Smoothed ARPU?

The graph below shows the different outcomes from increasing Smoothed ARPU by 5%pa, 7.5%pa and 10%pa for each year over a 5 year time horizon.

As you can see, a 5%pa increase in Smoothed ARPU speeds up by a year (from 5 to 4) the time needed to reach your target (at 21%pa growth in subscribers, the same rate as the base case).

Conversely, a 7.5%pa increase in Smoothed ARPU speeds up by two years the time needed to reach your target (at 22%pa growth in subscribers). If you can get a 10%pa increase in Smoothed ARPU then you can reach your target in 3 years at 17%pa growth in subscribers.

So, we can see that increasing ARPU every year has a material impact on speed.  But, how realistic is a 7.5%pa or 10%pa increase in Smoothed ARPU? Well, the average increase since 2013 has been about 5%, when they are made.

We know that a key driver of your business is happy (and sticky) customers. Churn, which is what happens when you lose a customer, is like a slap in the face to your growth plans.  It takes momentum away.

It seems to me that without a step change in your offering, there’s a real risk of higher churn if you increase subscriptions by more than what you’ve conditioned your customers to expect. I think 5%pa is possible but not 7.5%pa or 10%pa.

What about Investing for Growth?

The alternative then, is investing in the resources you need for growth.  In your case, this means hiring more people to drive your growth and investing in Marketing.

Staff Costs and Marketing are two of the major costs in your business. If we can work out targets for these, then along with the Revenue and Subscriber targets, we’ll have a good chunk of your future profit and loss statement worked out.

Let’s take a look at the recent trend in these costs.

The first graph looks at Staff Costs to Revenue.  You can see in the graph below that Staff Costs have fluctuated between 68% and 104% of Revenue.  Considering the drop in subscriber growth in the September half, I am going to invest in new employees to drive growth, but will set a cap of 80% of forecast Revenue as the maximum investment in any given year.

The next graph looks at Marketing Costs relative to Revenue:

You can see that Marketing Cost has fluctuated between 15% and 27% of Revenue. In this case, I am going to use 20% of forecast Revenue as the cap for the maximum amount I will spend on Marketing in any one year.

Ok, having established some guidelines, we need to turn out mind to the number of staff you’ll need to support your growth ambitions.  And then we’ll need to runs a cross check on the cost of these employees to the business.

Let’s take a look at some employee related statistics.  We’ll begin with the trend in Subscribers per Employee.

At September 17, you had 1,853 employees in total, representing 1 employee for every 604 subscribers.  You can see that even as employee numbers have increased, so too has the number of subscribers per employee.  In other words, since 2013, there has been a trend of increasing efficiency.

What about Revenue per Employee?  Here is the graph:

So, just like Subscriber/Employee there is an increasing trend in Revenue/Employee.

Ok, we can use this information to help understand the number of employees we need to support 2.9 million subscribers, or the number of employees we need to generate $1bn in Revenue. You’ll see the outcome in the two graphs below:

Right then, if each employee can support 604 subscribers then you will need 4,825 employees to support 2.9 million subscribers.

Similarly, if each employee helps your business generate $183k of Revenue then you will need 5,451 employees to generate $1bn in Revenue.

By now I reckon you’re asking yourself the “How much will this cost” question.  Let’s find out, shall we?

We can see from this that average Salary per employee was $125k at September, and had been consistently around that level since FY16.

If we bring this information together we get the following graphs:

So, now we have both trends over time and a range of that covers employee numbers required to support either $1bn in Revenue or 2.9 million in Subscribers and what it will cost to employee this number of people based on the current average Salary in your business.

But, which do we use.

Well, remember in Part 1 we discussed that until growth stops it is very hard to get a true picture of your actual ARPU.

The same issue applies with Revenue per Employee.

So, I think Revenue per Employee at Sept 17 is understated because of growth, and hence, the number of employees needed to support $1bn in Revenue overstates the actual requirement.

For that reason, I would prefer to use the number of employees needed to support 2.9 million subscribers as my benchmark – 4,825 employees.

I still think this will be more than we need, because we’ll be targeting a greater proportion of employees to drive and support growth in subscriptions, but not head office employees engaged in Company admin and support services.

So, let’s call the target 4,250 employees, an increase of ~2,400 from present levels.  When we apply the current average salary of $125k the total cost is about $530m, about $300m more than your current cost.

Bringing it all Together

I thinks it time to summarise this conversation and work out where we’re at and what we want to measure.

The things we measure are not absolutes, but they are drivers of growth that we can check at any time and use as guides as to how we’re going.

I think we need to set the following goals:

  • Subscriber growth of 15%pa in FY18, which is on the low side.
  • This reflects the slow down in subscriber growth experienced in the September 17 half-year.
  • To compensate for FY18, a higher growth rate of 25%pa in subscribers in FY19, FY20 and FY21.
  • Increasing ARPU each year has a material impact on the speed at which you can reach your goal.
  • For that reason, I will be forecasting an annual increase in Smoothed ARPU of 5%pa.
  • Total employees of 4,250 to be reached by the end of FY20 (ie: over a 2.5 year time frame).
  • We will add 800 by the end of FY18 and then another 800 in each of FY19 and FY20.
  • A cap on Staff Cost, set at 80% of Revenue.
  • A cap on Marketing Cost, set at 20% of Revenue.

What will this Cost?

Using these goals as my guide, I have built a three-way financial model to work out the funding needed to support this growth.  The key details are set out below, but for now, the main things that stand out are:

  • You need $250m in new equity to fund this growth.
  • By the end of FY21 you will have 2.3m subscribers, generating $969m of Revenue.
  • Both Staff Costs and Marketing Costs are well within the caps we established.
  • But, Revenue/Employee and Subscribers/Employee are either flat or go backwards.
  • Perhaps we can achieve this growth with fewer additional staff than originally thought.

The main driver of these different outcomes is the impact of increasing Smoothed ARPU by 5%pa. It means you need less subscribers than initially thought to get you to your $1bn target and, as a consequence, less additional employees than additionally thought to support that growth in subscribers.

So, let’s now look at what happens if we can reduce the number of additional employees, and move our Subscriber per Employee back to around the 600 mark more quickly than under the base case. Again, the details are set out in the dashboard below, but the main outcomes, compared to the base forecast, are:

  • Your business is profitable a year earlier, by the end of FY20.
  • You generate a cash flow surplus a year earlier, also by the end of FY20.
  • This reflects lower Staff Costs, driven by lower staff numbers.
  • Subscribers/Employee trend up from the FY18 low, but do not exceed the 600 level again until FY21.
  • Consequently, the equity funding you need has reduced to $100m.

The power of this analysis is that it makes crystal clear that the key drivers of your business is ARPU, Subscriber Growth, Subscriber Numbers and achieving an efficient Subscribers per Employee outcome. As the business owner, you now have a road-map you can use to easily keep track of how your business is performing.

In addition, you also know the levels of each that you need to reach and the time-frame to achieve those goals.

Well, it’s been a long meeting, and we’ll wrap it up here. But, when next we meet, in Part 3, we’ll look at some of the risks in your business, how these could derail your growth plans and what you can do to reduce these risks.