Are UK SaaS Businesses Investing in Enough Product Development to Support Upsell Growth?

Recent years have seen significant growth in private equity interest and investment in “software as a service” businesses (SaaS), driven by their revenue predictability, scalability, cash-generative nature and attractive exit options.

Fairgrove has undertaken commercial due diligence on a number of SaaS businesses and we have spent some time benchmarking aspects of their performance against other publicly available comparators.

This research reveals some evidence of underinvestment in UK private company SaaS R&D, or product development, and potentially consequent underperformance in levels of upsell versus industry norms.

The headline numbers are:

MetricIndustry AverageFairgrove Average
Upsell & Expansion Revenue / Revenue37%18%
R&D Spend / Revenue28%12%

It is not clear if this underinvestment and underperformance is due to the relatively early stage in development of the businesses we have assessed for our clients, structural underinvestment in UK plc or some other factor.

As a minimum, we recommend that our clients review the following metrics and, if their portfolio company performance varies significantly from the benchmark, that they understand why:

MetricFairgrove Indicative Guide
R&D Spend / Revenue25%
Upsell & Expansion Revenue / Revenue30%
Upsell CAC / New CAC55%

The Importance of Upsell:

“It’s cheaper to sell an existing customer than a new one”

It is no great surprise that the cost of upselling to an existing customer is lower than the cost of acquiring a new one, although the gap does appear to be closing a little. By ‘upselling’ we mean selling additional licences or higher value versions of the current product.

Customer Acquisition Cost (KBCM SaaS Survey)

Upsell CAC / New CAC

As a result, SaaS business are increasingly focusing their efforts and investment on growing the share of revenue originating from upsell. In contrast, the SaaS deals that Fairgrove has worked on have typically had a significantly lower upsell share, averaging 18% versus 37% in the KeyBanc 2019 survey (2018 results).  This lower share of upsell may be a result of the businesses we look at being at an earlier stage in their development than potentially larger and more mature businesses in the KeyBanc survey although it should be noted that the smallest companies in the 2019 survey with ARR of $5m to $10m still had a median upsell ratio of 29%.

Share of Revenue (KBCM SaaS Survey) 

Recent Deals Share of Upsell (Fairgrove)

Cross-sell is important as well:

“Cross-sell customers are worth more and are stickier”

In addition to the cost benefits of upsell, there is also significant revenue upside in trying to cross-sell to existing customers, where cross-selling is defined as the sale of other products in addition to the original purchase. Analysis of one company in our sample showed that the average revenue uplift for customers with two products from the business portfolio was 3.1x those with only one product, and for those with three products the uplift was 6.8x. Similarly, if we looked at the churn amongst those customers, revenue loss amongst multi-product customers was significantly lower than single product customers.

Multi-Product Revenue Uplift (Fairgrove)

Multi-Product Revenue Churn (Fairgrove)

N.B. Churn is calculated on a bottom-up basis by product and is defined as revenue in previous year not purchased in the current year / revenue from the same products in the current year. As such, this churn is not equivalent to standard industry benchmarks of using year end ARR and will also appear lower due to growth in existing products offsetting the loss of other products. However, it is indicatively meaningful and consistent across the presented data.

R&D Investment:

“UK businesses may be underinvesting”

Existing customer growth is unlikely to come without ongoing development of existing products for upsell, or the introduction of new products either through internal development, acquisition or licensing for cross-sell. Our research shows a consistent picture of R&D investment in our public benchmarks and a lower level of investment from the UK deals we have worked on.

We have reviewed the last four years KeyBanc benchmarking data, two years OpenView benchmarking data as well as 36 US IPOs since 2016 and found a consistent level of R&D spend.

R&D Spend / Revenue

There was very little correlation between company size and R&D ratio in our IPO analysis, suggesting the c.28% benchmark may be appropriate for all size businesses.

FY19 R&D Spend / Revenue vs Revenue (US SaaS IPOs since 2016)

However, the 2020 Serena European SaaS Benchmark does show a wider variance in spend, although still with a weighted average of c.30%.

Serena 2020 European SaaS Benchmark R&D Spend / Revenue

Interestingly, there was a drop in R&D spend in the year of IPO, perhaps to “polish the numbers” for listing valuations. This quickly bounced back in subsequent years. Consistent with our upsell analysis, Fairgrove deals had a significantly lower level of product development investment with an average of 12% of revenue. There may have been some reduction in this akin to the “IPO effect”, trying to optimise the P&L at the time of potential investment, but it does suggest there may be some systemic underinvestment in UK private company SaaS R&D.

R&D Spend / Revenue (US SaaS IPOs since 2016)

Recent Product Development Spend / Revenue (Fairgrove)

Investment in R&D does not necessarily mean product revolution. Our customer referencing indicates that continuous improvement in enhancing the user experience is just as important in terms of increasing stickiness and reducing churn. The creation of user forums to collect improvement ideas from customers is a quick win. Common requests for improvement include improving log-in security and improving customisation of reports.

Fairgrove has deep experience of assessing SaaS investments across multiple sectors. If you are a SaaS business reviewing your strategy or an investor considering an investment opportunity, please contact Patrick Woodrow or Paddy Woods Ballard.


Sources

  1. 2019 KeyBanc Capital Markets SaaS Survey, KBCM, July 2019
  2. 2019 Expansion SaaS Benchmarks, OpenView Advisors, June 2019
  3. 2018 Expansion SaaS Benchmarks, OpenView Advisors, July 2018
  4. 2020 European SaaS Benchmark, Serena Capital, March 2020