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The Agency SaaS dilemma and how to transition

Many companies we encounter fall into the agency trap and struggle to get beyond a profitable to scale-limited stage of growth. They find themselves trapped by high COGS (cost of goods sold) which means that as they growth, the simply can’t get to a scale where they have enough ‘spare cash’ to be able to develop anything that can slingshot them into exponential growth. 

Generally what happens is they have a client, and the resources allocated to servicing those clients means there’s little left over for anything else. So, growth comes from getting more of these clients, and the cycle repeats. There’s limited that you can do in that situation to break that vicious cycle. 

This agency situation is made worse in our B2B companies where the paying company expects bespoke modifications to the product before they’ll be willing to engage, desperate startups tend to agree with these kind of conditions, which sucks up tech resources and may result in certain features being delayed.  

On the other hand, agencies tend to be stronger on cashflow, sometimes clients will be willing to pay in advance, so there’s a benefit to doing this kind of work, but its not a sustainable path to replicated this into SaaS and VC level multiples and numbers, so its important that companies consider that agency is a stage in the evolution to a SaaS business; its therefore important for us to reflect on how we can quickly and efficiently transition out from the agency stage into the SaaS stage, rather than simply assuming with can skip the stage.

The primary difference between agency and SaaS relate to two key areas, there’s many, but in my opinion these are the two most obvious and impactful. 

Firstly is the cost of servicing the customer (the COGS) agencies have most of the OPEX tied up here, and it related to how bespoke or hands-on their support needs to be compared with a SaaS where technology or process compensate for a lack of custom ‘hand holding’ – generally, its acknowledged that the lower costs for a SaaS solution offset the bespoke service… the problem most startups encounter here is providing an agency-type solution at a SaaS cost and end up drowning to support the customers the get. 

The second area of difference is with CAC (Customer Acquisition Cost) where SaaS companies then to have the bulk of their spend, whats interesting about CAC, is that to spend in this area, there’s needs to be clarity over the Life Time Customer Value (LTV) and therefore an understanding of the Churn rates of customers, the logic is that by understanding how much revenue you can make for a recurring customer (ARR- Annual Recurring Revenue), you can increase your CAC significantly more, this is harder with an agency model. 

To put it another way, if a company pays the startup 10,000 over their life time of 1 year, in an agency the COGS might be as high as 900, this means that only 100 is profit that can be reinvested into the business, but in a SaaS the COGs might only be 300, so that means the profit is 700 which could be reinvested back into the business, in a SaaS since the COGs are 300, you could lower the LTV to 500 and still make a profit of 200, which still beats the agency profit. Now to compound this, since the profit is higher and we can consider profits to be CAC, we have more resource to work with to get more business and now we have a fly wheel effect, this allows us to transition from this agency predicament to a SaaS situation, so the question is how can we get to this point.

To get to this transition we need to look at the cost of servicing a client and start to optimise that part of the experience, we want to look for ways to limit variation, reduce human interaction and reduce customisation. So to this end there are few details:

  • Limit custom development of features, but if its unavoidable, negotiate, try to control the time you have for development and try to find other companies that would be willing to pay for the same added feature, the goal here is if you can develop features that multiple companies would be willing to pay for then its worth spending time on, but if its bespoke for one company, you’ll end up sucking up dev resource for a one hit wonder. So its arguably preferable to charge less, but have ownership of the feature, dictate the timeline and have other companies increase their spend with you as a result of a new feature. Whilst its easier said than done, strive towards this ideal.
  • Look for ways to automate and standardise client servicing processes, firstly, segment your teams between a client success team and a client consulting team, the consulting team should be billed at an hourly rate and service the client on a regular basis, but the client success team focus on processes and automation, over time more and more of what the consulting team does should be automated by client success, handbook, guides, worksheets, workshops and videos should be developed to reduce aspects of the consulting teams work that are repeatable. Next, negotiate with clients a reduced fee if they opt for a self service account, but only do so after you have all the materials prepared.
  • Look at your products and services and run some analysis to determine various packages, you should then segment-out the elements of each package that require consulting and customisation and create pricing around those, you should add a premium to those prices, and you should separate them out from the packages and apply them as add-ons, the goal here is to help with ‘segmenting’ your customers and highlight the cost saving to the customer for opting for something standard, and highlight the premium for more bespoke agency solutions, this will also help when you review finances and you’ll be better able to understand the commercial impact of agency elements on your business.

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