A Blood Bath for Net Dollar Retention Rates
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A Blood Bath for Net Dollar Retention Rates
It’s tough out there if you’re a net dollar retention rate.
I took a look at NDR’s across a swath of tech companies who make their figures publicly available. I compared the highest and lowest rates they reported over the last two years and measured the gaps. Below are the companies who saw the nastiest declines.
Across the broader set I looked at (n = 32) the average drop was 7%, and the median was 5%.
But that doesn’t tell the full story.
Usage based companies (and historically top quartile standouts) Snowflake, Digital Ocean, Zoominfo, Elastic, DataDog, and MongoDb all experienced double digit declines.
So what’s going on?
If I were to summarize: Hiring declines, optimization pushes, and buyer’s remorse.
Hiring across the tech industry, which also happens to be its largest buyer, fell. That means there’s less opportunity for license growth.
“I once sold a company that wasn’t out of stealth 275 3rd year licenses.
And they were worried it wasn’t enough 😂”
-Text from my friend who runs sales at a software company
CFOs aren’t looking to commit to more spend for a slightly larger discount if they aren’t too sure what their headcount will look like two years from now.
“Executives at Salesforce, UIPath and other companies have acknowledged in recent days that businesses have turned hesitant about doing big software deals. They’re grappling both with macroeconomic uncertainty and very real questions about the effectiveness of AI-powered tools. Those questions would surely cause anyone to hesitate before pulling the trigger on long-term commitments.”
-The Information
Signing up for longer term contracts just isn’t a great risk adjusted tradeoff anymore.
Let’s explain the usage based piece of the equation - there are two sides to it.
Net dollar retention rate is like a video game cheat code in good times: Customers start at a lower level than subscription, and ramp their activity over time as the product becomes a core part of their workflow. This puts the majority of their growth into the expansion bucket, which gets big time net dollar retention credit.
BUTTTTT…
Usage is easier to scale back during macro headwinds: The same volatility on the way up, also exists on the way down. When times get tough, it’s much easier to “optimize” your consumption spend than it is to get out of an ironclad, annual ass Subscription contract. Dad might come home from work and turn the thermostat down.
And many usage based contracts are linked to a value metric associated with revenue growth. So when top line stalls, what gets paid out to vendors drops too. And those vendors, in turn, also need to “optimize” their expenses.
“Optimize” should be interpreted as a bearish term in earnings calls. It essentially means your customers are looking to reduce costs by identifying and eliminating any slack in their cost structures. Many times they find it in orphaned licenses, over zealous API calls, and always on cloud queries.
Finally, not to be Douglas Downer over here, but there could be a further reckoning - many companies who bought massive three and five year ramping commitments in 2020 and 2021 are entering the tail years. Do they regret buying ahead? Will they sign up for the same amount going forward?
Net dollar retention rates in the second half of 2024 will indicate any such buyer’s remorse.
TL;DR: Multiples are trending slightly DOWN week-over-week.
Top 10 Medians:
EV / NTM Revenue = 12.5x (-0.4x w/w)
CAC Payback = 23 months (flat w/w)
Rule of 40 = 48% (-6% w/w)
Revenue per Employee = $398K (+$19K w/w)
Figures for each index are measured at the Median unless otherwise stated
Average, Median, and Top 10 Median are measured across the entire data set, where n = 116
All margins are non-gaap
You can find the list of companies within each sector here.
All definitions and formulas can be found here.
If you’d like the specific company level performance benchmarks used in these reports book a benchmarking consultation with Virtua Research
Revenue Multiples
Revenue multiples are a shortcut to compare valuations across the technology landscape, where companies may not yet be profitable. The most standard timeframe for revenue multiple comparison is on a “Next Twelve Months” (NTM Revenue) basis.
NTM is a generous cut, as it gives a company “credit” for a full “rolling” future year. It also puts all companies on equal footing, regardless of their fiscal year end and quarterly seasonality.
However, not all technology sectors or monetization strategies receive the same “credit” on their forward revenue, which operators should be aware of when they create comp sets for their own companies. That is why I break them out as separate “indexes”.
Reasons may include:
Recurring mix of revenue
Stickiness of revenue
Average contract size
Cost of revenue delivery
Criticality of solution
Total Addressable Market potential
From a macro perspective, multiples trend higher in low interest environments, and vice versa.
Multiples shown are calculated by taking the Enterprise Value / NTM revenue.
Enterprise Value is calculated as: Market Capitalization + Total Debt - Cash
Market Cap fluctuates with share price day to day, while Total Debt and Cash are taken from the most recent quarterly financial statements available. That’s why we share this report each week - to keep up with changes in the stock market, and to update for quarterly earnings reports when they drop.
Historically, a 10x NTM Revenue multiple has been viewed as a “premium” valuation reserved for the best of the best companies.
Efficiency Benchmarks
Companies that can do more with less tend to earn higher valuations.
Three of the most common, and consistently publicly available, metrics to measure efficiency include:
CAC Payback Period: How many months does it take to recoup the cost of acquiring a customer?
CAC Ratio is calculated as: (∆TTM Sales * Gross Profit Margin) / TTM S&M
CAC Payback Period is calculated as: (1 / CAC ratio) * 12
Note: Some may measure CAC Payback using the change in last quarter’s revenue x 4, but I believe this overstates a company’s progress if they are growing fast, and the output can be volatile due to quarterly sales seasonality. That’s why I look at it on a Trailing Twelve Month Basis.
Rule of 40: How does a company balance topline growth with bottom line efficiency? It’s the sum of the company’s revenue growth rate and free cash flow margin. Netting the two should get you above 40 to pass the test.
Rule of 40 is calculated as: Total Revenue Growth YoY % + Non Gaap Operating Profit Margin %
Non Gaap Free Cash Flow is calculated as: Net cash provided by operating activities, minus capital expenditures and minus capitalized software development costs.
Revenue per Employee: On a per head basis, how much in sales does the company generate each year? The rule of thumb is public companies should be doing north of $450k per employee at scale. This is simple division. And I believe it cuts through all the noise - there’s nowhere to hide.
Revenue per Employee is calculated as: (TTM Revenue / Total Current Employees)
A few other notes on efficiency metrics:
Net Dollar Retention is another great measure of efficiency, but many companies have stopped quoting it as an exact number, choosing instead to disclose if it’s above or below a threshold once a year. It’s also uncommon for marketplaces and fintechs to report it at all.
Most public companies don’t report net new ARR, and not all revenue is “recurring”, so I’m using annual change in TTM revenue timeframes as a proxy in my calculations. I admit this is a “stricter” view, as it is measuring change in net revenue, rather than gross revenue additions pre-churn.
Operating Expenditures
Decreasing your OPEX relative to revenue demonstrates Operating Leverage, and leaves more dollars to drop to the bottom line, as companies strive to achieve +25% profitability at scale.
The three most common buckets companies put their operating costs into are:
Sales & Marketing: Sales and Marketing employees, advertising, demand gen, events, conferences, tools
Research & Development: Product and Engineering employees, development expenses, tools
General & Administrative: Finance, HR, and IT employees… and everything else. Or as I like to call myself “Strategic Backoffice Overhead”
All of these are taken on a non Gaap basis and therefore exclude stock based comp, a non cash expense. SBC is still an important figure to track for total comp and dilution purposes, though.
All benchmarking data provided by Virtua Research.
Book a benchmarking consultation with them here.
"Hiring declines, optimization pushes, and buyer’s remorse."
It's gonna be an interesting 2H24, isn't it?
I've been thinking about how to capitalize on these very issues.
It's looking like we're going to have to venture out beyond selling to each other in the tech space to make ends meet.
Great insights as always.
I’ve recently wondered how mgmt teams decide which additional metrics to report - specifically NDR, lots of notable names missing from your broader set spreadsheet. Is it follow the leader, a metrics arms race, or don’t ask don’t tell?