Product Led Growth: The Secret to Becoming a Top Quartile Public Company

Sean Fanning by

Software investors have traditionally focused on three key valuation drivers when evaluating businesses, including:

  1. Revenue growth, which is strongly positively correlated with valuation (enterprise value / revenue)
  2. Gross margin, which demonstrates the scalability and repeatability of product delivery to customers
  3. Rule of 40, calculated as revenue growth plus EBITDA margin, which acts as a proxy for efficiency (balancing growth vs. burn)

Surprisingly, the 1H 2018 IPO Cohort1 is not differentiated on key valuation drivers as compared with the broader public SaaS index2. Let’s take a look:

Product Led Growth Index

Source(s): Pitchbook on 8/10/2018. Market data as of 6/30/2018.

Growth, particularly forward (2019P) growth of the Cohort is on par with the broader SaaS index (+1.6%). The Cohort isn’t surging towards market dominance significantly faster than other public companies. The 1H 2018 IPO Cohort operated at lower trailing gross margins compared to the SaaS index (-2.3%) suggesting implementation, support, and platform have not yet achieved the scalability of other public businesses. The median “Rule of 40” for the Cohort significantly trails the public SaaS index (-21.8%) which implies the capital outlay required to support the growth is greater than other companies.

Intuition alone tells us that the 1H 2018 IPO Cohort should not be significantly differentiated on valuation; however, despite performing (arguably) worse than the public index, the 1H 2018 IPO Cohort traded at a median multiple 3.1x (39%) higher than the rest of the public set as of 6/30/2018.

The data available for the 1H 2018 IPO Cohort neither support the valuations these businesses have received, nor can they be reconciled with performance since IPO.

What can we learn from recent IPOs?

Wall Street has lost its mind and is paying ridiculous multiples to get companies public!

Well, not so fast…

A subset of the companies in the 1H 2018 IPO Cohort are in fact significantly differentiated in that they leverage product led growth (PLG) strategies. Together, this group of public PLG companies is pulling up the median valuation of the Cohort. For these businesses, product usage serves as the primary driver of user acquisition, expansion, and retention meaning they can forgo significant investment on traditional marketing and sales activity.

Product led growth companies deliver a superior product experience, and as a result their products are extremely sticky – people log in regularly, users share the products with colleagues and friends, and these businesses tend to boast amazing NPS scores.

With the virality of user adoption and significant goodwill that they’ve built up with users, it’s easier for PLG business to successfully (and efficiently) accelerate growth via cross-sell / upsell over time. Atlassian, a great example of a PLG business, was able to show in their S-1 that $1 of spend in year 1 would become $7 of spend by year 5.

Intuition tells us that PLG businesses should perform better across all key valuation drivers. With that in mind, let’s look at another cut of the key valuation drivers for the 1H 2018 IPO Cohort, this time with the data segmented to visualize the characteristics for PLG businesses separately from non-PLG businesses:

Product Led Growth Index

Source(s): Pitchbook on 8/10/2018. Market data as of 6/30/2018.

Revenue growth of the PLG IPOs will outpace the SaaS index (+14.3%) in 2018E, spurred on by the ‘delightful’ product experiences product led companies deliver.

Because product usage drives go-to-market, it isn’t surprising that PLG gross margins also outperform the SaaS index as fewer implementation and support resources are required.

Finally, PLG companies in the 1H 2018 IPO Cohort do close the gap on Rule of 40. While “Rule of 40” of the Cohort still trails the broader index, businesses in this group will grow more efficiently over time due to strong net dollar retention and can therefore invest more upfront due to significant expansion potential.

When we segment statistics for PLG vs. non-PLG companies in the 1H 2018 IPO Cohort, we can see that not only do product led growth businesses perform better on all key valuation drivers, they also trade at revenue multiples 48% greater than their non-PLG peers in the 1H 2018 IPO Cohort (as of 6/30/2018).

Our intuition was right – the numbers speak for themselves and it’s clear that PLG companies perform better than non-PLG peers in the SaaS index!

Public market investors have realized that not all SaaS revenue is created equal. And in fact, companies that implement PLG strategies are more valuable.

What does this mean for you?

Let’s examine how product led growth plays out in reality by evaluating two giants in file sharing: Dropbox and Box. Both were founded in the mid 2000s and reached scale quickly. But Dropbox, which pursued a freemium, product led growth strategy, has clearly won the file sharing war. The company generates double Box’s revenue, spends a lower share of their revenue on sales & marketing, and consequently trades for a far higher revenue multiple (9.1x versus 5.2x).

Growth, gross margin, and “Rule of 40” are fundamental to software valuations, and it is clear that companies that employ PLG strategies are better suited to optimize all three. PLG businesses are therefore increasingly attractive to investors who gain high certainty around future growth and market leadership.

At OpenView, we believe businesses with PLG strategies will feature prominently among top performers in the software landscape.

To support ongoing thought leadership and to communicate trends in PLG businesses OpenView is excited to unveil our Product Led Growth Index to make available the financial, operating, and valuation data for the public PLG companies that we track.

Product Led Growth Index

Source(s): Pitchbook on 8/10/2018. Market data as of 6/30/2018.

The trends observed within the PLG segment of the 1H 2018 IPO cohort hold for the entire PLG Index. Growth, gross margin, and Rule of 40 all track above the non-PLG SaaS index, and this is reflected in the median revenue multiple (valuation) of PLG businesses tracking 29% higher (as of 6/30/2018).

You can listen to some of our findings below:

 

  1. 1H 2018 IPO Cohort includes Avalara, Carbon Black, Ceridian HCM, DocuSign, Domo, Dropbox, Pivotal Software, Pluralsight, Smartsheet, and Zuora.
  2. OpenView’s public SaaS index includes ALRM, APPF, APPN, APTI, ATHN, AVLR, AYX, BAND, BCOV, BL, BNFT, BOX, CARB, CBLK, CBLK, CDAY, CISN, CLDR, COUP, CRM, CSLT, CSOD, DBX, DOCU, DOMO, ECOM, ELLI, EVBG, FIVN, HUBS, INST, KXS, LOGM, MB, MDB, MIME, NEWR, NOW, TWLO, OKTA, PAYC, PCTY, PFPT, PS, PVTL, QLYS, QTWO, RNG, RP, SEND, SHOP, SMAR, SPSC, TEAM, TWOU, ULTI, VEEV, WDAY, WIX, WK, WTC, YEXT, ZEN, ZUO.