Why software? Valuable companies? Put another way, why have we spent so many years using software companies’ revenue multiples instead of the profit multiples commonly found in other industries?
There are several key factors. First, software companies have very strong gross margins; Software is cheaper to sell after you write the code. Secondly, and more importantly today, the point is that modern software companies are established over time to sell more of their products to existing customers.
This can often be achieved by selling additional seats (private use permits) for account sales or through command pricing to obtain additional aggregate service usage over time. Regardless of the method, the bottom line is that software companies today see limited churn (customers canceling their contracts) and positive net dollar retention (selling more product to existing customers over time).
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Net Dollar Retention (NDR) is basically a hard hit from existing customers and is simultaneously measured over a period of time. The resulting metric, measured as a percentage of past revenue, helps investors understand how well a company has built-in growth rates. The more net dollars a software company has, the more efficient its growth will be (selling more stuff to existing customers is cheaper than landing net new accounts).
NDR matters, and investors, more focused on effective growth than last year, are paying more attention to the metric. So, what should startups aim for when it comes to NDR results? Moreover, do those expected starts match what they actually report? And who has better net retention, public software companies or their startup competitors?
