Slack’s Unit Economics — Current State of Things & Future Growth Potential

It has been a distressful year for the technology companies going the IPO route — Uber, Lyft, Peloton, Pinterest. And let’s not even talk about WeWork — yeah, that bastard child of SoftBank!

Slack (acronym for “Searchable Log of All Communication and Knowledge”) was another big-name technology giant to go for an IPO this year by surprisingly choosing to tread down a different path, (similar to that of Spotify), listing via Direct Public Offering (DPO).

Apart from Zoom, almost all the other publicized IPOs went downhill (Uber is down ~25%. Lyft is down ~36%) including Slack — the current stock price is down ~13% from its listing price.

Image Credits: goptg

But what made me interested to go deeper into Slack’s financials is firstly, my love for the collaboration tool. Have been using it for more than a year now and love how easily it has managed to give a new life to short-form communications. And secondly, how will it compete with its giant, deep-pocketed rival — Microsoft Teams.

While I’ve not analysed all the companies that IPO’ed this year, I strongly believe Slack’s floundering is primarily due to the current state of investor sentiments, which doesn’t look to be in good light for the entire tech ecosystem and not just a particular company. Unlike Pinterest, it has a strong revenue model and unlike Uber / Lyft, it has high paying enterprise customers, people who love the product and has managed to stay out of controversies.

In my research, I found this greatly articulated and deeply-researched article by Theta Equity Partners which talks about the unit economics of Slack and gives a very concrete picture on why, even with the recent headwinds, Slack’s future revenue potential looks promising.

But first, What is Unit Economics?

As quoted by Cleverism, unit economics is the “direct revenues and costs associated with a particular business.”

Unit Economics provide a framework through which you can evaluate a business’s future revenue potential by taking into consideration business metrics such as CAC (Cost of Acquisition of Customer) & CLTV (Customer Lifetime Value). They’re like the fundamental or basic financial building blocks of a business.

(Now, before I begin, all the stats here should largely be attributed to this said piece & other hyperlinked articles. I don’t have the slightest of contribution towards any of this. My attempt is to just bring the information in a very simplified, easy to understand manner)

And for anyone interested in the history of Slack & how Stewart Butterfield built this amazingly sticky product, here’s a great read from First Round.

So let’s dive deep into Slack’s current situation.

Starting off with Acquisition first,

Given that Slack operates in the B2B space, naturally, its Cost of Acquiring a Customer (CAC) is on the higher side. And while that’s okay, Slack’s CAC has actually seen a continuous upward trend y-o-y. The estimated CAC for FY 2017 stood at $5210, increasing to $5504 in FY 2018, with a steep rise in FY 2019 reaching $7650.

Does that CAC seem overwhelming to you? Not entirely. As they have justifiable reasons for that high spends. We’ll discuss more on this in the revenue generation section.

The research also estimates that Slack spent an approximate of ~$233.2 million in FY 2019 (or about 58% of its revenue) as part of its acquisition efforts through Sales & Marketing, in turn, acquiring ~30,000 new customers.

What’s truly interesting is that most of Slack’s new team sign-ups come Directly — meaning users type “www.slack.com" into their browser. The second most get there by a Google search, and 72% of the time they search for “slack”. That means that nearly 75% of Slack’s new accounts are already familiar with their brand before they sign up. Slack barely pays for *any* sign-ups.

Moving on to Revenue Generation now,

On average, Slack’s newly acquired customers generate ~$99,000 of revenue in the entire time they stay with the company — the CLV (Customer Lifetime Value). This nets in $107,000 in post-acquisition value (PAV) per customer against ~$7,700 spent on CAC.

Now, coming to why Slack’s high CAC is justifiable,

Slack uses a definitive metric for a particular segment of its users called “Heavy Customers” — ones with an Annual Recurring Revenue (ARR) of more than $100,000.

These heavy customers account for nearly 40% of company’s revenues and in FY 2019 alone, they generated about $350,000 of annual revenue per customer on average. The heavy customers also represent the top 1% of its customers, accounting for almost 50% of total value of Slack’s current customer base.

No. of heavy customers every quarter since 2018

As per Slack’s latest 2nd Quarter FY 2020 Financial Results, total revenue was up $145.0 million, an increase of 58% year-over-year. But it also saw losses surge ten-fold to $360 million and annual revenue growth slow to 82% compared to 110% a year prior.

This increase in losses can be attributed to several factors which can include, among other things,

Interestingly, the company ended the quarter with over 100,000 Paid Customers, up 37% year-over-year and its number of “heavy customers” also grew to 720, up 75% year-over-year.

A report from Slack’s pre-IPO stage stated that, at the close of April 2019, the company had over 88,000 Paid Customers. This means that post IPO, and within only 6 months, the company added 12,000+ paying customers, an increase of ~13%. And this is probably the outcome of the increased spending on Marketing & Sales which we discussed in the above section.

Slack’s paid users breakdown

Also & as per the same FY 2020 filings report, Slack said it has a 136% dollar retention rate. This straightforwardly means that customers are not only staying on the platform, but with increasing time, they’re also buying more of its services. (Head over to this Dollar Retention Rate Calculator, if you want to know how to calculate it)

Looking at Slack’s Engagement Stats

One of the biggest and highly popular metrics for consumer facing businesses, to evaluate engagement, is the number of Daily Active Users, called DAUs.

What’s Slack’s DAU? — As of Oct 22, it had 12 million daily active users.

In September 2019, on average, more than 5 billion weekly actions (writing messages, reading messages, uploading or commenting on files, performing searches, interacting with an app, or a similar action that indicates active use of Slack) took place in Slack, during a typical work week.

Moreover, users at paid customers averaged 9 hours connected to Slack through at least one device (such as a laptop or mobile phone) and spent about 90 minutes actively using the platform.

But all things said and done, what’s Slack’s true North Star metric?

Well, Stewart Butterfield says, it’s 2000 messages.

“Based on experience of which companies stuck with us & which didn’t, we decided that any team that has exchanged 2,000 messages in its history has tried Slack — really tried it. For a team of around 50 people that means about 10 hours’ worth of messages. For a team of 10, that’s maybe a week’s worth of messages. But it hit us that regardless of any other factor, after 2,000 messages, 93% of those customers are still using Slack today.”

Wrapping up with Slack’s Churn Rates

Around 10% of newly acquired paid customers churn in the first year after acquisition, and 80% of paid customers, as predicted by the research, will still be paying 5 years later.

How much has it been since Slack launched? — A measly 7 years.

And while Slack takes ~3 years to recuperate its CAC, it has the potential of enhanced revenue generation from its clients till 7 years, only after which it flattens. This is on the back of its strong dollar retention rate.

My take on the future potential of Slack,

While Slack’s recently been in the news on the back of heated competition from Microsoft Teams, which it’s essentially giving for free (Microsoft’s age-old predatory pricing and bundling strategies), I think due to the factors such as,

Slack is uniquely positioned to grow its revenue and even minimise its losses, with increasing time, as we just read how Slack takes at least 3 years to extract its CAC back from its customers.

Moreover, it might not be a great idea to equate Slack’s current & future growth potential to that of its initial growth number. Early on, there wasn’t a specific use case for a seamless “communication platform” and Slack was just a brand new toy in the shop. That, Coupled with first mover advantage, Butterfield’s successful stint with Flickr and a positive investor sentiment towards the new product, it was pretty natural for Slack to see exponential rise.

But in the face of increasing competition from not just biggies like Microsoft Teams and Facebook Workplace but even relatively smaller players like Flock and Zoho, it’ll finally come down to the number of “heavy customers” (>100,000 ARR) Slack will be able to not only acquire but keep.

Another reason for Slack to be optimistic is the growing market share of G suite, which, as of December 2018, had amassed 5 million paying users.

Well, you might ask, what’s G suite got to do with Slack’s survival?

Microsoft Teams, apart from being a respectably okay product, has been able to capture a major chunk of the market, not because of any of its own special attributes or even some big marketing campaigns to help with the penetration. The one and only method Microsoft, unsurprisingly, has been using to catapult Teams into mainstream is by making it free and offering it as a part of its bundled service in Office 365.

With G suite now hot on the trails of Microsoft, and as long as Google doesn’t come up with its own Team collaboration software, expect Slack to be still there, giving Microsoft a run for its money. Because companies which use G suite, will still require a team collaboration software, and what better alternative to bank upon, than Slack.

Finally,

Remember the Slack directory I talked about?

Such is the platform’s flexibility that today +600,000 third-party developers are registered on Slack, building over 500,000 custom applications. Out of which, many are built by customers’ themselves to improve employee productivity.

A great case in point is Shopify, which created functions inside of Slack to give employees quick access to critical data such as problem ticket status, customer metrics, or data center statistics.

Even this latest piece by The Motley Fool talks about how the tides will turn for Slack in the long run.

Some Interesting Facts about Slack

8. Slack has the highest conversion rate of 30%, among freemium software products.

9. Nearly 60 percent of startups pay for Slack’s workplace communications software, according to new data from Kruze Consulting.

10. At least 65 companies in the Fortune 100 use Slack and its biggest client (which it didn’t name) has more than a 100,000 users.

11. And this blog was the ending of Glitch & beginning of Slack — https://web.archive.org/web/20130102151524/http://www.glitch.com:80/closing

Product Marketing @ WebEngage || Disciple of Human Psychology & a lifelong Chelsea fan.