This is the fourth part of a six-part series answering the question of why I stated Engage for CPAs. Part I explains why using engagement letters is important for accountants. Next, Using Engagement Letters in my Practice describes how engagement letters were a persistent pain point and how it led to my thinking about possible solutions. Part II describes what we built and why Engage improves small accounting practices with automatic engagement letters and advance fee payments. Part III is about the market and why this is a compelling opportunity that was worth pursuing.
Part IV, below, describes how we valued the market opportunity
Part IV: Valuing the Market
There were three steps to valuing the market opportunity. The first was to identify the total potential market, and then to specifically define the target market by demographics and other characteristics. The next step was to figure out a pricing model and how much to charge for the app. These results were used to estimate the total addressable market (TAM).
Finally, using some reasonable assumptions about market share and the company’s growth, we could determine the value of the market opportunity.
Demographics. The outside boundaries of the market are simply anyone who works in accounting, bookkeeping and tax preparation services. This includes Certified Public Accountants (CPAs), Enrolled Agents (EAs) and non-regulated accountants. Combining government records, surveys and demographics from professional organizations results in about 1.3M potential users.
Engage is designed for small and solo practices: professionals whose practices are big enough to have sustainable revenue and aren’t big enough to justify full time administrative staff to handle these kinds of tasks. Again, government records and professional surveys show that about 87% of all accountants practice in small firms with less than nine employees. The total market is therefore about 1.1M potential users.
Next, we built a model of our ideal user and used this to define a target audience. Our ideal customer is someone with a solo or small practice with enough volume to create time constraints that could be mitigated by automating some parts of their practice. Most small practices would be unable to generate enough revenue to be a sustainable stand-alone practice with only tax preparation services, which means our target market is also performing bookkeeping and accounting services.
Finally, accountants are conservative by nature and are notoriously slow to adopt new technology. Younger, more technologically adept professionals are expected to embrace new technologies more readily than those who had more years of practice.
Our ideal customer is therefore (1) a small or solo practice accounting pratice; (2) owned by a professional within their first 10 years of solo practice; (3) performing tax preparation and accounting or bookkeeping.
Monetizing the app. Before we thought about pricing, we first needed to figure out the best way to monetize the app. We considered giving the app away for free and then adding a couple of points onto Stripes service charge. However, small businesses – including accountants – are already chaffing against transaction fees, and this kind of service fee comes with bookkeeping headaches. Specifically, the gross revenue is recorded as income first; then the transaction fee is recorded as an expense; and now the service charge for the app would need to be recorded separately.
In truth, these expenses amount to nickels and dimes (or immaterial, as accountants say) but, of course, accountants more than anyone else want to get right.
Feedback both from alpha users and from surveys therefore suggested that a monthly subscription fee would be the best model. We designed a three-tiered service based on user volume and increasing premium features for each tier. For example, the basic service is routed through the Engage app with our logo and uses Engage urls. The highest tier service includes full customization like proxy email addresses, proprietary urls, and branding with colors, fonts and logos.
Pricing. Pricing is an art based on both operational and marketing criteria. We started by looking at comparable services and similar SaaS applications. More importantly, we talked with as many users as we could.
There was a wide spectrum of perceived value. On one end, users valued the app in terms of reducing nonbillable cost. For example, one user paid a part time assistant $25/hr. If the app eliminated 10 hours of administrative time (which is reasonable), then the perceived value was $250 per year.
Next, a handful of users were persuaded by the content of the contracts. I wrote a propriety document in plain language that included the terms that were reasonable to the accountant and were also fair to the client. These letters are automatically updated for new law, rules and regulations. Some users would hire a lawyer every year or two to review their letters and to ensure they were legally protected. The app would therefore eliminate an hour or two of legal fees. At $250 per hour, for example, the app has a perceived value of around $500 per year.
Finally, on the other end of the pricing scale, was the most common response: users saw the potential to convert the accountants’ nonbillable admin time into billable hours. If the user’s billable rate is $150/hr and the app saves them 10 hrs of nonbillable time that they could otherwise use for billable work, then the value is $1,500 per year.
This model is particularly important during ‘busy season’ when the accountant needs to complete as many tax returns as possible before the filing deadlines. Engage essentially compresses a set of expertise into an easily accessible interface that increases available billable hours.
The potential range of perceived value was therefore between free (plus a nominal margin per letter) and as much as $1,000 per year.
To determine a starting price, I spoke with several advisors and used the guidance from Y Combinator. The advisors suggested big numbers and Y Combinator strongly encourages new startups to price their products and services very high. The argument is that (1) people value a product or service according to what they pay for it; and (2) its much easier to lower prices than it is to raise them later.
Consequently, we set our prices using best estimates for time saved and average hourly rates, and then bench marked the price against low-end legal SaaS products. Our debut price was $99 per month (with a 20% discount for an annual subscription).
This price was deliberately high and frankly uncomfortable. For several months, I interviewed every user who signed up for trial accounts but didn’t convert to a paid subscription. Sometimes I would walk the user through a perceived value exercise, like above, and others I would ask them to intuitively pick a number.
We used these ‘guesses’ to A/B test various price points and marketed the price down to $29 per month (with the same 20% discount for annual subscriptions).
Total Addressable Market (TAM). We could now determine the value of both the total addressable market and the value of the market opportunity.
The total addressable market (TAM) calculated my multiplying the total number of users by revenue per user per year. In our case, the TAM is the entire universe of 1.3M potential users at a price point of $29/mo, or about $350 per user per year. Our TAM is therefore about $455M.
When building our pro forma financial models, however, we projected a 2.5% market share after 5 years, with 50% year over year growth, resulting in an annual revenue of $11.3M. After accounting for churn, annualized revenue smoothing, and estimated expenses, the net annual income was about $3.4M.
We therefore had a product, a price and a market valuation that made this an opportunity worth pursuing.
However, there are many good ideas and even great ideas that never get off the ground. In my case, I had the good fortune to have a potentially great startup team within my immediate network.
Next – Why I Started Engage: Part IV, Resource Opportunity