SaaS metrics can answer important questions about your venture: Do I have the right business model? Is this the time to accelerate growth or to hit the brakes? Do I need to add new customers or focus on the existing ones? Should I add that new pricing level the products guy has been pestering me about? Is there really a limit to how much my venture can grow? Can it be changed?
With all the jargon and metrics whizzing around, it can be hard to keep track of what really matters. Today we break down what is that needs to be measured to unlock explosive growth! This article focusses on:
- What are the most crucial metrics to measure at each stage of the startup?
- Why are SaaS businesses different and how are the challenges they face different from other software startups?
- And finally, is your SaaS business model viable?
So, what makes building a SaaS business so tough?
In one word.
Think about it. The revenues from a customer do not come instantly, like how it does when you sell a product. The revenues come over a period of time. If your subscriber is happy with your product and sees no reason to change it, they will stick with it for longer. And the longer they stick, the more money you pull out of them (on second thoughts, that sounds so pervert!). The longer a customer stays with you, the more you profit.
If on the other hand the customer signs up but ends up finding a better product or cheaper pricing or whatever, the customer will hit that CANCEL button and leave (churn). If this happens before you recover the money you spent in acquiring them, then, my friend you just made a loss. (Ouch!)
So, let’s get it straight. SaaS is not just about selling some piece of software to a customer. It has more to it. There is not just one but two sales you have to make. That’s right, two!
- Getting your customer. Well, because, you need someone to buy your subscriptions.
- Retaining that customer. So that you can increase the revenues generated from that customer. The longer the customer stays, the more revenues you get.
There is one last and final aspect to the two sales above. That is monetizing your customer.
Let’s look more into each one by one.
Getting those Customers (Acquisition)
Now, what do you think happens to your P&L while you are acquiring your customers? (Hint: Nothing good)
If ‘you bleed cash’ seems too hard a way to put it, then let’s just settle on, ‘you suffer significant losses’ Your server costs, employee wages, office rents, and all other costs don’t go on a pause magically.
And to add to your sorrows you also have to spend a bomb to woo your customers to your product.
A newbie SaaS business spends 92% of its revenues to acquire customers.
All this takes cash. Loads of it.
But wait, it gets worse.
The faster you try to grow, the more you bleed. (Ouch again!)
This naturally will extend to a cash flow problem as your customers will pay you only at the end of the year or month.
If you spend 1000 bucks to acquire a customer and bill them for $50 pm, you’ll need 20 months to break even on just one customer. Even worse, the customer may leave just after one year. Before you could recover your $1000.
But it’s not all blood and tears. The humble J curve is here to help you.
The horror story I just told you, well that applies only to the trough you see above in the J curve (the hockey stick head).
Once you hit breakeven on the individual customers, you’re off to the races!
So how do I know if I have hit the breakeven? Well, we have two metrics that help you do just that.
The first one is the Customer Acquisition Cost or the CAC, the horrors of which we discussed above. The CAC has been dubbed as the killer of startups. This is the amount you spend to get each customer. This of course varies from business to business.
Some businesses find a way to hack their way through the miseries of CAC. They build an audience first and then offer a solution to them. This way you get access to a ready-made audience that most probably will throw their money at you. You won’t have to spend (or spend not much) anything to get your customers.
The accompanying metric to CAC is the Long-Term Value or the LTV of a customer. Loosely, this is the total revenue you expect to get from each customer.
Using these two, you can find out if your business model works or not. There are two rules of thumb to keep in mind:
- Make sure your LTV > 3x CAC. Even higher LTV is better. Some startups have LTV at 4, 5, 6 even 7x to their CAC. While such a high ratio may seem good, just make sure that you are spending enough on marketing. Chances are you could do with putting in more money.
- Make sure the months to recover CAC is less than a year. Basically, you should hit break-even within one year of acquiring your customer. Good startups have has this figure at just 10, 8, even 5 months.
This second rule can also be inverted and used to get a rough idea of how much you should price your product. Remember that $1000 spending to get your customer to pay you $50 pm? Well maybe you should bump your subscription cost to $83 (= 1000/12) or reduce your CAC.
Once you have these two rules nailed down, you can really step on the gas and expand like crazy. The LTV > CAC shows that your business model is viable and the CAC within 12 months shows that you can do hit profitability without going bankrupt. You have these two working in your favor, most VCs will be ready to fund you. (Nice!) Otherwise, maybe you need to change your business model somehow.
Based on Unity’s disclosure in its S-1 about the number of >$100,000 customers, adjusted with a bit of extrapolation for a single quarter we arrive at the numbers for the beginning of 2018. We are no able to judge that Unity added approximately 116 new and increasing >$100,000 customers in 2018 and approximately 111 new and increasing <=$100,000 customers back in 2019.$1.6 Mn per customer might seem huge, however, these are a large token of customers who are willing to spend more than $100,000 per year.
You can also combine them with segmentation (another qualitative metric of sorts) to see what segments of your customer base seem to be most promising. Alternatively, you can also use LTV: CAC to gauge what ad streams offer you the best returns and then heavy down on the ones that offer the most customers for the cheapest.
Making those Customer stick with you (Retaining)
So, you have a proven business model that has LTV > 3x CAC and time to LTV < 12 months. You’ve also secured funding now and have also expanded the team. Now you just scale the business and very soon you’ll make a bank!
You begin with 100 customers. At the end of the month, you find that 3 of them are no longer with you (not dead, they canceled subscription). 3 fewer participants on the platform. Big difference. You simply shrug it off and keep expanding rapidly.
A year passes and now you are acquiring customers by thousands. One fine month you acquire 10000 customers. At the end of the month, you notice 300 of this cohort (the group of customers acquired this month) have left.
Maybe losing 3 customers a month was okay, but 300 is big!
My friend, you’ve just run into customer churn…
The churn is the % of customers you lose from a cohort each month. And this isn’t just another number in the spreadsheet. These are the number of people that tried your product but did not want to continue with it. You can only guess the reasons. Maybe they found a better product or maybe they found something cheaper. Either way, this sheds light on if your product is lacking.
The appropriate churn for a medium-stage startup is less than 5%. Great companies like Salesforce have kept it to less than 3%. This means that out of the 100 customers that signed up, 97 stayed on. Now as the scale of your business goes up, the goal must be to keep the churn numbers lower. As low as possible.
Now for all those who run a B2B SaaS. Let’s say you lose 5 customers out of the 100 you have. No big deal maybe. But what if these were your 10 biggest clients, responsible for a substantial churn of your MRR (Monthly Recurring Revenue)? Well, now you’re trouble. (again)
This kind of churn is called revenue churn. Again, there isn’t a clear way to get out of this, maybe you need to reiterate on your product or maybe you need to get a better sales team. There is however one trick to hack your way out of it.
You just ask your customers to pay upfront and provide them access to your platform or app or whatever that you have. There are two benefits of doing this:
- You get good cash flow, even before the sale is officially recognized. This increases your capital efficiency.
- The customer is also less likely to churn as they have already parted with their money, they must as well use your product.
You may keep a track of this using the ‘Months up Front’ metric. The more months upfront you have, the lesser are the chances of cash flow issues and customer churn.
One has to be careful in asking for upfront payments though. A lot of the customers will not be happy paying for the product before they use it. (did I ask you to get a better sales team…?)
There is another superpower that only a few startups have. And that is the negative churn. Negative churn is when you increase your revenue from existing customers such that it offsets any revenue you lost from the churned customers. There are two ways to get to this coveted stage:
- Up-sell your existing customers. Maybe sell premium versions or cross-sell other subscriptions.
- Add a variable to your product. Maybe keep a variable number of accounts allowed/leads tracked/seats used. As the customer expands usage, the more you get paid.
Now as your startup expands to new customer segments or other markets, you may wonder if there was a way to know beforehand if the churn would trouble you or not. To counter that, we suggest startups use a Customer Engagement Score and Net Promoter Score.
Customer Engagement Score is a startup-specific metric that tracks how likely is a customer to continue using the product based on the features of the product they use and the frequency with which they use it. You basically assign points to each feature of your product (or to each product, if you have multiple products). Allocate more points for features/products you think would be more engaging.
You can verify your points allocation by using your historical churn data to see if the features/products you used actually predicted that churn.
You can also use this to find out which are the best features/products so that you can double down on improving that feature or up/cross-selling those products.
To put things into perspective Unity grew by 33% without taking into account any new customers and its actual growth was 42% because it added new customers. A growing base of customers that spends more every year is the reason behind the stellar growth numbers of Unity. Organic growth is much easier when you have a niche product.
The other metric worth tracking is the Net Promoter Score. This is a startup agnostic score, making it useful to compare across startups. You can learn more about NPS here.
The range lies between -100 to 100. Anything above zero is considered ‘good’, 50 above is ‘excellent’, and 70 above is ‘world-class. Any score above 71 is rarely attained.
For Unity, the score is between 41-50 among various platforms, which makes it number one amongst its competitors. Even the best of the companies like Amazon (54) and Apple (47) haven’t attained a score beyond 70.
There are a lot of additional factors to consider as well. The market has changed slightly, with many VCs now prioritizing profitability over crazily high growth. Companies that have both are ideal, but they are quite rare. Financial indicators are an excellent method to measure the health of a firm if it has more than a million ARR, but we also take a lot of qualitative aspects like the addressable market size, its demography, management and the team, and other factors into account. The majority of traditional SaaS businesses aren’t like that. In order to push the expansion forward, the business must cautiously look at the health of its metrics mentioned above and invest money in sales, marketing, and its team.
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This article has been co-authored by Khubaib Abdullah, who is in the Research and Insights team of Torre Capital.