"If you cannot measure it, you cannot improve it" - Lord Kelvin
It's a quote we hear time and time again, and by now most of us have come to agree. The challenge isn't so much not measuring, but instead asking the question: what should we measure?
In this post I explain 5 key SaaS metrics that every software company should be measuring for sustainable growth.
Customer Acquisition Cost (CAC)
What is It?
Your CAC is quite simply the amount you spend to acquire each new paying customer. Your CAC is a combination of all your sales and marketing costs, divided by the number of customers acquired with that expense. The lower you can get your CAC, the better.
Why is It Important?
Your CAC is important for determining the profitability of your SaaS company. If your CAC is too high, then your business will not be profitable (or will take too long to recover it's CAC, to the extent it will burn through all its cash before the company becomes profitable). You should always be optimising your sales and marketing strategies to improve on your CAC.
How Do You Calculate It?
CAC = (total marketing expense + total sales expense)/number of customers acquired
It usually makes sense to use a rolling number, so for example you could measure your CAC over the previous 12 months. The length of time you choose to measure over will depend on a number of factors. If you tend to close very large deals at irregular intervals, you'll need to measure over a longer period to minimise the impact of variance.
Likewise, if your industry is rapidly evolving and new competitors are constantly joining the market -- then it's quite common for your CAC to change significantly month-to-month, which may make measuring over a shorter time period better.
Example
A marketing software company employs a marketing agency (£100k/yr) and 2 person sales team (each cost £70k over previous 12 months fully loaded). In addition to this the company spends £20k/yr on marketing software, £100k/yr on pay per click advertising, £50k/year on discretionary marketing spend (e.g. tradeshows etc) and £5k/yr on software for the sales team.
During the last 12 months, the company has acquired 300 new customers.
CAC = (£100k + £70k + £70k + £20k + £100k + £50k + £5k)/300 = £1,383.
Lifetime Value (LTV)
What is it?
Lifetime value is simply the revenue you generate from each customer you acquire, over the entire timeframe they continue to buy from you. This includes any and all revenue the company generates, averaged over all customers. If your SaaS has multiple packages, it's also often sensible to work out the LTV for individual packages.
Why is it Important?
Your LTV works in close partnership with your CAC. If your LTV is lower than your CAC (and there's no obvious way of increasing your LTV, or rapidly decreasing your CAC), you're in big trouble -- as each customer is worth less than what you're paying to acquire it. You should always be working on improving your products and up/cross selling abilities to drive your LTV up.
If your SaaS company is an early stage start-up, the LTV of your customers may be very low, and your CAC quite high. This can be okay, so long as you foresee a path to significantly increasing your LTV, or decreasing your CAC. I discuss the importance of your LTV:CAC ratio later in this post.
How Do You Calculate It?
LTV = (revenue from customers)/(number of customers)
Usually this is calculated across your entire customer database, rather than on a rolling basis like CAC. This means that your LTV should be increasing year-on-year in the early stages of growing an SaaS company, as the length of time customers stay with you should increase over time.
Example
An HR SaaS company has 3 different packages. Basic, Pro and Enterprise. Basic costs £100 per month, Pro costs £500 per month, and Enterprise costs £1000 per month. The company has the following number of customers on each package:
Basic customers: 300
Pro customers: 100
Enterprise customers: 50
The average customer lifetime for each package is as follows:
Basic: 22 months
Pro: 26 months
Enterprise: 36 months
The LTV for each package is therefore:
Basic: 22 x 100 = £2,200
Pro: 26 x 500 = £13,000
Enterprise: 36 x 1000 = £36,000
The lifetime value for an "average" customer is: (£2,200x300) + (£13,000x100) + (£36,000x50) / (300 + 100 + 50) = (£660,000 + £1,300,000 + £1,800,000) / 450 = £8,355.
Months to Recover CAC
What is it?
It's the number of months a customer needs to continue paying for your SaaS to generate enough revenue to cover their CAC. Again, it's usually beneficial to measure this for individual packages, as well as to work it out across all of your customers.
Why is it Important?
A general rule of thumb is that a successful SaaS company should recover the CAC in less than 12 months. This figure is a result of analysing hundreds of successful SaaS companies. Many top SaaS companies are able to recover their CAC in 5-7 months. Again, if you are a very early stage company, it's not uncommon for your months to recover CAC to exceed 12 months -- it's just important you have a plan to reduce it over time.
Large enterprises can typically afford more months to recover CAC than mid-sized companies, as they will have greater access to cheap capital to fund growth.
How Do You Calculate it?
It's simple, for each of your packages, simply take the CAC, and divide it by the monthly revenue generated per customer.
Months to Recover CAC = CAC / Monthly Revenue Per Customer
Example
A supply chain SaaS start-up has two packages: professional and enterprise. Their CAC for the professional package is £6,000, and their CAC for the enterprise package is £15,000.
The professional package costs a fixed £800 per month, and the enterprise package £1,500 per month.
Professional Months to Recover CAC = £6,000 / £800 = 7.5 months
Enterprise Months to Recover CAC = £15,000 / £1500 = 10 months
This calculation is made more complicated if your customers have lots of add-ons they can buy, or pay per seat. In these instances, you'll need to average the monthly revenue generated per customer on each package, rather than using the headline package figures alone to get an accurate picture.
LTV:CAC Ratio
What is it?
As it says on the tin, it's the ratio of your LTV to CAC.
Why is it Important?
Your LTV:CAC ratio gives a good idea of the financial strength of the company. If your LTV:CAC ratio is close to 1:1, you're unlikely to ever make a profit, without drastically reducing your CAC, or increasing your LTV by several hundred percent.
Healthy SaaS companies generally have an LTV:CAC ratio that's better than 3:1. Some companies achieve as high as 8:1.
How Do You Calculate it?
Simply work out your LTV and CAC, then simplify the ratio down.
Example
An education SaaS company has just the one package, which is charged per seat. The average customer has a LTV of £24,000 and a CAC of £6,000. The LTV:CAC ratio is therefore 24,000:6,000 = 4:1.
Monthly Revenue Churn
What is it?
Simply put, the percentage of your monthly revenue you lose from your existing customers each month.
Why is it important?
High revenue churn rates quickly kill the growth of any SaaS company. In the early days, a high churn rate often isn't too important -- for example, if your monthly revenue churn rate is 3%, and you have £10,000 in monthly revenue, that means you're losing £300 of revenue from your existing customers each month. It's not that hard to replace £300 of lost revenue each month, and grow in excess of that.
As you grow, high churn becomes a huge problem. For example, if you have £10,000,000 in monthly revenue and the same 3% churn rate, you're now losing £300,000 in monthly revenue per month. That could be all but impossible to replace, no matter how good your sales and marketing effort is. High churn is often a key factor in the stalling of growth in larger SaaS companies.
Churn also compounds. If you stop acquiring customers, but churn 3% of your monthly revenue each month, you'd lose almost 30% of your monthly revenue over the course of a year. In comparison, if your churn was 1%, you'd lose ~10%.
The best solution to this problem is to have negative churn. That is, your revenue from your existing customer base grows faster each month than the revenue you lose from customers cancelling or downgrading. To achieve negative churn, you need to be very good at retaining customers (i.e. great customer service, and an excellent product), and also be effective at both up/cross selling.
How Do You Calculate It?
Churn = (sum of monthly revenue from lost customers/downgrades - sum of monthly revenue gained via upgrades/cross selling) / total monthly revenue
Example
For this metric I'll give two examples, one of positive churn, and one of negative churn:
- A project management SaaS company generates £1,000,000 in recurring monthly revenue from its customers. Last month the company lost 600 customers, each paying £50 per month. There were also 200 customers who upgraded from a £10 per month package to a £50 per month package.
Churn = ((600 x £50) - (200 x (£50-£10))) / £1,000,000 = (£30,000 - £8,000) / £1,000,000 = 2.2% - A recruitment SaaS company generates £200,000 in recurring monthly revenue from its customers. Last month the company lost 8 customers, each paying £500 per month. There were also 6 customers who upgraded from a £500 per month package to a £1500 per month package.
Churn = ((6 x £500) - ((£1500-£500) * 6)) / £200,000 = (£3000 - £6000) / £200,000 = -1.5%
So there we have it -- 5 SaaS metrics that your company can't afford to ignore if it wants to grow. Have you been measuring these metrics for your SaaS company? Why not?
