“You can’t manage what you can’t measure.” Peter Drucker
Part I of this post covered the first four metrics that are the macro drivers of valuation, including ARR, Bookings, the Cash Conversion Score, and the Rule of 40. Part II covers additional metrics that provide powerful insights derived from measuring SaaS unit economics.
Here are the key metrics to track:
5. Churn ($$$ and Logo)
Churn is the total amount of existing business that is lost in a period. It is expressed as a % of starting ARR (or MRR) and initial customer count.
Churn is a headwind to ARR growth, as this lost ARR must first be replaced before the ARR “snowball” can grow. The higher the churn, the greater the amount of new business and upsell that must be attained just to maintain your current revenue run rate..
Best-in-class SaaS companies demonstrate consistently low rates of churn. They achieve this by understanding the reasons for customer churn (some of which may be beyond the control of the company) and deploying and empowering a customer success team to mitigate churn. Controllable factors include:
- Customer onboarding and training
- Technical support
- Product quality
- Selling to customers who are not a good fit
- Over-selling features or benefits
6. Revenue Retention % (Gross / Net)
Gross Revenue Retention and Net Revenue Retention measure the overall quality of SaaS revenue, i.e. the stickiness of the current revenue and how it expands over time. Retention compares current period MRR with the same period in the prior year as follows:
a. Gross revenue retention
If churn and contraction were $0, then gross retention would be 100%. Best in class B2B SaaS companies have a gross revenue retention in excess of 90%.
b. Net revenue retention
The calculation of net revenue retention offsets the loss of revenue from churn and contraction with expansion revenue to get a net change in MRR from the existing customer base.
If expansion exceeds the aggregate of churn and contraction, then net retention would be > 100%. Best in class B2B SaaS companies have a net revenue retention in excess of 105%.
7. Customer Acquisition Cost (CAC) / CAC Payback
The “CAC” (Customer Acquisition Cost) is the average cost to acquire each new customer calculated as follows:
Next, it is important to know how long it will take to recover the cost of acquiring each new customer. The “CAC Payback” metric is calculated as follows:
The fewer months to recover CAC the more exponential will be the growth in cash flow. A best in class SaaS company will recover its CAC in less than 12 months.
8. Customer Lifetime Value / LTV:CAC
Probably the most important metric in the eyes of investors is the LTV:CAC ratio. This measures the ROI on investment in sales and marketing expenses. Because a major use of investment capital – especially in later rounds – is to fund sales and marketing expense, investors are intensely interested in this metric.
Dividing aggregate bookings by the number of logos will give the ARPU, or Average Revenue Per User.
Ideally, ARPU will grow over time as the company adds new features to create upsell opportunities or support a price increase at the time of renewal. Once we have calculated ARPU, we can figure the expected lifetime value of each customer as follows:
Note that the churn rate is one of the biggest determinants of LTV and the one that should be controlled to boost LTV.
Best in class SaaS companies have a LTV:CAC ratio greater than 3X.
9. Sales Efficiency Ratio (aka the “SaaS Magic Number”)
The sales efficiency ratio (aka the “SaaS Magic Number”) is another way to measure the ROI on the investment in sales and marketing expense. In its simplest form, it compares the net increase in ARR with the expense of acquiring that ARR. It is calculated as follows:
The magic number is a useful guide as to whether to increase investment in sales and marketing according to the following rule of thumb:
Best-in-class SaaS companies with a Magic Number > 0.75 are well-placed to receive additional investment capital to fuel topline growth.
Using SaaS Metrics to Make Good Decisions
Calculating the CAC Payback and LTV:CAC is not just key to obtaining capital. Knowing these numbers is essential to effective decision making and the optimum allocation of resources. Some examples of how these metrics can be used to make data driven decisions include:
- Evaluating investment in customer success: e.g. a 20% reduction in churn rate generates a 25% increase in LTV. However, investments in customer success that reduce churn also reduce the gross margin which reduces the LTV. There is a tradeoff that needs to be evaluated.
- Evaluating different products, end-user markets, use cases, pricing models, etc. to establish which are the most profitable and allocating resources accordingly.
- Evaluating different marketing initiatives. Tracking lead sources and calculating the CAC for different programs (e.g. LinkedIn, Google AdWords, media advertising) will show which ones are profitable and merit additional investment.
The bottom line: Measuring and managing the appropriate SaaS metrics is the key to your “Saasifaction”. If you don’t know your numbers, then you don’t know your business. If you don’t know your business you will never be able to attract investment to grow or to ultimately sell it to an investor.
Need a Hand Implementing SaaS Metrics Reporting?
vcfo’s experienced SaaS CFOs can help you define the metrics that are key to your business, set up the reporting systems to capture the data, draw accurate conclusions and make appropriate decisions based on the data.