@torquepeak posted the link to this on another board, but I’m sure many here will appreciate it as well:
SaaS Metrics 2.0 – A Guide to Measuring and Improving what Matters
SaaS/subscription businesses are more complex than traditional businesses. Traditional business metrics totally fail to capture the key factors that drive SaaS performance.
The article describes how SaaS companies have big losses early on, due to necessary investments needed for customer acquisition. And the faster the business wants to grow, the more investments are needed, leading to larger losses. Many investors/board members have a problem understanding this, and want to hit the brakes at precisely the moment when they should be hitting the accelerator.
But there is light at the end of the tunnel, as eventually there is enough profit/cash from the installed base to cover the investment needed for new customers.
In terms of evaluating whether a SaaS business is actually viable, the article describes two aspects:
LTV – Lifetime Value of a customer
CAC – Cost to Acquire a Customer
The two metrics proposed are:
• LTV must be greater than 3 times CAC
• It should take less than 1 year to recover that CAC
Obviously, if your business is losing money and capital is hard/expensive to raise, the second criteria should be even shorter (or at least, shorter cost recovery is better).
The author, David Skok, states that a good time for a business to expand is when both of the metrics are met. But also, since customer acquisition costs vary, it can be useful to look at which customer leads have lower costs and/or higher lifetime values, and focus on using those lead generation types. Similarly, if the company has various SaaS cost options, these metrics can be used to determine which combination is best.
Which brings me back to a prior discussion on Splunk. Most of us complained that Splunk’s high charges are hurting its possible success. I wonder if Splunk management has looked at CAC and LTV - it does seem like they haven’t experimented with different structures to find what’s optimal.
BTW, the article has an example on using these numbers from HubSpot (a former Saul board stock), from 2011-2012.
In looking at net recurring revenue, it’s broken down into new, existing customer expansion, and churned/lost customer revenue.
Which brings up the importance of churn. According to Skok, churn doesn’t matter as much early on, but because it’s measured in percentage, it gets really important as the number of customers increases.
Let’s say that you lose 3% of your customers every month. When you only have a hundred customers, losing 3 of them is not that terrible. You can easily go and find another 3 to replace them. However as your business grows in size, the problem becomes different. Imagine that you have become really big, and now have a million customers. 3% churn means that you are losing 30,000 customers every month! That turns out to be a much harder number to replace. Companies like Constant Contact have run into this problem, and it has made it very hard for them to keep up their growth rate.
The important goal metric here is to have expansion revenue from existing customers be larger than the revenue lost from customers lost.
The article goes on to differentiate customer churn from revenue churn, and why both are important.
I’m out of time to devote to this - there’s much more in the article to read and understand. There are dashboards one can construct to look at the health of SaaS companies, for instance. Understanding NPS, levers to advance growth, etc.
One thing that’s interesting is that this article appears to be half a decade old (with some more recent updates).