How can we measure the results of our SaaS business? Most SaaS businesses are using recurring-revenue models to monetize the business.So, measuring KPIs and results can be more difficult compared to traditional business models.
With that being said, in this guide, we will discuss how to have a detailed look at the key metrics that will determine the success of your SaaS business, as well as how we can improve each of them.
Before we begin, however, let us briefly discuss why measuring KPIs and key metrics can be unique in a SaaS environment.
Why Measuring Performance Metrics for SaaS is Unique?
Most of SaaS businesses are using recurring-revenue model, especially subscription-based business model. This fact alone changes how a SaaS business will generate revenue: when a customer is happy with your product, they will continue the subscription. This way, the revenue and profit can increase exponentially.
On the other hand, even after a customer have made a purchase, if they are not happy with your product—or customer service—they can cancel anytime, and the potential profit from this customer will decrease significantly.
In short, your revenue won’t solely rely on the product purchase, but on the relationship with the customer (the customer lifetime), and there are now two different areas to focus on in your marketing efforts:
- Getting a customer to purchase your product—in this case, your software—.
- Keeping the customer to stay with your business, or, maximizing their retention
With that being said, we will also need to measure different performance metrics for these two different aspects.We will see more performance metrics designed to measure retention and churn compared to other business models.
Important Saas Goals
Before we delve further to the important metrics, let us first discuss the three major goals of any SaaS businesses. The idea is, we will measure performance metrics and KPIs according to these goals:
- Revenue and profit: pretty self explanatory. As with any businesses, the goal of a SaaS business is to bring more revenue while generating profit along the way.
- Maintaining Cash Flow: while cash management is very important for any businesses, it is arguably even more important for SaaS businesses. In the SaaS business model, the cost to acquire a customer can be relatively high, while the subscription fee for a customer is usually smaller, and so the cost will only be covered over a long period of time. So, maintaining positive cash flow can be difficult. Throughout this guide, we will learn the important metrics related to maintaining cash.
- Growth: for SaaS business, growth is closely related to customer retention. The longer you can keep a customer to stay with your business, the higher the chance they will recommend your product to their colleagues or friends. Having a positive growth will bring your business closer to that position of market leader.
So, below we will discuss key performance metrics according to these goals, starting with the first category: metrics related to profitability.
SaaS Profitability Performance Metrics
There are three main ways to measure SaaS profitability:
1.Profitability per customer: also referred as micro-economics profitability, and as the name suggests, here we measure the profitability on a single customer level, which is based on two main things: the cost of acquiring this customer, and the monetized revenue from this customer.
In the SaaS industry, there are two main metrics to measure in regards of microeconomics profitability:
- CAC (Customer Acquisition Cost): the cost of acquiring a single customer.
- LTV (Lifetime Value): the generated value from a single customer during their relationship with your business
We will discuss these two metrics more further below, but the main idea is that your LTV should be higher than your CAC in a long-term basis. In general, your LTV should be at least 3 times greater than your CAC.
2. Macro-economics profitability: this might be the most familiar approach for the most of us, which, in a nutshell, is your total revenue – total cost of your product (COGS) – other expenses.
The key thing to consider here is the revenue, since for a SaaS business, the elements for revenue are fairly unique compared to other industries.
There are two main elements of SaaS revenue: Monthly Recurring Revenue (MRR) and services revenue. MRR will be a very important metric for any SaaS business, and so we will have a deeper discussion about it further below.
3. Profitability per employee: human resources (HR) cost is generally one of the biggest costs in SaaS businesses. Obviously, we all want a higher ROI for every single cent we spent on an employee, and this is why measuring profitability per employee basis is important.
To be a profitable company in the long-term basis, we want to see our revenue per employee higher than the total expenses.
All about Monthly Recurring Revenue (MRR)
As promised, here we will discuss Monthly Recurring Revenue, which we have mentioned as one of, if not the most important metric you should track in a SaaS business.
How to measure MRR? In a nutshell, MRR is calculated by multiplying your total number of customers by the average monthly revenue per customer (ARPU), which is, the average amount each customer pay you each month.
- Total number of customers: in a SaaS business, you should regularly track the total number of customers you have. Why? Because it is constantly changing: every customers that churn—cancelled the subscription— will decrease this number, while every new acquired customer will increase it.
- Average Revenue per User (ARPU): commonly calculated in a monthly basis, this is another very important metric for any SaaS business. As the name suggests, here we track the average revenue size for a single customer in a month. Increasing ARPU will directly contribute to growth.
Calculating LTV can vary a lot depending on many different factors. However, for a SaaS business, here is the basic formula:
LTV= average lifetime for a single customer x ARPU – COGS
How to calculate a customer’s average lifetime? We can calculate it with a simple formula: 1 divided by churn rate (we will discuss churn rate further below). So, if your churn rate is, let’s say, 30%, the average customer lifetime is 1 divided by 30%, which is 3.33 months.
The key to remember here is to measure both your churn rate and the average lifetime. One common mistake for many SaaS businesses is only measuring the monthly churn rate, while ignoring the changes in average lifetime.
If your average churn rate is low, you either have a problem with your product or your customer satisfaction. As mentioned, we will discuss churn rate further below including how to improve it.
The basic formula to calculate CAC in a SaaS business is:
CAC= Total sales and marketing costs/ Total number of acquired customers
As you can see, CAC can be a complex metric to calculate, mainly because calculating your marketing and sales costs can be really difficult at times.
There are two main approaches when calculating CAC for SaaS: first, is to only look at marketing costs, and the second, calculating all other expenses including human resources that are related to sales and marketing.
The first approach is good when your human costs and other expenses won’t rise significantly as you grow your prospects. Vice versa, the second model is more useful if your sales model involves a lot of human touch (i.e., if you are using a lot of salespersons to close the deal).
Measuring CAC is one thing, but the main purpose here is to keep your CAC as low as possible. Here are some important variables to optimize:
- Costs of marketing channels: If you can lower your marketing channels’ costs, you can dramatically lower your CAC. These costs can include the cost for your PPC campaigns, email marketing, radio and TV ads, events, tradeshows, and so on. Below, we will further discuss how to calculate these costs properly.
- Conversion rate: If your sales funnel can convert more people from the same number of leads, you can lower your CAC (while increasing revenue and profit at the same time). This is a very important aspect to focus on, and we will discuss more on how to improve conversion rate further below.
- Human touch requirement: the more human sales touch required to convert a prospect, the higher your CAC will be. This is why automation is important, if you can decrease the required human touch—even more, a totally touchless model—, you can significantly decrease your CAC. However, many if not most SaaS businesses are not pursuing this touchless conversion.
- Human resources costs: this is directly related to the human touch requirement discussed above. As we have discussed above, we can measure personnel costs as CAC over time, so we can improve it.
Optimizing Funnel Conversion Rates
While there can be many different sales funnel types with different metrics to track, there is one simple way to measure the conversion rate of each funnel:
- Measuring the number of prospects/lead that went into this specific stage of the sales funnel.
- The conversion rate to the next stage of the sales funnel
You will also want to measure the overall effectiveness of the sales funnel by measuring the number of leads that went into the very top of the sales funnel, and then measuring the conversion rate of the whole funnel.
You can also use this data to plan the future: for example, let’s say you want a $1m revenue for the next year, you can reverse engineer the process backwards on the sales funnel: how many salespeople are required to reach this revenue number? How many leads are required? And so on.
Measuring ROI for Each Marketing Campaign
In SaaS businesses, there can be many different marketing campaigns involved from PPC ads (AdWords, Facebook Ads, etc.), content (inbound) marketing, email marketing, media placements, and so on.
Measuring the overall ROI of each of these lead sources is important, and there are three key factors to consider:
- The number of leads generated from each of these channels
- The conversion rates
- The cost of each generated lead
Generating leads is one of the key challenges for any SaaS businesses, and is also the biggest factor in determining your growth. If you can grow your leads quickly enough to beat your existing customers’ churn rate, you can grow exponentially.
Measuring Churn Rate
When we discussed LTV above, we have mentioned that churn rate will have a direct effect on your customer lifetime. If you can decrease the churn rate by 50%, it will essentially double your LTV, which will translate to more revenue and profit.
A high churn rate can generally be attributed to a low customer satisfaction, whatever the reason whether it’s the quality of your product, bad customer service, or other factors. We can use surveys and interviews to measure customer satisfaction,as well as measuring Net Promoter Score, which is also a very important metric to track.
When aiming to improve your churn rate, here are some key considerations:
- In the SaaS business model, renewal can be a critical period. This is where your customers decide whether to continue their business with you or not. Treat renewal period almost as a new sale: nurture this customer through various marketing channels to continue the business with you.
- Monitoring product usage pattern can be a good way to predict when a customer is about to churn. Low usage levels can indicate high possibility of churn. You might want to setup your product to measure this metric.
- You can use Cohort Analysis to further predict churn. Cohort analysis, in a nutshell, is monitoring a group of customers that start subscribing at around the same time. You generally want to monitor two main things:
- How churn varies over time
- The deviation of churn rates between different cohorts. For example, in the earlier days of the company, the churn rate can be higher because of imperfect product, and you should check whether the churn rate has decreased over time.
SaaS Cash-Flow Performance Metric
Further above, we have mentioned that the number of months required to recover CAC is the key metric to monitor cash-flow.
A common tactic implemented by many SaaS businesses to manage cash is to offer longer contract periods while incentivizing your customers. For example, you can let your customers pay a 12-month subscription with a cheaper price. This tactic brings two main benefits:
- You get more cash up-front, which, as mentioned, a very important thing for the SaaS business model
- You locked your customers into a longer contract, and so they can’t churn within this time frame. However, this can affect your accuracy when measuring your actual churn rate.
While managing cash-flow is essential for any businesses, it is even more important for a SaaS business due to the nature of the business model. Also, in a SaaS setting, it is important to understand the difference between cash-flow profitability and revenue profitability due to long-term contract options discussed above. In a long-term contract, you get revenue in advance, and so your cash-flow profitability will look better compared to your revenue profitability.
SaaS Growth Performance Metric
The main goal of any SaaS business is to grow new customers acquisition every month while preventing churn. This is the main way you can achieve growth, and there are three main ways to achieve this:
- Have more generated leads every month
- Improvement in conversion rate, so more leads will convert into actual customers
- Increasing your sales funnel capacity
Above, we have covered how we can optimize our sales generation and conversion rate. However, growth in sales funnel capacity is a metric that is often overlooked by many SaaS business. As we have briefly discussed further above, we can grow the sales funnel capacity in two different ways:
- Hiring more salespeople, which will increase your human resources costs
- Automating your sales funnel to reduce the human touch requirement, or even eliminating it altogether
Also, another way to accelerate growth is to introduce more products, as well as different version of your product with more features. This way, we can encourage up-sell and cross-sell to increase our revenue.
As we can see from all the different metrics discussed in this guide, there are many different ways to optimize a SaaS business. However, it will help to divide your analytics efforts into three different areas: cash-flow, profitability, and growth, as mm.each of them might require different optimization approaches.
In a SaaS business, a change in a single metric can affect a lot of things, and so it is wise to implement a result-driven approach throughout your organization: take decisions based on data, especially the important metrics we have discussed above. With this mindset, we can manage our cash-flow to secure our finances, maximize growth, and in the end, maximize our profits.