3 Key SaaS Metrics
Traditional business models may be easier to comprehend when compared to the SaaS (Software as a Service) business model, but SaaS solutions are here to stay. Although more complex, more organisations are starting to adopt this business model as they make use of the cloud services. How a SaaS business runs is that it has a centrally hosted software, which is then licensed to customers via a subscription plan. A few examples that you might have came across in your daily lives of SaaS products are Slack, Dropbox, MailChimp, DocuSign, Microsoft Office 365 and Netflix.
There are two types of SaaS business model, those with primarily monthly contracts or annual contracts. For businesses running primarily on monthly contracts, the primary key metric will be Monthly Recurring Revenue (MRR); whereas those focussing on annual contracts keep an eye on their Annual Recurring Revenue (ARR). There are multiple metrics revolving around MRR or ARR, examples like growth rate, gross churn rate, net churn rate or expansion rate. A key thing to remember is that the net MRR/ARR = New + Existing Customer — Lost Customer.
The second most popular metric you hear people discussing about a SaaS business model is the CAC payback period. CAC, also known as customer acquisition cost is arguable the most important expense in a SaaS business model. CAC includes all sales and marketing costs incurred to gain or acquire a new customer. CAC payback period is a measure of efficiency, and usually the faster it is, the better. Most investors use a 12 month period as a rule of thumb, but it’s definitely not a standalone metric. A decrease in CAC spending will almost definitely result in a faster CAC payback period, but is that necessarily better in the long run?
The third metric to pay attention to will be the Lifetime Value (LTV) of a user. This is an important metric as it paints a bigger picture of the company. LTV calculates the total dollar amount an individual customer will pay over the life of their account. When comparing to other metrics such as retention rate or average revenue per user, while useful, there is often a gap in terms of the timeline. LTV helps us in addressing all the blank spaces in between. One can also use LTV to determine the appropriate amount of CAC, as there really is no point if the CAC exceeds the LTV of a customer.
While there are many more ratios and formulas that can be applied to a SaaS business model, it is essential to remember that there isn’t one golden ratio or rule to adhere by. What I find appealing about SaaS business model is the predictable recurring revenue, which brings considerable amount of confidence to the table.
