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
Important Saas GoalsBefore 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.
SaaS Profitability Performance MetricsThere 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
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.
Measuring LTVCalculating 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.
Measuring CACThe basic formula to calculate CAC in a SaaS business is:
CAC= Total sales and marketing costs/ Total number of acquired customersAs 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 RatesWhile 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
Measuring ROI for Each Marketing CampaignIn 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
Measuring Churn RateWhen 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 MetricFurther 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.
SaaS Growth Performance MetricThe 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
- 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