We recently came across an excellent article “SaaS Metrics 2.0 – A Guide to Measuring and Improving what Matters” posted by David Skok on January 13, 2013. David is a serial entrepreneur turned VC (at Matrix Partners). We highly recommend that you read the entire article, which is rich in insights and actionable information, but what follows are our key takeaways:
Investors/directors be warned: periods of accelerated growth (which are critical to establishing and maintaining a leading position in the company’s vertical) create a “cashflow trough”. This cashflow pressure results from the relatively high initial cost of acquiring a customer vs. the relatively small monthly revenues/customer (assuming a subscription model).
Two key metrics that a SaaS company must track are LTV (lifetime value of a customer) and CAC (cost of acquiring a customer). David’s rules of thumb for gauging a SaaS business’s viability are:
- LTV should be at least 3 times greater than CAC
- It should not take more than 12 months to recover CAC
Metrics-based business decisions: By tracking and evaluating your company’s LTV and CAC metrics, you can make more informed business decisions such as: Should your metrics be improved before hitting the accelerator pedal? Which lead sources should you invest in further (or drop) depending on their positive (or negative) impact on your metrics? Similarly, which market segments/models should you concentrate on because they contribute more to your profitability?
The impact of customer churn, or the importance of customer retention: High churn figures put additional pressure on the effort to acquire new customers which, as we have noted, is expensive. If you are having difficulty retaining customers, you must ask hard questions about your product and its long-term value to various customer segments and make adjustments as necessary in product robustness, feature sets, as well as marketing and sales processes.
Some churn is inevitable but SaaS companies should be aspiring to negative churn, i.e., expanding revenues from existing customers is greater than lost revenue from churning customers. To achieve negative churn, the business model should be such that if an existing customer increases usage of the service, the subscription rate increases. And, of course, the company must be good at up/cross-selling additional services.
Plan ahead! If your metrics indicate the need for adjustments in your growth strategy, it typically takes 9-12 months from the decision to implement various actions until you start seeing results. And, going back to the first point, don’t forget that you have to make sure that you have the funds (!) to deal with the cashflow issues that result from accelerated growth.