SaaS (Software as a Service) metrics are specific to measuring the performance and effectiveness of software delivered and accessed over the internet rather than installed locally on a user’s device.
SaaS business owners and executives in SaaS companies appreciate some metrics more than others. Below are some of the most valuable metrics SaaS companies use, what they do, and how to calculate them by following a simple 7-Step process.
STEP 1: Calculate Customer Acquisition Cost (CAC)
CAC is designed to show how much you spend to acquire a new customer. Customer Acquisition Cost SaaS, therefore, is determined by two factors—marketing expenses, or the cost of creating leads, and sales costs, or the cost of turning the information into a customer.
You will get the CAC figure when you add up marketing and sales expenses and divide them by the number of customers acquired.
Here is the same formula presented visually:
CAC = Sales & Marketing Costs/Number of New Customers
- This CAC SaaS formula might present a somewhat inaccurate picture because it doesn’t consider the scalability factor – the team members you just hired will handle more customers as your business grows. In such a case, you can adjust your Sales and Marketing figures to contain only a portion of the sales and marketing people’s salaries.
- The same applies if your company has invested significantly in SEO or product launches. The investments will bring results at a later stage, but they are already affecting your CAC, so you might want to adjust them accordingly.
- You can improve CAC by optimizing your website and reducing the number of shopping cart abandonment, developing a new way of extracting money from customers, and implementing a contract acquisition system or CRM for better sales management.
STEP 2: Calculate Customer Churn
Assume you have 100 customers. That number will turn 0 after a certain period, and your customer churn rate defines that period.
The customer churn definition looks as follows:
Customer Churn = 1 – Retention Rate, with the Retention Rate formula being as follows:
Retention Rate (Customer) = Number of New Users/Total Number of Users
Retention Rate (revenue) = Number of New Users Revenue/ Total Revenue
When calculating the churn rate, don’t consider the “activation” step or the trial period if the person ends up canceling the trial; however, if the customer continues to use the product, you can include that trial period in the churn calculations.
The average customer lifetime is defined as follows:
Customer Lifetime = 1/Customer Churn Rate
Depending on whether you take a monthly or yearly Customer Churn Rate, the customer’s lifetime will show the figure for the same period. For example:
- Take a Monthly Customer Churn rate of 5%, and then the Customer Lifetime will be 1/0.05, which is 20 months.
- For a yearly churn rate of 15%, the Customer Lifetime will be 1/0.15, which is ~ 6.5 years.
STEP 3: Calculate Lifetime Value (LTV)
LTV, or the lifetime value of a customer, is one of the most critical SaaS metrics because it shows you the complete picture of your business. The LTV is defined as the amount of money each customer is expected to pay from when the user becomes a customer until the moment he leaves. LTV gives you a general idea of how many repeat purchases you can expect, pointing out how much you should spend on acquiring customers for your business.
LTV value is based on ARPA and customer churn rate over a certain period.
- ARPA (average revenue per year) is defined as total revenue divided by the number of subscribers.
- ARPA = Total Revenue/Number of Customers (take monthly numbers for both figures)
Here is how to calculate customer lifetime value once you figure out the ARPA and churn rate:
- LTV = ARPA/Revenue or Customer Churn
These customer lifetime value formulas excel at getting the job done but have some variations depending on your customer base. For example, the cost of losing a high-value customer is not comparable to losing a low-value customer. That’s why it’s better to use the Revenue figure in the denominator, not the Customer Churn. Unfortunately, not understanding these principles is one of the main reasons startups fail.
Read More : Why It’s So Damn Hard to Be ‘Customer Centric’
Gross Margin is another metric that is recommended to take into account for lifetime value calculation.
LTV = ARPA * Gross Margin %/Revenue Churn Rate
STEP 4: Don’t Neglect The Factors Affecting LTV
The LTV formula looks very simple, but, in reality, there are a lot of factors that business owners tend to overlook.
One of them is that customer revenue will change over time. In simpler terms, the customer can start as a primary member and then upgrade to premium or splurge on in-app purchases.
In such situations, the expansion revenue will overtake the losses from the churn, but after some time, the churn rate will decrease the Value of high-paying customers. Here is how you can calculate LTV if your business has a significant cohort of customers characterized by gradually increasing revenue:
LTV = a/c + m(1-c)/c2
- “a” is monthly ARPA x GM%
- “m” is monthly growth in ARPA per account x GM% (in monetary value)
- “c” is the customer churn rate percentage
STEP 5: Compare LTV and CAC
Tracking your LTV to Customer Acquisition Cost ratio shows whether you are spending enough or too much on customer acquisition. Another way to use LTV is to measure the marketing channel’s effectiveness and prioritize channels that bring the most valuable customers.
This metric is considered optimal if it reaches the Value of 3. The metric helps you understand whether your management decision drives constant optimization and improvement. Any deviation from 3 will show that you are wasting money or missing opportunities because you are not spending enough.
STEP 6: Consider Months to recover CAC
The sooner you recover CAC, the better it is for your business. If it takes you too long to regain a low-value customer, there is a chance that the customer will churn before the recovery takes place, and you will face a loss.
Here is how you can determine Months to recover CAC:
Months to recover CAC = CAC/Average MRR per customer
- Where MRR stands for monthly recurring revenue at the end of each month, MRR is calculated by adding MRR from the previous month and Net MRR for the current month.
The Monthly Recurring Revenue formula is, therefore:
MRR = MRR (previous month) + Net MRR (current month)
- Ideally, the number of months to recover should be less than 12 months, assuming you are using a simple LTV formula and have a Gross Margin of a minimum of 80%. This figure is determined by analyzing top SaaS companies’ metrics. So don’t panic if you spend more time on CAC recovery – put a plan into place and focus on reducing the metric instead.
Also, some companies can spend more months recovering customers because they can access cheap capital.
STEP 7: Familiarize Yourself With SaaS Business Acronyms
- ARR – Annualized Run Rate (also called Annual Recurring Revenue) = MRR x 12ARR. If you don’t churn anything, this is a yearly recurring revenue for the coming 12 months.
- ACV – Annual Contract Value measures the Value of the contract over 12 months. ACV SaaS metric is different from ARR since it shows how much, on average, your contract is worth over a given period, while ARR is not an average metric
- New MRR/ACV – additional MRR from new customers in the current month
- Churned MRR/ACV – MRR you lost from churning customers (using account cancellation or downgrading the account)
- Expansion MRR/ACV – additional MRR from existing customers (using transferring to a more expensive plan)
- Net New MRR – New MRR + Expansion MRR + Churned MRR
- Average Contract Length – this gives you the average duration of all your contracts in months or years
- Months up-front – this number shows the middle months of payment received upfront. If you have been able to get your customers to pay upfront, this has a significant impact on your cash flow. However, you need to keep track of new customers as they might be taken aback by the need to pay upfront
- ARPA (average revenue per year) is defined as total revenue divided by the number of subscribers. The number shows the average monthly payment per customer
- Number of new customers – number of customers added this month
- Number of churned customers – number of customers lost this month due to churn
- Net New Customers = Number of new customers – Number of churned customers
- % Customer Churn = Number of churned customers/Total Number of Customers
- % MRR Churn = Churned MRR/Previous month’s MRR
- % MRR Expansion = Expansion MRR/Previous month’s MRR. The optimal % MRR Expansion should be close to negative
- Customer Renewal Rate = Number of customers who renewed their contracts/Total Number of contracts up for renewal
- Gross Dollar Renewal Rate = $ Value of renewed contracts/Total $ Value of contracts up for renewal
- DRR (Net Dollar Renewal Rate) = $ Value of renewed contracts + Expansion MRR/Total $ Value of contracts up for renewal