SaaS Metrics - An Introduction

It is no secret that subscription-based businesses are more complex than your traditional goods and services enterprise. In this post we hope to help the SaaS founder get a better grasp of SaaS metrics, how to use them and what they actually mean for your subscription-based business.

Note that SaaS KPI’s are meant to help you assess the current operation of your business, they help you identify areas that need to be improved but KPI’s are not a fix or a cure to a problem. That being said SaaS metrics work best once you have achieved a product/market fit and your Startup is currently working on a profitable and scalable growth model.

Recall that investors and creditors will require you to prepare GAAP compliant financial statements but as a founder, you look at a completely different set of financials. It is normal to have a discrepancy between a GAAP reported FS and your internal SaaS operations financial data in terms of presentation.

So, let’s jump right into it!

Let’s look at three of the most important SaaS metrics:

1. LTV- Life time value of a customer

2. CAC – Customer acquisition cost

3. Churn rate

LTV – LIFETIME VALUE OF A CUSTOMER

As its name implies, the LTV is the length of the customer subscription lifetime. A subcomponent of the LVT is what we refer to as the ARPA or the Average Revenue (MRR) per Customer.

In the simple example where all of your subscription customers have the same ARPA (i.e. the same period of time of subscription – 12 months let’s say) then the LVT can be calculated simply as:

LTV = ARPA x Customer Life (in months)

Alternatively, the LTV is also the ARPA/Churn rate (in months).

It is worth mentioning that seldom is the above applied in such a straight forward way since subscriptions may end earlier, you may have expansion MRR (upselling to existing customers), and or different products with different lifetimes. Furthermore, what if you have high value customers and low value customers? What if you lose a contract that is 5x the average customer? The above would not take that into considerations. Therefore, we tweak our formula as follows:

LTV = (ARPA x Gross margin %) / Revenue churn rate

The formula above instinctively tells us that with the introduction of the GM% and a revenue churn rate, the picture becomes more accurate, since a loss of a high value customer would be reflected in the revenue churn rate and also in the decrease of the GM %.

CAC – CUSTOMER ACQUISITION COST

This one is simple – your cost to acquire new customers. CAC is defined as:

CAC = Sum of all sales and marketing expenses / # of new customers

Note that the “sales and marketing expenses” includes everything: salaries, commissions, benefits, etc. All costs included to acquire that new customer.

A word of caution when dealing with CAC formula: in the early days of your start-up, your sales people and marketing people may not be working at full capacity and scaling to the extend that they are capable of. Therefore, your CAC may seem overstated at the beginning of your operations.

CHURN

The metrics for churn (or customer expiry) are a little more complex and there are many variations depending on the specific KPI you are looking for. Let’s look at some of the more common ones:

% Customer Churn = # of Customers who churned / Total # of Customers

This one is intuitive, total customers that have churned as a percentage of total customers in your cohort. Let’s look at it now from the perspective of your monthly recurring revenue (MRR):

% MRR Churn = Churned MRR / Previous Months MRR

To get a better picture of the activity during the month, you cannot just use the churned MRR, but you must also consider any upsells or what we refer to as Expansion MRR, therefore we tweak the above equation as follows:

% Net MRR Churn = (Churned MRR – Expansion MRR) / Previous Months MRR

Let’s now apply our knowledge… A key KPI used by SaaS companies to gauge a company’s improvement over time is the LTV : CAC ratio:

LTV:CAC ratio = LTV/CAC

Industry rule of thumb is that your ratio should be 3 or higher.