Funding in supply chain tech reached $24.3B in the first three quarters of 2021, which was 58% more than the entirety of 2020. Many of these companies offer products under a Software as a Service (SaaS) model.
A SaaS business is a subscription business. Companies develop and then market their software and recoup those investments over time. The challenge is that the customer breakeven point, or the ability to recoup your expenses could be months or years. For a young company, this can become a cash flow issue as more customers are acquired. But at the same time, growth is essential to gain adoption and satisfy investors.
As a startup, companies must look at financial metrics with an eye on cashflow, growth and customer retention. And there are five key metrics that are important for measuring these items in a SaaS business.
Monthly Recurring Revenue
Monthly Recurring Revenue, or MRR is the amount of revenue you should expect each month based on subscriptions. This can also be expressed and calculated on a yearly basis as Annual Recurring Revenue, or ARR. MRR is a key indicator of growth and the month-over-month growth percentages indicate how quickly the company is gaining new customers and revenue.
MRR is calculated by multiplying the monthly Average Revenue per Unit (ARPU) by the total monthly users. One thing to keep in mind is that this metric tracks MRR in the present. If you are growing quickly, you can also take into account growth rate for projections of future MRR.
Churn Rate
The Churn Rate, or Attrition Rate, is the percentage of customers leaving each month as a percent of total customers. Like MRR, you can also calculate this on an annual basis. While MRR is a measurement of growth, Churn Rate measures how well you maintain customers.
If churn is high, it could be your product, your service or some other factor. Typically, if you are losing customers within a short period of time, it could indicate that customers did not realize the value expected from your services. If longer term, it could be a competitive issue or a problem with your customer support.
Customer Acquisition Cost
Customer Acquisition Cost, or CAC is an approximation of expenses used to acquire a new customer. It’s calculated by dividing sales and marketing expenses by the total number of new customers during a period. When calculating this, a couple things are important. First, you must define what to count as a new customer. You may have different segments or products that you want to measure differently. Second, you must define what is included as a sales and marketing expense.
I calculate the acquisition cost for each marketing program and channel. I personally do not include activities not directly relating to a lead acquisition, for example customer retention investments or longer term branding initiatives. I’m interested in the incremental cost of a new customer rather than the ROI of all marketing department investments. Tracking CAC helps you track new account investments with an eye on your customer Lifetime Value (LTV).
Average Revenue per User
Obviously, you don’t want to spend more supporting the customer than the revenue achieved. When compared with customer maintenance costs, Average Revenue per User or customer, often referred to as ARPU helps identify profitable customers and segments. It is calculated by dividing the monthly recurring revenue by the total number of paying customers or paying users for the period. For most SaaS subscription businesses, it makes sense to calculate this monthly. You can also calculate this for different customer groups and segments.
ARPU helps you determine if you are charging enough for your service relative to customer value. It also allows you to set new revenue goals and develop ways to improve revenue by gaining a greater share of your customer’s business, for example through add-ons, new pricing tiers, upgrades and just focusing on higher value customer segment.
Lifetime Value
Lifetime value is the average gross margin of a customer over the average life of the customer. It allows you to understand the value of a new customer over their average lifetime. You can compare this to metrics including customer acquisition cost and customer maintenance costs to see how profitable your customers may be. This measurement takes into account some of the other metrics including customer churn rate, customer acquisition cost and average revenue per user.
There are a number of different ways to calculate this metric, but one common way is to divide the average revenue per user in recurring revenue by the churn rate. So for example, if your ARPU is $20 and the churn rate is 5%, then your estimated lifetime value is $400. If you choose this approach, just keep in mind that churn rates can change month-over-month and even a small change in churn can affect the LTV calculation. I suggest you watch this number over time and perhaps use a smooth average over a period of time.
This was an overview of five important SaaS metrics. You’ve probably realized that all of these metrics are dependent on the others and only make sense when viewed together. Also, this is just a few of the metrics you should consider tracking. A few others include CAC:LTV Ratio, Breakeven point and a number of marketing KPI metrics.
