SaaS Overarching Goals
The overarching goals for a Software-as-a-Service (SaaS) company are to:
- Acquire customers
- Retain customers
- Monetize customers
Understanding revenue dynamics is key for any company with recurring revenue. This requires planning and tracking information by relevant dimensions. Examples of dimensions you may use are:
Geography – most companies will plan and have actuals by country at a minimum.
Product – this is fairly easy to track. It may require you to subdivide revenue for customers that buy multiple products.
Others – Examples are vertical and channel. Gathering and tracking this data often requires more internal processes and possibly a change to a segment in your GL string (chart of accounts). However, more granularity in the analysis can often yield interesting trends. Tracking customer groups requires some effort and may not be perfect as a customer may change groups. However, it is often worth the effort when you have a large customer base.
Cohort – The cohort is the month in which the customer first became a customer. So all customers that joined in October 2014 will be analyzed in a cohort over their lifetime.
Graphic 1.1 shows Revenue, Number of Customers and Revenue/Customer for a SaaS company segmented by Geography:
Most companies will be up and running and generating revenue when they begin this analysis. However, it is worth going back in time to collect this information and include it your historical data. The trends can be very helpful. The analysis needs both customer count and revenue.
There are two types of SaaS businesses:
- MRR (Monthly Recurring Revenue): Those with primarily month to month contracts.
- ARR (Annual Recurring Revenue) or ACV (Annual Contract Value): Those with primarily annual or longer term contracts.
There are three main elements that contribute to a change in ACV or MRR:
- Added – from new customers
- Expanded – from existing customers
- Churned – from lost customers
Companies that sell internationally also need to consider the gain/(loss) on foreign currency exchange when calculating their total change in ACV (or MRR). In Graphic 1.2 below, the foreign currency gain is 45% of the increase in ACV. If you do not isolate the foreign exchange impact in this example, the expansion ACV will be overstated.
SaaS companies should track the monthly change in ACV (or MRR) over time to see how each of the three elements contribute to the overall trend. Graphic 1.3 provides a six month summary of Net New ACV. The graph also includes a dotted line to show the planned growth for this period. This allows managers to see how they are doing against their plan.
Five Key Metrics for a SaaS company
1. Lifetime Value of Customer
LTV. The simplest calculation is below. Companies with a high up-sell rate will require a more sophisticated approximation.
For a SaaS company with month-to-month or no contracts, churn is defined as:
For companies with a annual and longer term contracts, the appropriate formula is below. For a two-year contract, the Annual Contract Value (ACV) is 50% of the total contract value.
Note that Churn = 1 – Renewal Rate when revenue is steady. For a growing company churn will be a lower number; lost customers were acquired in a prior month with less new customer revenue.
Churn can be negative when the value of expanded businesses is higher than the value of contracts lost. It is worth understanding that dynamic. In Graph 1.4, churn is negative in May and June.
DRR – Dollar Revenue Retention highlights the value of renewing customers. It is defined below where Expansion Revenue is the increased purchases from a cohort.
2. Cost to Acquire a new Customer
CAC – The CAC is the sales and marketing spend divided by the number of new customers. If the sales cycle is three months, the expenses should be from three months prior to acquiring the customer. The spend should include all expenses from the Sales and Marketing departments and not just the marketing campaign spend.
LTV : CAC should be at least 3 for a SaaS company.
3. Revenue per employee
Generally 80% to 90% expenses in a SaaS company are compensation and expenses directly related to headcount. For example, rent, travel expenses and software subscriptions all related to headcount. Projected revenue and cash generation (consumption) per employee will drive your staffing plan.
4. Customer Loyalty
The Net Promoter Score is gaining acceptance as a measure of customer loyalty.
Usage is a leading indicator for churn. If customer adoption is low, the renewal will be at risk. Prior to the renewal date for low usage customers, there may be an opportunity to offer services at a discount to increase the product’s utility for the customer and thereby reduce churn.
This article is borrowed in part from an article by David Skok