SaaS (Software as a Service) businesses are very distinct in many ways if compared to other industries like retail or wholesale. Typically, the cost of acquiring a new customer is significantly higher than in other industries (e.g. retail). On the other hand, once a customer is a subscriber or member, there is typically a monthly or annual recurring membership fee or recurring fee, assuming that the company meets customer’s expectations.
There are very specific Key Performance Indicators (KPI) that management must pay attention such Cost of Acquisition, Churn, etc. On the other hand, Finance Managers should not have a dashboard with 15 or more metrics and suffer from analysis-paralysis. It is important to recognize which KPIs should be monitored from a big picture perspective and which ones should be evaluated at a detail level if needed.
Our recommended approach for identifying and tracking KPIs involves several key steps:
Following the above approach, we recommend the following SaaS KPIs divided into categories:
Number of Subscribers/Members
This metric gauges the number of customers acquired during a specific period. The frequency of monitoring depends on whether the business is B2B or B2C-focused. For instance, B2B models might merit monthly tracking, while B2C models may benefit from weekly assessments.
Cost of Acquisition (CAC)
The metric captures sales and marketing expenses directly associated with acquiring new customers. Calculated by dividing the total expenses over a specific period by the number of customers acquired, CAC provides insights into the unit economics of customer acquisition. CAC is measured monthly.
Life Time Value (LTV)
The LTV metric reflects the product of the period a customer stays with the company and the monthly recurring revenue. For instance, if a customer remains subscribed for six months with a monthly fee of $400, the LTV is $2400. This metric essentially quantifies the value of each customer, assuming a specified duration of association.
Very often LTV is compared to how much did it cost us to acquire a customer (CAC). Depending the fixed cost structures, companies can calculate a specific ratio of CAC:LTV to break-even. Here is an example:
Monthly subscription: $500
Period: 6 months
Cost of service: $250 per month
CAC: 1000 per customer
Fixed expenses: $83 per month
What is the maximum CAC that the company should pay to break even?
Proforma Profit and Loss
Revenue: $3,000 (6x$500)
Cost of service: $1,500 (6×250)
GM: $1,500
CAC: $1,000
Fixed Expenses: $500 (6x$83)
Operating income: 0
In this example, the LTV/CAC ratio is 3:1. This means that for every CAC dollar the company must generate 3x of LTV. For simplicity purposes this example assumes zero churn. In real life churn and other factors impact LTV and ultimately the LTV/CAC ratio. It is also worth mentioning that during the early stages of the business that the CAC will probably be significantly higher than normal while the customer aggressively market its services in order to capture market share.
MRR/ARR
Monthly Recurring Revenue or Annual Recurring Revenue measures the average monthly or annual revenue that each user generates on a recurring basis. For example, if the company charges $10/month for the subscription, then the MRR is $10. If the company charges $200/year the ARR is $200. The calculation becomes more intricate when multiple products/services or promotions or seasonality come into play. This metric should be reviewed on a monthly basis.
Cost of Service
A critical metric for service-oriented SaaS businesses, it includes the cost of delivering services per customer. This cost is typically evaluated on a per customer basis, with the total cost during a specific period divided by the number of active members. Cost of service is usually monitored on a monthly basis.
Churn/Retention
Churn represents the opposite of retention. Many businesses prefer framing it positively, focusing on how many customers they retain rather than how many they lose. Calculated based on either revenue or the number of customers, churn provides insights into customer attrition. Customer churn is calculated as the number of customers lost during a specific period divided by the number of customers at the beginning of the period. Chur/Retention are usually evaluated on a monthly basis.
CX (NPS Score)
The Net Promoter Score (NPS) serves as a vital KPI, measuring customer satisfaction and the likelihood of customers recommending the company’s products/services to others. NPS or a similar metric should be evaluated on a monthly basis.
R&D/Revenue
This metric provides a window into the level of investment a technology company is making, preferably towards future product enhancements. While a year-over-year increase doesn’t necessarily indicate investment in the future, quarterly measurement can offer valuable insights.
Leverage ratio
Given the capital-intensive nature of SaaS companies, understanding how capital investment is financed is crucial. This ratio evaluates the proportion of long-term debt to equity, ensuring a balanced and sustainable capital structure. Measured quarterly, it provides insights into the financial health of the company.
For example, Netflix in 2022 had $8 million in long-term debt and $16 million in Equity. Therefore, their debt/equity ratio was 50% (excluding any short-term debt).
In the realm of marketing strategy, two pivotal metrics, though not strictly considered Key Performance Indicators (KPIs), have significant influence:
Leads (TOFU)
This metric tracks the number of leads at the Top of the Funnel (TOFU), representing the initial stage of customer engagement. The abundance and quality of leads at this juncture serve as a critical precursor to subsequent actions. Effective management of TOFU leads lays the groundwork for a robust and successful customer acquisition process.
Conversion Rate (BOFU)
In navigating marketing nuances, the Conversion Rate at the Bottom of the Funnel (BOFU) assumes paramount importance. While various definitions exist for conversion rates, our emphasis lies on the transformation of a prospect into a bona fide “customer.” While conversions from calls to action in advertisements are pivotal for gauging advertising efficacy, the ultimate business success metric is discerned in understanding the conversion rate from a lead to a customer.
This metric, while not aligning strictly with classic KPI criteria, emerges as a key indicator for the marketing team’s strategic management. It directs attention to the fundamental question: how effectively are leads being translated into valuable, revenue-generating customers? As such, it stands as an indispensable compass for overarching business management in addition to its vital role in marketing strategy.
Effectively steering a SaaS business demands a deep understanding of marketing dynamics, customer retention strategies, future investments, and capitalization metrics. By prioritizing and understanding these KPIs, businesses can navigate the complexities of the SaaS landscape, ensuring sustained growth and success.