Anyone who intends to start a SaaS business must get to know about SaaS KPIs. This article is supposed to present the important SaaS metrics for you to evaluate your business performance.
The Significance of SaaS Metrics
SaaS (Software-as-a-Service) is pretty common these days. Our accomplished projects like LuminPDF, Swell & Switchboard, Walrus Education, and CV Simply are some examples of SaaS.
SaaS metrics are standards widely adopted by SaaS or subscription companies to measure their growth over the long haul. They are the MRR (Monthly Recurring Revenue), ARR (Annual Recurring Revenue), Churn Rate, Customer Lifetime Value (CLV), Customer Acquisition Cost (CAC), and so on. Unlike various commercial companies that aim at immediate sales, SaaS businesses prefer generating future revenues and painting a prospective economic picture over years.
SaaS indicators help companies stick to their plan of attracting, acquiring new users, and monetizing by responding to such important questions as how to build long-term values for customers yet guarantee the business success, or how to increase customer retention.
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The 6 Major SaaS Metrics
1. MRR/ ARR
MRR is the abbreviation for Monthly Recurring Revenue. This metric refers to the prediction income received by a SaaS company from a number of subscriptions every month. In other words, the business may base its monthly revenue on how many users are expected to employ its products.
If MRR is multiplied by 12, the firm will obtain ARR, short for Annualized Run Rate or Annual Recurring Revenue. Assuming a customer chooses a yearly subscription plan of US$120, ARR is US$120 and MRR equates to US$10. Inevitably, this formula is theoretically correct provided no new customers are subscribed or users cancel their accounts.
However, the calculation proves more complicated in reality. Nothing guarantees the permanent loyalty of existing customers, not to mention the coming of new clients. Therefore, it’s paramount to estimate how long a user will stay with the company according to their historical behaviors. This element is identified by the Churn Rate which would be discussed later.
MRR plays an important role for SaaS or subscription companies, especially startups because it helps attract investors and venture capitalists. Founders may chart the MRR growth rate accordingly. Nevertheless, this indicator sometimes doesn’t express exactly where sales come from. Thus, MRR should be broken down into smaller categories. Excluding all non-recurring expenses such as hardware or installation, the net new MRR calculation counts expansion MRR (existing customers), new MRR (earned customers), and churned MRR (lost customers). Entrepreneurs may track how those metrics have changed over months in tabular form. The same also applies to ARR.
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2. Churn Rate
1. Customer Churn
Customer Churn talks about the percentage of those who stop using products or services of a company over a period.
It’s computed by dividing the number of lost users by the number of customers at the beginning of the period. For example, the January batch has a total of 100 users. Coming to February, 50 new clients are subscribed to your company’s service whereas 10 customers decide to halt their subscription. The customer churn rate is 10% thereby. Bear in mind that 50 added customers shouldn’t be entailed in the calculation because this figure doesn’t appear at the start of the period.
According to Ron Gill, a CFO at NetSuite, the churn rate, in conjunction with the new ARR, identifies the growth rate and even the maximum size of the company. But churn is occasionally not that important for startups in their early stages should the rate be insignificant. The metric becomes a big concern when they grow in size. Provided a company merely has 100 users in the first month, a 5% churn in the consecutive month will translate to 5 subscribers and the company may easily find another 5 customers. In a scenario of a million users, the client number shrinks by 50,000. It’s daunting to regain the pre-churn figure afterward.
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2. Revenue Churn
This metric measures how much a company loses when customers give up subscriptions. It’s a result of dividing the lost amount by the total sales at the beginning of the period.
In case the business offers only one subscription plan, for instance, US$25 a month:
- a total of 100 users in January bringing US$2,500 in sales;
- the removal of 10 accounts in February leads to a US$250 loss;
- the revenue churn rate is then 10% (= 250/2500).
In case the business offers two or more subscription plans, for instance, 30 individuals registering for a US$25 monthly plan and the rest for a US$15 scheme:
- a total of 100 users in January bring US$1,800 in sales;
- the removal of 5 accounts each plan in February led to a US$200 loss;
- the revenue churn rate is then 11.11% (= 200/1800).
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3. Customer Lifetime Value (CLV)
Speaking of all crucial SaaS metrics for tech startups, customer lifetime value should be among the top priority because it demonstrates the capability to monetize clients. The metric is frequently used to gauge the average payment that a customer makes during the time he/she subscribes to the SaaS product or service. To understand how this metric is calculated, you should consider such factors as follows:
1. Average Lifetime
This indicator portrays how long a customer commits to the company. Dividing one by the customer churn rate, you’ll have the average lifetime of a client denominated in months. If a churn rate is 10%, the average lifetime will be 10 months. Meanwhile, a 5% churn rate will result in 20 months. Obviously, the lower the customer churn rate is, the longer customers engage in the company.
2. Average Revenue Per Customer (ARPC)
As the name states, ARPA is estimated by the division of MRR by the number of subscribers. Assuming the business has US$100,000 in MRR and a total of 2000 users. Thereby, the average income generated from each client equates to US$50 per month.
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3. Customer Lifetime Value (LTV)
At this phase, you only need to apply a simple mathematical formula to assess the value that a customer builds during their stay with the company. For the monthly sales of US$50 created by each client, the 10-month participation will translate to US$500, while 20 months will return the LTV outcome of US$1,000.
Apart from this formula, LTV can be quantified as follows:
4. Customer Acquisition Cost (CAC)
Instead of burning a fortune uncontrollably on marketing and sales to draw new clients, managers think of the possible expenditure they are willing to allocate to secure a new customer. This metric also helps evaluate precisely whether the acquisition process is worthwhile and then manages cash outflows effectively.
The simplest method to quantify this metric is to divide the total marketing and sales expenses by the number of new clients. Speaking of the sales and marketing costs, HubSpot suggested involving overheads, personnel spending (salaries and commissions), and advertising expenses. If the company spends US$10,000 to advertise the SaaS product and eventually reaches 20 new customers in January, the CAC will be US$500.
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5. Unit Economics
Startups hardly take full advantage of LTV or CAC when using them separately. How much they wish to earn from a single customer should be inextricably linked with the amount they must spend to attain new clients. Little wonder that well-balanced business models always have a greater LTV than CAC, regardless of industry, and vice versa. Therefore, one salient metric that deserves attention here is unit economics, commonly called LTV: CAC ratio.
A higher LTV:CAC ratio can add more ROI to the firm’s bottom line. Having said that, companies should target a proper ratio to ensure not only financial targets but also sustainable development. Normally, the benchmark LTV:CAC ratio should be kept at 3:1. A too-high level such as 5:1 or more means the business expends a little on sales and marketing, which makes SaaS offerings or services less attractive and then holds the company’s growth in check. Meanwhile, a near 1:1 ratio indicates that the spending is excessive. Consequently, it’s more challenging to recoup the initial investment in a short time.
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6. Net Promoter Score (NPS)
Unlike the given SaaS growth metrics, the Net Promoter Score is an effective tool to directly measure customer satisfaction from using the company’s products. This metric is essential in the early days of any given SaaS business as it provides qualitative data obtained from user feedback on which marketing and sales teams can base the improvement of products.
To calculate this indicator, you should first ask clients a simple question: “How are you able to recommend us to a relative or coworker?” and subsequently divide customer feedback into three chunks: detractors, passives, and promoters. NPS is a result of subtracting the proportion of detractors from promoters. For example, out of 100 respondents, there are 50 promoters and 38 detractors. So, NPS will be 12% which is considered not so great.
There are dozens of SaaS metrics out there that should be considered by any software company. They can be categorized into Growth, Sales, Marketing, and Customer Success. Based on your company’s common goals, you should pick up suitable indicators to effectively prepare yourself for a sustainable economic future.
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