While it’s easy to use immediate sales and short-term metrics as success indicators, SaaS startups must consider other factors to prevent bottlenecks when scaling. Given the nature of monthly subscriptions, metrics such as churn and user retention are exceedingly important. However, it’s easy to go down a rabbit hole of different metrics that ultimately might distract a founder from what’s important.
To make matters simple, here are five important metrics founders should always consider as they grow their SaaS company.
Recurring revenue is the amount of revenue that is expected to continue in the future. Founders can use reoccurring revenue to help project cash flow and growth. Recurring revenue is calculated in intervals, most commonly monthly (MRR) and yearly (ARR) time frames. Investors also look at MRR and ARR to determine the value of the company and whether they might invest or not.
SaaS MRR calculation:
( $ from new subscribers ) + ( $ from existing customer subscriptions ) + ( $ from upgrades and add-ons ) - ( $ from canceled subscriptions ) - ( $ from downgrades and canceled add-ons )
SaaS ARR calculation:
MRR X 12
Calculate the monthly recurring revenue by first adding the revenue made from new subscribers, existing subscribers, and upgrades made during that month. Then subtract the revenue lost from that month's canceled subscriptions and downgrades. The final number is the monthly recurring revenue of the SaaS. Now easily calculate ARR by multiplying MRR by twelve.
MRR should be monitored and watched closely. It’s a direct reflection of the success of sales and marketing in addition to customer acquisition and retention. ARR is more closely linked to a startup’s valuation, with the average private SaaS company being worth 16.6x their annual recurring revenue according to SaaS Capital (an all time high).
Use these metrics to your benefit. If revenue from new subscribers is low, look to improve customer onboarding and explore new marketing channels. If cancellations are high, collect customer feedback to determine why your customer are leaving to keep growing your reoccurring revenue.
The churn rate is the percentage of new subscribers who cancel their subscriptions prior to the next billing period. Plain and simple, churn is unavoidable. There will always be a percentage of customers who choose not to renew their subscriptions. As a note, the churn rate is the inverse of the customer retention rate. For example, if 15% of users unsubscribe in one month, the monthly churn rate is 15% and the monthly customer retention rate is 85%.
SaaS subscriber churn rate calculation:
(# of cancelled subscribers in the last 30 days ÷ # of active subscribers 30 days ago ) X 100
The monthly churn rate is calculated by dividing the number of subscribers who left in the last month by the number of active subscribers in the previous month.
Naturally, a lower churn rate signifies that customers are satisfied while a higher churn rate could allude to underlying issues with the product. Customer feedback should be prioritised in this situation. Send out surveys to existing users to see what they like and dislike and make sure unsubscribed users provide a reason as to why they are unsubscribing. However, high churn rates are not always concerning. Depending on the time frame used to calculate churn, percentages can vary greatly. One month, churn could be 15%, while over a year, churn could be as low as 5%. Typically, it’s better to calculate churn over longer time periods.
Customer lifetime value (LTV)
Closely related to the churn rate is the customer lifetime value (LTV). Typically, the lower the churn rate, the higher the LTV. The customer lifetime value is the revenue estimate of one subscriber over the course of their entire subscription period.
The customer lifetime value is calculated by taking the price of the subscription and multiplying that by the amount of time the average customer pays for the service. It can also be calculated by multiplying the average revenue per user by the churn rate.
SaaS LTV calculation:
( $ of subscription ) X ( average # subscription months )
(average revenue per user) X (churn rate)
The customer LTV and the churn rate are a balancing act. The idea is to lower the churn rate as much as possible to get the lifetime value as high as possible. If fewer users are unsubscribing each month, LTV increases and you will be able to spend more to acquire a user.
TIP: A trick to instantly boost LTV is to offer better deals on annual subscriptions, this will instantly make your customer stay for at least 21 months.
Expansion revenue is the additional revenue generated from customers already subscribed to the service. One of your goals as a SaaS founder should always be to grow revenue through existing customers, people who already pay for your service and understand its value.
Acquiring new customers is a drain on resources and time, so it makes sense to offer more value to already loyal, paying customers.
SaaS expansion revenue calculation:
Expansion revenue =
( $ upgrades from existing customers ) + ( $ add-ons from existing customers )
Drive expansion revenue by upgrading subscribers to a larger plan as their usage grows. Or cross-sell subscribers additional services. Existing subscribers are more than willing to upgrade their respective packages when they hit the tier limits and are growing their own revenue. This metric is also calculated within MRR as the money made from upgrades and add-ons.
Customer Acquisition Cost (CAC)
Customer acquisition is the last key metic for a SaaS founder. CAC is how much your company spends to acquire a new customer. The smaller the number the better. As a general rule of thumb, the customer acquisition cost should be one-third of the customer lifetime value (LTV). SaaS companies can therefore spend more to acquire a new user since they know they will recoup their losses at a future point in time.
CAC in relation to LTV is also an important metric to attract investors. A low CAC and high LTV is a strong sign of future profitability and stable revenue.
SaaS CAC calculation:
( $ spent acquiring customers ) ÷ ( # of new customers )
Calculate the customer acquisition cost over a monthly or annual time frame. But similar to churn, be careful which time frame you use in relation to your marketing strategies. If your SEO strategy takes six months to start acquiring new customers, of course your monthly CAC will be higher in the first few months. Measuring CAC at an annual rate is oftentimes a better way to evaluate marketing costs.
Predicting and monitoring these 5 metrics over time is essential to understanding the health and sustainability of your SaaS startup, but it can be difficult. Not only does it require time manually entering data into a spreadsheet but also assumptions are made to predict these metrics over time. It’s easy to make mistakes and it is expensive to hire a professional to handle this for you. Instead, check out Sturppy’s financial modeling tool to generate realistic predictions and focus back on delivering value to your users.