Source: OpenView Staff
For many SaaS company founders and execs it’s understandably easy to get obsessed with tracking performance. It certainly doesn’t help that there is no lack of data to sift through
Before you know it, you can easily be submersed in wave upon wave of metrics and corresponding acronyms — customer acquisition cost (CAC), annual recurring revenue (ARR), annual contract value (ACV), lifetime value (LTV), just to name a few. At its worst it can be like searching for clear answers in a bowl of alphabet soup.
So which of these metrics (if any) can entrepreneurs reliably turn to for the tell-tale signs of imminent failure or burgeoning success? In theory, that’s where KPIs come in.
Short for Key Performance Indicator, KPI is a term for the metrics that are most critical to tracking a company’s performance against its objectives, writes KISSmetrics’ Lars Lofgren. Sounds simple enough, right?
The problem is that there are dozens of metrics that can fall under the KPI umbrella. And tracking them all is neither productive nor efficient. In fact, as former Intuit director of research and analytics Avinash Kaushik writes on his blog, choosing the wrong ones can create “sub optimal…tear-inducing outcomes that will, slowly over time, bleed the business to death.”
So, what are key performance indicators that really matter to SaaS companies? Below, we’ll cover the six KPIs that allow SaaS entrepreneurs and their teams to monitor and analyze their company’s performance, without getting distracted by the wrong dials.
1) Churn Rate
It may seem obvious to suggest that SaaS companies need to track how many customers they lose year over year, but obvious doesn’t always translate to “must-do.”
Far too many SaaS businesses overlook this number in favor of more sophisticated or derivative metrics — and that’s a big mistake. At the end of the day, there is nothing more important to a SaaS company than its ability to retain existing customers while also acquiring new ones.
Research by Bessemer Venture Partners suggests that the top performing SaaS companies typically achieve annual renewals at a rate above 90 percent. Ultimately, the logic is pretty simple: if you want to create revenue growth, you have to add new customers and keep the ones you have.
2) Monthly Recurring Revenue (MRR)
Growing SaaS companies tend to concentrate on bookings and revenue numbers and lose sight of their secured monthly revenue flow. Monthly Recurring Revenue (MRR) is a simple but powerful metric that tracks new sales, up-sells, renewals, and churn on monthly basis.
MRR keeps SaaS companies focused on the present, and allows them to track the momentum of the business as it grows. Furthermore, tracking MRR can keep a SaaS company’s management team from falling into the trap of obsessing over long-term contractually booked sales.
While those long-term sales can significantly boost bookings and instill profitability optimism, they may not contribute significantly to monthly cash inflow and short-term scalability.
3) Committed Monthly Recurring Revenue (CMRR)
More or less a modified version of MRR, the goal of tracking committed monthly recurring revenue is to show what a SaaS company’s revenue stream will be going forward if the business halted its sales and marketing efforts.
To reach the steady state value of its CMRR, a company needs to take its MRR, add future recurring revenue to that number, and subtract the recurring revenue of customers that are unlikely to renew within the fiscal year.
Ultimately, this metric gives SaaS executives a much clearer picture of their company’s financial health, and it can be helpful in forecasting future revenues.
It may seem like an overly simple KPI, but cash is one of the most important performance indicators for SaaS businesses. Why? Because the nature of SaaS is that it takes significant working capital and initial resources to come up with a good product, and the repayment on that investment occurs over a long period of time.
Therefore, SaaS founders must be very aware of — and vigilant with — their cash reserves. If they fail to do that and end up overspending, the company may require outside financing simply to survive — and that’s rarely a good position to be in.
5) Customer Acquisition Cost (CAC)
This metric isn’t exclusive to SaaS companies, but it is absolutely critical to monitor. Customer acquisition cost (CAC) measures the cash that a SaaS business burns to acquire new customers, and indicates how long it will take a company to recoup the initial investment used to capture those customers. Consequently, SaaS companies can use this metric to determine whether they can afford to boost sales and marketing spending, or whether they should be cutting back.
To calculate CAC, take the gross margin of annualized new revenue from a given quarter and divide it by the sales and marketing cost from the previous quarter (less account management fees). The rationale here is that new revenue from sales and marketing spending is not realized until approximately three months later due to the customer ramp-up period.
Ultimately, CAC speaks to a company’s economic viability and efficiency, particularly when it’s compared to the next KPI on this list.
6) Customer Lifetime Value (CLTV)
If a SaaS company’s CAC is higher than its average customer lifetime value (CLTV), the business is in trouble. Essentially, that scenario equates to selling a product for less than what it costs to make it — and that’s not exactly the best route to profitability.
Calculating CLTV can be a little bit tricky, but SaaS expert Joel York does an excellent job of outlining it on his blog Chaotic Flow. Simply put, CLTV is a more advanced way to look at a SaaS company’s economics. If CLTV is greater than CAC, you’re on steady ground. Expansion-stage SaaS companies should strive to create an economic model in which the net cash they bring in from customers relative to the cash they spend to acquire and manage them is positive and grows over a long period of time.
Cautionary Note: Why Obsessing Over SaaS Benchmarks Isn’t Always Productive
While each of the metrics listed above are critically important KPIs for SaaS companies, it’s important not to fixate on how your numbers compare to industry averages or benchmarks.
The reason is simple: every SaaS company is different and you need to consider your unique circumstances before blindly following a rule of thumb that was created for a different circumstance. Yes, benchmarks can be helpful in providing context and framing reasonable expectations when you’re just beginning to scale a SaaS business. But once you begin tracking your KPIs, it’s critical to establish your own benchmarks.
In the end, the most pragmatic thing you can do is calculate the metrics above based on your company’s numbers and then explore and test ways for improving them. Whatever your current numbers are, your basic goal should be to implement initiatives that align strategically with your goals and strengthen your financial position.
Bonus KPI: One Often Overlooked Metric that SaaS Companies Should Also Monitor
Jason Lemkin, author of the popular SaaS blog, saastr.com, and founder of SaaS company EchoSign, says that while revenue growth, churn, and customer lifetime value are critical SaaS metrics, one other important metric often gets overlooked: inbound qualified lead velocity.
Defined as the rate at which your qualified, inbound leads grow month-over-month, Lemkin argues that inbound lead velocity is a harbinger of organic interest and demand, which is an asset that can very inexpensively and efficiently set SaaS companies up for success in the short- and long-term.
The reason, Lemkin says, is that an engine fueled by word-of-mouth and virality naturally drives high lead velocity. And with that in your back pocket, you can solve virtually any other problem given enough time and runway, and upgrades to the team and product.
Additional SaaS KPI Resources
3 SaaS Metrics that Investors Really Care About by Daniel Klass
Do You Have Your Hands on the Right Dials? by Adam Marcus
About Scale Finance
Scale Finance LLC (www.scalefinance.com) provides contract CFO services, Controller solutions, and support in raising capital, or executing M&A transactions, to entrepreneurial companies. The firm specializes in cost-effective financial reporting, budgeting & forecasting, implementing controls, complex modeling, business valuations, and other financial management, and provides strategic help for companies raising growth capital or considering M&A/recapitalization opportunities. Most of the firm’s clients are growing technology, healthcare, business services, consumer, and industrial companies at various stages of development from start-up to tens of millions in annual revenue. Scale Finance has multiple offices in the Carolinas including Charlotte, Raleigh/Durham, Greensboro, and Wilmington with a team of more than 45 professionals serving more than 120 companies throughout the region.