SaaS Metrics

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Overview

ARR/MRR

ARR 3-Year CAGR

% Recurring Revenue

Customer Retention

LTV to CAC

Gross Margin

Expenses

ASP/Customer/Year

Average Contract Length

Total Addressable Market (TAM)

Additional Resources

Template for One-Pagers

  • Subject
  • Definition
  • How to Calculate
  • SAAS Benchmarks/Standards (i.e. SAAS Companies have been valued at 7x of ARR, if you get from 1-5 million, 90% customer retention, 3:1 LTV to CAC Ratio)
  • Related Metrics (i.e. for ARR->MRR, TTM)
  • Drivers for Improvement
  • Examples (blog posts, graphs, etc.)

Overview

This document is designed to provide the reader with a basic understanding of the performance metrics that tend to be most significant to a SaaS startup company. A working knowledge of how to calculate, interpret, and drive improvements in the following metrics is critical to the success of today’s SaaS founder.

ARR/MRR

  • Definition 
    • The value of total recurring revenue in a particular year/month (old – lost + new subscriptions)
    • ARR – Annual Recurring Revenue
    • MRR – Monthly Recurring Revenue
  • How to Calculate
    • Monthly Contracts: sum the total amount of revenue coming in from subscriptions (OR total revenue – one-time payments – churned subs – trial user revenue)
    • Annual Contracts: take the total amount of each contract active in that month and divide by the number of months that contract covers and sum that monthly total 
      • Choose which measurement works best for the style of subscription service you provide for your customers. 
      • ARR – primarily annual contracts, with some contracts for multiple years.
      • MRR – primarily monthly contracts with some longer term contracts. 
  • SAAS Benchmarks/Standards
https://medium.com/point-nine-news/6-saas-metric-frameworks-benchmarks-to-know-before-fundraising-901b4b1c9125

ARR 3-Year CAGR

  • Definition
    • ARR 3-Year Compound Annual Growth Rate (CAGR) is a measure of the mean annual growth rate in ARR (annual recurring revenue) over the past 3 year period
  • How to Calculate 
    • To calculate you need two numbers
      • ARR at the end of year 3 
      • ARR at the beginning of year 1 

Plug the numbers into the formula to get the CAGR %:

  • Example: If the ARR at beginning of year 1 is $100K and the ARR at the end of year 3 is $700K, CAGR is 91.29%
  • SAAS Benchmarks/Standards
    • Not Strong: 5-20%; Solid: 20 – 50%; Great: 50%+ 
  • Related Metrics
    • Monthly Recurring Revenue (MRR)
    • Annual Recurring Revenue (ARR)
    • Customer Retention and Churn rate
  • Drivers for Improvement
    • Increase ARR/MRR by increasing subscription fees and/or charging for addons/upgrades
    • Reduce churn rate 
  • Examples (blog posts, graphs, etc.)

% Recurring Revenue

  • Definition
    • Recurring revenue is the portion of a company’s revenue that is highly likely to continue in the future. Recurring revenue is revenue that is predictable, stable and can be counted on in the future with a high degree of certainty. The % Recurring Revenue is how much of your total annual revenue comes from your subscriptions.
  • How to Calculate 
    • Revenue that will recur/Total Revenue
    • Example:  Business A has an MRR of $10K/month and total revenue of $20K/month.  The % of Recurring Revenue= $10k/$20K*100%= 50%
  • SAAS Benchmarks/Standards 
    • Knowing what percentage of your total MRR your plans make up is very important. For example, what if you have 90% of your customers on a plan that only makes up 10% of your MRR? That’s balance you really shouldn’t force to work because the support load wouldn’t cover itself.
  • Related Metrics 
  • Monthly recurring revenue is part of the calculation in order to account for % recurring revenue.
  • MRR is computed by multiplying the total number of paying customers by the average amount that they pay you each month (ARPU).
  • Total Customers:  a key metric for any SaaS company. This increases with new additions coming out the bottom of the sales funnel, and decreases by the number of customers that churn. Both of these are key metrics, and we will drill down into them later.
  • ARPU – average monthly revenue per customer: (The term ARPU comes from the wireless carriers where U stands for user.)  This is another extremely important variable that can be tweaked in the SaaS model.

Customer Retention

  • Definition 
    • Customer retention represents the percentage of customers that do not churn (end subscriptions) over a given time period, typically one year
  • How to Calculate
    • Traditional Approach: 1 – (# of churned customers at end of period / total customers at start of period)
    • Startup Approach: ((# Customers at End of Period – # Customers Acquired During Period)) / # Customers at Start of Period)) X 100
  • SAAS Benchmarks/Standards
    • According to Mixpanel’s 2017 Product Benchmarks report, for most industries, the average customer retention rate was below 20%. In the media or finance industries, retention over 25% is considered above average, and in the SaaS industry, retention above 35 is considered above average.
  • Related Metrics 
    • Customer Satisfaction/NPS
  • Drivers for Improvement
    • Drive for negative churn: expansion revenue from existing customers > lost revenue from churning customers
      • Expansion: variable pricing scheme that increases as the volume in the system increase (licenses used, leads tracked, etc.) OR upsell/cross-sell 
    • Predicting Churn w/ Customer Engagement Score: create a Customer Engagement Score, based on allocating points for the particular features used. Allocate more points for the features you believe are most sticky.
      • Later on you can go back and look at the customers who actually churned, and validate that you picked the right features as a predictor of who would churn. 
      • And separately score how many users are engaged with specific scores.
      • Over time you’ll also come to discover which types of use are the best indicators of possible upsell.
      • This allows you to predict churn and act on it (Customer Service), as well as tweak onboarding or focus on driving particular behaviors early on
    • Cohort Analysis
      • In SaaS businesses, cohort analysis is used to observe what happens to the group of customers that joined in a particular month (both as a percentage of original customers and percentage of original revenue)
  • Examples (blog posts, graphs, etc.)
  • Cohort analysis can help you answer key questions about your customer that you can then turn into actionable insight:
    • When are we losing most customers? 
    • Does our churn stabilize at any point?
  • These answers help you develop plans to address key areas in the customer lifecycle, try things (i.e. product features, easier on-boarding, better training, etc.), and then analyze their effect on retention compared to the previous cohorts 

LTV/CAC

  • Definition
    • LTV: the lifetime value of a typical customer, expected income from one customer over the course of their involvement with you
    • CAC: the total costs required to acquire a typical customer (typically sales and marketing spend)
    • LTV/CAC: profit per customer for every dollar spent to acquire them
  • How to Calculate
    • LTV/CAC
      • LTV = Average Revenue per customer / % customer churn
      • CAC = COGS + Marketing Costs / Total Number of Customers
  • SAAS Benchmarks/Standards
    • Goals to display viability
      • LTV > 3X CAC
      • Months to recover CAC <12 months
    • Great tool to understand when you are ready to accelerate growth and when you need to tweak further to improve the ratio
    • Also great for evaluating different lead sources (i.e. Google Adwords, Social Media). If we’re getting paid $500/month, we can afford to spend up to 12x that amount to acquire them.
    • Use for segmentation as well. Good to examine which segments show the quickest return or highest LTV to CAC as you assess the most profitable to pursue.
    • Early stage startups should not focus on this metric until the growth process becomes repeatable and scalable
  • Related Metrics 
    • MRR
    • Customer Retention & Churn Rate
  • Drivers for Improvement
    • Increase LTV: reduce churn rate, cross-sell, up-sell, customer success, reduce sales friction, increase margins, scalable pricing, product line expansion
    • Reduce CAC: improve conversion rate through experimentation, automation, inbound marketing
  • Examples (blog posts, graphs, etc.)
  • Hubspot drove up their LTV:CAC ratio by zeroing in on MRR Churn rate.
    • “In 2011 and early 2012 we used this chart to guide many of our business decisions at HubSpot. By breaking LTV:CAC down into its components we could examine each metric and understand what levers we could pull to drive overall improvement. It turned out that the levers we could pull varied by segment. In the SMB market for instance we had the right sales process in place – but had an opportunity to improve LTV by improving the product to lower churn and increasing our average price in the segment. In the VSB (Very Small Business) segment, by contrast, there wasn’t as much upside left on the LTV (VSB customers have less money and naturally higher churn) so we focused on lowering CAC by removing friction from our sales process and moving more of our sales to the channel.” – Brad Coffey, HubSpot

Gross Margin

  • Definition 
    • Gross Margin represents the percentage of total sales revenue that the company retains after incurring direct cost associated with producing the goods and services it sells.
  • How to Calculate
    • (Total Revenue – Cost of Goods Sold “COGS”)/ Total Revenue = Gross Margin %
    • Important costs to include in COGS: Hosting Costs, employee costs to maintain production environment, employee costs for customer support, cost of any third-party software included in delivered product, any other direct employee costs required to deliver ongoing service
    • It is common to include Support, Services, Customer Success (CSM), and Cost of Operations (COO).  COO can vary, but often includes hosting costs, R&D amortization from capitalized software for sale (if any), and resold product expense.  Of course, there could be other expenses in COO, but these are the major expenses.
      • You may choose to place CSM under sales and marketing in operating expense (OpEx). If your CSM team also transacts some business such as seat add-ons, then put them below the gross margin line in OpEx. If your CSM team is purely focused on retention, then keep it in COGS. 
  • SaaS Benchmarks/Standards
    • You want a Gross Margin in the 80%+ range.
    •  Gross margins typically range from 60% to more than 80% with the primary COGS being network and delivery costs, as well as services personnel (e.g., maintenance, training, implementation, etc.).  As the customer base matures and the company reaches scale, most SaaS companies should achieve gross margins in the 75%–80% range, depending on the level of professional services required to deploy the solutions.
    • Founders and SaaS teams must understand how and which revenue streams are contributing to their overall SaaS gross margin.  The blend between services, recurring, and any other revenue streams is important.
      • For example, you could have a great 85% SaaS gross margin, but your service margin is at 50% and masking lower-than-ideal margins from recurring revenue.  Or vice versa, you undercharge for on-boarding and configuration which drags down your overall margin, but you don’t get credit for great recurring margins.
    • It also helps in your planning sessions to balance resource requests against forecasted margins.  It’s hard to make decisions without knowing revenue stream margins and impact of investments in your business.
  • Related Metrics
    • COGS
    • Net Margin 
  • Drivers for Improvement
    • To improve gross margin, you have two options: increase revenue or decrease COGS.
    • When you’re just starting out, your gross margin is likely to be lower because you’re not benefiting from economies of scale. As you acquire more customers, it becomes cheaper to support each one. As a result, your COGS decreases and your gross margin increases.
    • It can be tempting to continue cutting costs and increasing prices to grow your gross margin. But it’s a balancing act. Too little quality or too expensive a product might mean too few customers. A 50% gross margin on $1000 of revenue is still better than a 90% gross margin on $500 of revenue.
  • Examples (blog posts, graphs, etc.)

Expenses

  • Definition  
    • Expenses represent the cost of activities undertaken by your business. 
  • How to Calculate
    • If you practice diligent accounting, you should be tracking your expenses closely.
    • Typically, expenses should be categorized and could, for example, include the following categories.
      • Cost of Goods Sold (aka Cost of Revenue, Cost of Sales)
      • Sales & Marketing
      • Engineering (R&D)
      • General & Admin (Overhead)
  • SaaS Benchmarks/Standards
    • The more detailed your expense accounts, the easier it is to track your performance against the budget . For example, if it looks like in May that you’re spending more than you had planned, why is that? Is it because your Engineering is hiring faster than expected, or are there expenses that are getting out of hand? Or perhaps Sales activities are actually working and you should be doubling-down.
    • COGS is necessary to calculate Gross Margin, which in turn is necessary to calculate Customer Lifetime Value
    • Sales & Marketing is necessary to calculate Customer Acquisition Cost
    • Engineering – The benefits of separating Engineering from your General & Admin expenses are less obvious, but still likely worthwhile. For one thing, you might want to benchmark your Engineering spend as a percentage of your total expenses to compare yourself to other SaaS companies. Even if you couldn’t care less what others do, you might want to determine if you are investing enough in the long-term success of your presumably tech-focused company.
  • Related Metrics
    • COGS
    • Sales & Marketing
    • R&D
    • General Administrative Costs
  • Drivers for Improvement
    • Diligent, disciplined accounting and goal-oriented financial planning.
  • Examples (blog posts, graphs, etc.)

ASP/Customer/Year

  • Definition
    • ASP/customer/year is a ratio that examines the average price of product or services offered to all customers in a given year
  • How to Calculate
    • Determine the Average Sale Price per Customer per Year
    • ASP/Customer/Year is calculated by taking all selling price points and dividing by the total number of customers sold to in a given year
    • Startup Approach:
      • Sum all sales prices
        • =([SalesPrice1]*[#sales@SalesPrice1])+([SalesPrice2]*[#sales@SalesPrice2])+…..([SalesPriceN]*[#sales@SalesPriceN])
      • Divide Calculated Average Sales Price (ASP) by number of customers sold this year
  • SAAS Benchmarks/Standards 
    • Critical part of calculating LTV which is used in many valuation calculations. 
    • This is relevant to early stage companies that might offer trial periods at discounted prices.
  • Related Metrics
    • Customer Lifetime Value (CLV)
    • Average Contract Length (ACL)
  • Drivers for Improvement
    • Increase Price
    • Reduce discounts/Trial offers
  • Examples (blog posts, graphs, etc.)

Average Contract Length

  • Definition
    • The average contract length examines the average duration of all signed customer contracts
      • Also known as Average Contract Term
  • How to Calculate
    • Average contract length is calculated by taking the duration of all signed customer contracts and dividing by the total number of customers
    • Calculate payment duration for all customers
      • Sum length of time customers have been paying
      • Divide duration by number of customers
  • SAAS Benchmarks/Standards
    • Critical component of calculating LTV
    • Estimates length of time customers will be revenue generating
    • The longer the better, but standards will change with the type of business  
  • Related Metrics
    • CAC
    • LTV
    • Churn Rate
  • Drivers for Improvement
    • Improve Customer Retention (lower Churn)
    • Offer longer term contracts
  • Examples (blog posts, graphs, etc.)

Total Addressable Market (TAM)

  • Definition
    • Total Addressable Market (TAM) is the total value of all customers that a product or service can be sold to in a given industry.
  • How to Calculate
    • TAM can be calculated from top-down, bottom-up, or by looking at value creation. TAM can be calculated using known inputs and/or industry research reports. See below for more detail with examples using the US market for coffee:
  • Top-Down: Starts with the size of the entire market, typically using information from industry studies. Example: The U.S. coffee market is $50B.
  • Bottom-Up: The price of your product/service or the typical price in the market multiplied by the number of potential customers. Example: 5M Americans drink coffee daily. Our coffee is $2.50/cup. 75M x $2.50 x 365 days = $68.4B 
  • Value-Theory: This rarely used method is applicable to brand new categories or extensions of existing products. It uses customer willingness-to-pay to assess the value created by a product/service and uses this information combined with existing prices to price for economic value maximization.
  • SAAS Benchmarks/Standards
    • There are no benchmarks for TAM. All products/services and industries differ. It is worth noting, however, that some investors use TAM as an investment criteria (i.e. “we only invest in TAMs in excess of $500M).
  • Related Metrics
    • For more granularity, use SAM (Serviceable Addressable Market) and SOM (Serviceable Obtainable Market). These metrics look at the percentage of the TAM that is realistically attainable.

Additional Resources

  • SaaS Metrics 2.0 – A Guide to Measuring and Improving what Matters by David Skok
  • https://married2growth.com/2018/08/14/saas-maturity-vs-saas-scale/
  • https://medium.com/point-nine-news/what-does-it-take-to-raise-capital-in-saas-in-2018-204d0a46cb23
  • https://www.saastr.com/benchmarks-in-saas-for-seed-and-series-a-rounds/
  • https://www.saas-capital.com/blog/cogs-for-saas-business/
  • https://saasholic.com/the-rule-of-40-for-saas-and-subscription-business-4bc2d7bcd868
  • https://www.clientsuccess.com/blog/4-ways-to-measure-churn-retention-part-1/
  • https://blog.chartmogul.com/wp-content/uploads/2015/04/ChartMogul-Ultimate-Guide-to-SaaS-Customer-LTV.pdf
  • https://www.forentrepreneurs.com/ltv-cac/
  • https://www.profitwell.com/blog/the-complete-saas-guide-to-calculating-and-reducing-cac
  • https://www.investopedia.com/terms/a/averagesellingprice.asp
  • https://www.saas-capital.com/blog/saas-contract-length/