SaaS startups are the new kids in the software business. SaaS, or Software as a Service, refers to the cloud applications and software that are readily available on the internet to be used by customers. SaaS has become a common delivery model for many business applications, including office and messaging software, payroll processing software, DBMS software, accounting/management software, development software, etc. SaaS software is generally offered on a subscription basis, such as a monthly or yearly subscription. It is sometimes also referred to as “on-demand software”.
The SaaS model offers a win-win situation for both software vendors and its customers. Instead of making a huge investment upfront into IT software, the companies can now subscribe to the software for a smaller periodic fee (shifting the financial burden from capital expenditure to operational expenditure). Since the software lives in the internet, there is also no need for investing in servers or maintenance of the software. At the same time, the software vendor doesn’t have to deploy exclusive resources to install and maintain software in client’s location. Instead any updates can be directly patched and made available to everyone over the internet.
Forbes reports these findings about key metrics for SaaS business (69% based in the U.S and 31% based outside the U.S; median revenues of $4M a year, with 133 companies reporting less than $5M, and 57 over $25M. Annual Contract Value (ACV) across all respondents is $21K, with 17% of respondents reporting ACVs over $100K)
- Median subscription gross margins for SaaS companies in 2015 were 78%.
- Channel sales and inside sales strategies delivered the highest revenue growth rates in 2014.
- Companies in the $5M – $7.5M range achieved 70% revenue growth in 2014, surpassing the median 36% growth rate last year.
Source: 2015, Pacific Crest SaaS survey.
That said let us look at some of the key indicators that will help assess the success of a SaaS software business.
Industry benchmark usage terms are Monthly Recurring Revenue, Net Revenue, Average Revenue per User, Failed Charges, Lifetime Revenue, Revenue Growth Rate, Refunds, Upgrades, User Churn, Customer Growth Rate, Annual Run Rates, Customer Growth Rates, Active Users, ARPU Growth Rate, Per-plan Customer Count, Per-plan Churn and so on. There are far too many indicators, with new ones popping up every other day.
There are however some key metrics for SaaS businesses to assess their performance.
Monthly Recurring Revenue or MRR
What are your monthly revenues? This is an important assessment of the bloodline to your company. It is the revenue-generated month on month. It includes new sales, up-sells, renewals and churn rates. It takes into account payments made for the future by splitting them by the number of months they have been paid for. This is especially true in subscription businesses. Let’s say you offer your software for monthly (at $50 per month) as well as yearly subscription (at $500 per month). If a customer subscribes to a monthly plan at $50 per month, then your MRR increases by $50. However if another customer takes the yearly plan, then the MRR increases by $500/12 = $41.67.
MRR can help in assessing the selling price trends, impact of a promotion or discount on subscriptions, among other things. It also helps forecast future value of customers. This indicator helps monitor the monetary well-being of a business.
Businesses cheer their customer acquisitions but can gloss over their customer loss rate or churn rate. Churn rate refers to the percentage of your customers you lose every month. With a consumer oriented subscription service it is natural that some customers will unsubscribe, however, a high churn rate can be alarming. If your business is facing high churn rate, then it is important to properly assess it and find out the reasons behind it. Talking to customers directly can highlight the underlying problems such as something they don’t like about the product, problems with customer service, competitor promotions or any other reasons.
Just like any other business, it is important to monitor cash inflows and outflows in a SaaS business also. However, in a SaaS business, it is even more crucial because SaaS businesses typically require huge upfront investment in product development and marketing, and then the investment is repaid over a long period of time in the form of revenues/profits. The business owners must therefore be vigilant about cash reserves and carefully spend the money.
Customer Acquisition Cost (CAC)
Just like any other business, SaaS businesses also use various sales and marketing channels to promote their product. It is crucial for SaaS businesses to closely monitor the customer acquisition cost because you don’t want to spend more on acquiring a customer than you expect to earn back from him. In its most basic form, one can calculate the CAC by calculating the total expenditure on all sales and marketing efforts in a given period and dividing it by the number of new customers acquired in that period. Though not very details, this can give you a good estimate of what you spend on acquiring a customer. You can then go into further details by calculating CAC for each campaign and channel to find out which ones are expensive. CAC can give you an insight about the viability and efficiency of various marketing efforts.
Customer Lifetime Value (CLTV)
Customer lifetime value refers to how much revenue you expect to earn from a customer during its lifetime. If a company’s Customer Acquisition Cost is more than its Customer lifetime Value (CAC > CLTV), then it is a sign of trouble. SaaS companies need to focus on creating economic value by keeping their CAC low while increasing the CLTV.
Committed Monthly Recurring Revenue or CMRR
Committed MRR is a forecast of the MRR for the next or the coming months based on the current month. You calculate CMRR by starting from your current monthly recurring revenue, adding revenues based on customers you expect to move to a higher plan, and subtracting revenue for those you expect not to continue.
All these key metrics for SaaS business are useful but in no way complete. A company can look at the rate of lead conversion, loss of customers, expected revenue and still be quite far from being on top of their game. A monitoring of benchmarks alone is not adequate. The challenges, strengths and weakness of each SaaS business differs and need to be addressed.