By Siddharth Pati, Senior Engineering Manager, CDK Global
Software-as-a-Service or SaaS businesses have seen tremendous growth in recent years. McKinsey and SaaSBoomi peg the market cap of SaaS companies globally at $3 trillion and predict it would rise to $10 trillion by 2030. Accelerated digital adoption, cloud computing, and a preference for plug-and-play solutions have contributed to this unprecedented growth.
SaaS companies invest in the beginning to acquire customers and recover the investment from recurring revenues throughout the lifetime of the customers. Traditional accounting methods such as Income statements are backward-looking and often fail to reflect the health of SaaS companies. Instead, a different set of metrics is used to measure SaaS performance. Lagging metrics such as Renewals, Churn, CAC, ACV, etc. indicate the current state of the business. Leading metrics such as Funnel Conversion Rates, Churn Risk Daily Active Users, etc. can indicate where the business is heading. Metrics like ARPA and NPS can be both lagging and leading indicators.
In this article, let’s examine some of the most important KPIs to measure SaaS health.
Growth: Revenue Growth can be the most reliable indicator of product-market fit.
MRR/ARR: Monthly Recurring Revenue (MRR) is the recurring/subscription revenue, the company generates in a month. One-time charges for professional services or initial setups are excluded from MRR. MRR helps predict future cash flows. If the business is driven by yearly contracts, especially by selling to enterprises, Annual Recurring Revenue (ARR) is used.
MRR Components: Breaking down MRR by the key components helps track the growth momentum. The components that makeup MRR are New Sales: MRR added from new customers; Expansion: MRR added from existing customer upgrades; Resurrected: MRR added from former customers who have reactivated; Churned: MRR lost from customers who have discontinued; Contraction: MRR lost from downgrades; Retained: MRR retained from renewals.
ARPA: Average Revenue per Account (ARPA) shows the recurring revenue per account. It can be calculated on a monthly or yearly basis. It also makes sense to examine the average revenue separately for new and existing accounts. ARPA can be different from ARPU (Average Revenue per User) as one user or customer can have many accounts.
Customer Concentration
A small percentage of customers contributing to a large part of the company’s revenue can be a risk. Customer Concentration shows how the total revenue is distributed among the customer base. High customer concentration can be seen in SaaS companies – focused on enterprise customers.
Churn Metrics
Churn is the rate at which customers cancel their recurring subscriptions. Say last month there were 100 active customers and this month there are 100 active customers. It could be that last month’s 100 customers have churned and 100 new customers have been added. So Churn is calculated based on cohorts or groups of customers.
Customer (Logo) Churn Rate: It is the percentage of customers who leave the company in a given period. If there were 100 customers at the beginning of the month and of those 10 have discontinued, the Customer Churn Rate is 10%. Customer Churn needn’t give the complete picture. Only a few customers might be contributing to a large part of the revenues or some of them might have downgraded to lower-priced plans. So Revenue Churn also needs to be tracked.
Gross Revenue Churn Rate: It is the percentage of revenue lost due to customers canceling or downgrading. It is calculated as the ratio of lost and contracted revenue to the revenue at the beginning of the period.
Net Revenue Churn Rate: While Gross Revenue Churn doesn’t include upsells and reactivations, Net Revenue Churn includes them. Net Revenue Churn, calculated as Lost revenue + Contraction revenue –Resurrected revenue – Expansion revenue, can be negative and it is a good thing. A negative Net Revenue Churn means the company’s revenue would increase because reactivation and upgrades would negate the loss due to customers leaving or downgrading.
Unit Economics
CAC: Customer Acquisition Cost (CAC) denotes the cost of acquiring a new customer. CAC is the ratio of Sales and Marketing costs over a given period to the number of customers acquired during the same period. CAC is an important metric to decide if we can make more money from the customers than what we spent on acquiring them.
LTV: Lifetime Value (LTV) shows the gross profit generated from the average customer over the entire period of their relationship. The higher the customer churn, the lower the lifetime value.
CAC Payback Period: This metric indicates the number of months it would take for the gross profit generated from the average customer to pay back the cost of acquiring that customer. Also called Months to Recover CAC, it is often used as a north star metric for sales and marketing.
Apart from these important KPIs, other ones for engagement (Daily Active Users, Monthly Active Users), customer success (NPS, Customer Satisfaction Score), and sales (Conversion Rate, Average Sales Cycle Length, Annual Contract Value), etc. can also be tracked. Altogether, they provide the levers to move the company forward.