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Growth isn't easy, regardless of what kind of business you're running. SaaS companies have the added pressure of needing to sustain growth and retain customers over a long period of time. (Lucky us!)
That's because SaaS companies largely rely on future revenue. In more traditional business models, the majority of revenue is collected at the time of purchase, and retention (or repurchase rate, for e-commerce companies) makes up only a small percentage of revenue. For SaaS companies, revenue should be distributed more evenly across an extended period of time.
If a customer is unhappy, they'll quickly move on to greener pastures, causing you to lose money on the upfront sales and marketing investment you made to gain that customer in the first place. If too many customers are churning before you're able to earn back that investment—a time period often extending into months or even years—your business simply won't be sustainable.
This makes retention critical for SaaS companies. Decisions you make today drive future performance, and traditional business metrics aren't always able to account for the challenges of a business that relies on recurring revenue.
The key metrics for SaaS founders to understand, then, are all centered around generating future growth. Understanding key SaaS growth metrics like customer lifetime value, customer acquisition costs, and churn rates can make a big difference to your business down the line.
There are 2 types of churn you'll want to consider: customer churn and revenue churn. Customer churn measures the number of customers or accounts leaving your service each month as a percentage of your overall customer count. Revenue churn measures the amount of revenue paid by customers leaving your service each month, as a percentage of overall revenue.
For most SaaS companies, it's more helpful to measure revenue churn, since it provides a better indicator of the health of the business than customer churn.
For very early-stage SaaS companies, tracking churn isn't massively helpful—when you have only 100 customers, it isn't too difficult to find 2 or 3 new customers to replace those who have churned. However, as the company grows, minimizing churn becomes a much more critical goal. That 3% churn rate, translated to a million customers, means losing 30,000 customers every month. Replacing that many customers on a monthly basis is simply unsustainable.
Churn also compounds over time—a 3% monthly churn rate turns into a 31% churn rate when annualized, meaning you need to replace nearly a third of your entire customer base just to maintain the same revenue. The more customers you have, the more you need to invest in retaining those customers before you can even think about growing further.
There’s an argument to be made for reporting on “retention” rather than “churn” since they’re 2 sides of the same coin (positive thinking and all that), but the fact is, this metric becomes more urgent and more important when you’re losing customers. The goal is to get your churn rate down to a point where you can comfortably start talking about this metric in terms of customers and revenue retained, rather than lost.
Activation is arguably the most important SaaS metric of them all. This is even more true in a product-led growth model, in which the in-app user experience becomes a driving force for growth.
The moment of activation—experienced by the user as an aha moment in which they first realize your product’s value for themselves—differs from product to product. It often takes a combination of nuanced user journey mapping, user interviews, and behavioral analytics to discover which in-product actions correlate to long-term success and retention.
Once you’ve identified this critical moment in the user journey, you’ll want to optimize your user onboarding to shorten the time it takes new users to see value, activate, and begin adopting your product more deeply.
You can read more about how to find your product’s activation event here.
Monthly recurring revenue is a measurement of how much revenue your customers are generating in a single month. Multiplying this value by 12 months gives you the annual recurring revenue, or “run rate.” While you can work out your MRR manually, you can also use tools like ProfitWell to calculate all your SaaS metrics for you in real-time.
ARR = 12 x MRR
Recurring revenue is what makes the SaaS business model so appealing. As long as you continue providing value through your service, your customers keep paying you, each and every month.
Unfortunately, many young SaaS companies fall into the trap of undervaluing their services, and don't charge enough to make the business sustainable. By iterating on your pricing strategy until you're charging enough to allow consistent growth, your SaaS company can become self-sustaining much earlier.
CAC is a measurement of the amount you spend on sales, marketing, and other associated costs in order to acquire a new customer. You can work this out by taking the total amount spent on sales and marketing across a given month—including salaries and other related expenses—and dividing that by the number of customers acquired during that same period.
The cost of acquiring customers relates closely to the lifetime value you gain from each new customer—for a SaaS business to be viable, you need to be making more profit from your customers than it costs you to acquire them. In reality, the LTV needs to be much greater than the CAC to allow the business to stay profitable in the long run. A good rule of thumb is that lifetime value should be at least 3X larger than the amount spent to acquire a customer.
LTV > (3 x CAC)
One challenge facing many SaaS companies is that the cost of acquiring a customer is often much greater than the monthly revenue that customer generates—sometimes it takes months or even years to earn back that investment. Startups often find their growth is restricted by the amount they're able to spend on acquiring customers, and that cash flow is difficult in the first couple years.
Recovering the CAC quickly frees up cash flow that can then be reinvested into marketing—SaaS companies should be recovering this cost within 12 months to remain healthy.
Customer lifetime value (CLV or LTV) represents the total revenue generated by a customer over the lifetime of their account. The longer customers keep using your service, the higher their lifetime value will be.
At its simplest, the formula for CLV can be written as:
(Customer revenue x customer lifetime) - cost of acquisition and maintenance
Or you can go deeper, as HubSpot does:
(Average purchase value/average purchase frequency rate) x average customer lifespan
However you calculate it, customer lifetime value is one of the most important SaaS metrics that you can measure because it gives you a long-term perspective on customer engagement strategies, by allowing you to predict how valuable customers will be to your business over time.
One way to combat the inevitable effects of churn is to focus on expansion revenue. Expansion revenue covers increases in MRR (or one-time payments) when an existing customer upgrades to a more expensive plan.
Expansion revenue can actually push your effective churn rate into the negatives. First coined by David Skok, negative churn occurs when expansions or upsells exceed the value you're losing each month due to revenue churn.
Expansion revenue is often easier to gain, as well: It's much easier and cheaper to upsell customers to more powerful versions of your product than it is to acquire net-new customers. In fact, it’s 3X cheaper to generate expansion revenue than it is to acquire new accounts.
Shifting your goals from a model that narrowly focuses on net-new acquisition to a one that prioritizes expansion revenue can have a dramatic impact on growth. That’s why ProfitWell recommends that at least 30% of your revenue should come from expansions.
Unlike the financial metrics above, net promoter score is a direct measurement of how much value your customers are gaining from your product.
Measuring NPS allows you to quickly find out why customers might be dissatisfied and to use their feedback to improve your product. In the early stages of a SaaS business, the qualitative data gained from customer feedback can be helpful for determining whether you have product/market fit.
To measure NPS, you can survey your customers with a simple question: “How likely are you to recommend us to a friend or colleague?”
Customers can answer on a scale from 1 to 10, with 1 being the least likely to recommend and 10 being the most. Detractors—scores 6 or below—can then be followed up with directly to find out exactly what's making them unhappy with your service.
Now that you know which metrics actually matter, what do you do with them? How can you act on your measurements to improve your SaaS business? After all, collecting more data is only helpful if it helps you answer questions and take action.
The data that you collect for the key metrics above should help you find answers to the following essential questions:
For any business to be financially viable, it needs to be generating more money than it spends, and SaaS companies are no exception.
To review some rules of thumb, healthy SaaS companies should:
By following these rules of thumb, you'll ensure your company won't be losing money on every new customer, and that the company will begin seeing positive cash flow before you run out of capital.
A great strategy for improving cash flow and increasing average lifetime value is to encourage customers to sign up for a discounted annual subscription, instead of monthly. This makes the entire first year of payments available to the company immediately, while also saving the customer money on their subscription fees.
Here at Appcues, we offer a discount for annual subscriptions, to help encourage customers to take advantage of paying yearly.
Tracking changes in revenue churn can help identify when customers aren't happy with your product—if churn is rising each month or within a certain cohort, it's a strong sign something needs to change. To find out what changes you should make, your best bet is to talk with customers who have churned or are at risk of churning—tracking NPS can help identify these at-risk customers.
(Psst—Tools like Appcues can help you reduce churn through more effective onboarding, or measure your NPS scores and find opportunities for improving your user experience.)
In practice, not all customers are created equal—the metrics above can help you understand which customer segments are the most profitable, and how to best invest your resources and target your marketing messaging.
As mentioned earlier, earning more from your current customers is almost always easier and more cost-effective than acquiring net-new customers, so focusing on increasing expansion revenue pays off handsomely for most SaaS companies.
That said, if you want existing customers to pay more, you need to deliver an exceptional product experience. The metrics above can help you measure success at every stage of the user journey—but to move the needle, you need to attract, engage, and retain your users efficiently and sustainably.
The need to draw a clear line between the UX and your company’s bottom line is exactly why we developed the Product-Led Growth Flywheel—methodology for growing your business by making smart investments in the user experience.
And for more on becoming product-led, be sure to check out the Product-Led Growth Collective, where experts across the industry dish on the challenges they’ve faced and the lessons they’ve learned along their own path to product-led growth.
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