CAC, LTV, CAGR, ARR, MRR, ACV, Churn -- several acronyms and terms float around when it comes to SaaS KPIs. With SaaS expected to generate over $150 billion in revenue in 2021, this number is just going to increase.
It can be confusing, and at times overwhelming. Even for the seasoned pros. Then there is the problem of mistaking SaaS KPIs with software company KPIs.
This is why we are here to demystify the acronyms and get you up to date on the five most important SaaS KPIs.
Not everything that can be counted, counts.
Albert Einstein was not talking about KPIs, but he might as well have been. Just because it can be measured doesn’t mean it ought to be. This is why we have a list of the five most important SaaS metrics that directly impact business.
Other KPIs are helpful for specific functions, like sales KPIs or eCommerce KPIs. However, we will stay focused on SaaS KPIs in this article.
Whether you are in B2B SaaS or B2C SaaS, tracking these 5 SaaS metrics will help you align your actions, objectives, and spend the right way and keep your business moving forward.
By the time you are finished with this article, you would have:
- Developed an understanding of the top 5 SaaS KPIs for both B2B and B2C
- Learnt SaaS KPI calculations and how to use them
- Known why generic software company’s metrics and SaaS metrics are different
- The bragging rights in your group because you are now a SaaS expert :)
5 Most Important SaaS KPIs
So let’s not keep you waiting and let us jump straight to the five most SaaS KPIs to track.
Churn is the rate at which you lose customers. A straightforward way to calculate churn is:
Churn Rate = No. of lost customers/ No. of customers at the beginning of the month
So if you had 10 customers at the beginning of the month and acquired 15 new customers in the month, and you lost 5 customers, then your churn rate for the month would be 0.5, or 50%.
What this means is that you lose about half of your customers every month, and next month you can expect to lose 10.
Why you wonder, do we start with this metric?
SaaS is all about recurring revenue. And you’d only get recurring income if you retain your customers.
While it is impractical to aim for a 0% churn rate, you should be focusing on this metric right from the get-go, else you’d be spending loads of cash in acquiring new customers without ever seeing the benefit.
A healthy churn rate for the business results in better monthly recurring revenues, or MRR, the next SaaS KPI on the list.
Monthly Recurring Revenue - MRR
MRR is a measure of how much you are making each month from the customers. The income does not include booking revenue or one-time revenue. MRR is repeat revenue from your customers each month.
So if you have a subscription model, then:
MRR = (No. of existing customers + No. of New Customers - No. of Lost Customers) X Monthly subscription fee
The formula is also represented as:
MRR = No. of active customers X Monthly subscription fee
It is apparent from the above MRR formulas that:
No. of active customers = No. of existing customers + No. of New Customers - Churned Customers
Let’s assume that your monthly subscription is $10.
If you had 10 existing customers, and you acquired 15 new customers in a month, and you lost 5 customers, then your MRR would be:
MRR = (10+15-5) X $10 = $200
A growing MRR is an indication of a growing business. A stagnant or declining MRR, though, has to be acted upon in earnest by the company.
MRR extrapolated over 12 months becomes the ARR (Annual Recurring Revenue).
The general formula for MRR would be:
MRR = No. of active customers X ARPU
ARPU stands for Average Revenue Per User per month. It is also known as ARPA (Average Revenue Per Account).
Customer Acquisition Cost - CAC
As the name suggests, this is the cost of acquiring a customer. The cost here refers to the cost of goods sold or the cost of sales and does not include fixed costs or expenses that do not directly contribute to customer acquisition.
To give you an example, if you spend $500 in running a marketing campaign that helped you gain ten new customers, then these $500 will be counted for calculating CAC. The CAC will be:
CAC = $500/10 = $50 per customer
You would not include the office rent and employees’ salaries in this calculation. Why? Because they are going to be there even if there were zero sales. So they are not contributing to customer acquisition and hence should not be included.
With the above understanding, the formula for Customer Acquisition Cost would be:
CAC = Cost of Sales / Customers Acquired
Please note that this is a time-based number and will vary depending on the period you choose.
Great. So we know how to calculate CAC. But how do we use it?
For starters, CAC going down over a period of time is usually a good indicator. But what you want to measure in SaaS is how much revenue you make from your customer until they are with you and how it compares to the acquisition cost. This brings us to the next KPI - LTV or Life Time Value.
Life Time Value - LTV
SaaS is about generating recurring revenue. While there are some SaaS business models which follow one-time revenue, that is not where SaaS shines.
So how does LTV come into the picture?
LTV or Life Time Value of a customer is the total revenue you expect to generate from any given customer. So if you have a customer who pays you $10/month, and is going to be your customer for the next five years, then the LTV of this customer would be:
LTV = $5 X 10 X 12 = $600
Of course, you cannot predict how long a particular customer will stay with you with absolute certainty. The question then is how to calculate the life of a customer?
This is where “Churn” comes into play. Remember we learned what churn is and how it is calculated earlier? Well, the customer life can be defined in terms of churn rate as follows:
Customer Life = 1/Churn Rate
Therefore, it follows that:
LTV = ARPU X Customer Life = ARPU / Churn Rate
Here ARPU is the average revenue per month (we learned this in MRR above).
Let’s spend a few minutes understanding this.
Churn is the rate at which you lose customers. So if you see that your average monthly churn rate is 1%, the chance that a customer will leave any given month is 1%. However, since 1% of customers are leaving each month, each month the pool grows smaller. In 100 months or around eight years, the customer pool will be down to zero.
This applies to all customers that you have now.
So you can say that your customer lifetime in this scenario is:
Customer Life = 1 / 0.01 = 100 months
So if your average revenue per customer is $10 (your monthly subscription fee) and your churn rate is 50%, then:
LTV = $10/0.5 = $20
However if your churn rate is say 10%, then LTV would be:
LTV = $10/0.1 = $100
LTV to CAC Ratio
Now that we understand Churn, MRR, CAC, and LTV, let’s move to the most crucial KPI that you want to track: LTV to CAC ratio.
The formula for the ratio is pretty simple.
LTV:CAC = LTV / CAC
Why is this important?
This ratio helps you understand if you will grow as a business or not in the long run. This is an indication of unit economics being correct or not.
If your LTV:CAC is less than one, it means that you are unable to recoup your costs in full.
If your LTV:CAC is equal to one, it means you are breaking even and will not have enough cash in the future to sustain your business, as other costs will take their toll.
If your LTV:CAC is greater than 1, then you are growing, and eventually, not only will you break even, but also be profitable. However, you still need to watch out for growing costs elsewhere, like increasing office rent or employee salaries.
If your LTV:CAC is greater than 3, then you are growing at a fast rate. Great news. Keep up the excellent work, and make sure you keep up with customer demands to keep your churn low.
Word of Caution
So there you have it—the five most important KPIs for a SaaS business.
However, you must remember that obsessing over KPIs doesn’t improve your business. Good business practices and fundamentals improve your KPIs and not the other way around.
KPIs help you to measure the effect. They should not be mistaken for causality.
Do not be driven by benchmarks that work for other businesses. Remember, each business is unique.
Measuring the right things helps you guide the business towards the desired direction. But you set the pace. And you decide what success is. Don’t let empirical benchmarks get in your way.
What is the difference between software company KPIs and SaaS KPIs?
Software companies need not necessarily follow the SaaS model. They could be a service provider, wherein the critical metrics for them could be no. of hours clocked by each employee for a client and not the churn rate.
The business model, and not the industry, dictate the critical metrics for a company. So it is possible to be a software company and not have a need to measure SaaS metrics.
And that is a wrap. We covered the following five most important KPIs for a SaaS business:
- Churn Rate
- LTV to CAC Ratio
We learned what these metrics are, how they are calculated, and their significance to a SaaS business. I hope you found these useful. Of course, understanding financial reporting is just as important as tracking other vital metrics and must not be overlooked for any business. So better keep a close eye on general financial KPIs at all times in addition to the above.