- SAAS BUSINESS MODEL
- THE MARKETING FUNNEL
- KEY METRICS
- Customer Acquisition Costs (CAC)
- Average Revenue Per Customer
- Monthly Recurring Revenue (MRR)
- Average Customer Rate of Return
Introduction / Challenge
In order to properly estimate and plan their marketing and operating costs, software as a service (SaaS) and other subscription/recurring revenue models, require metrics that are different from these of traditional businesses.
SaaS often face early cash flow problems because it has to invest heavily and upfront into customer acquisition but recovers profits from that investment only over long periods of time.
Additionally faster a business decides to grow, the worse its losses become since their revenue comes over an extended period of consumption (the customer lifetime). This creates a fundamentally different dynamic from a traditional business model where customer lifetime value, satisfaction, retention and churn metrics are key for proper planning.
Often many investors/board members/marketers have problems with proper evaluations of their marketing ROI and want to hit the brakes precisely when they should be hitting the accelerator or vice-versa.
SaaS Business Model
SaaS has typically a lower initial setup cost than the equivalent enterprise software and is often priced per user, available features, number of events or processors required.Over the last 10 years the acceptance and growth of SaaS solutions has been facilitated by a number of technology landscape changes:
- The growing use of web-based user interfaces
- The increasing popularity of web development as a practice.
- The standardization of the HTTPS protocol as an universally available lightweight security.
- The wide adoption of lightweight integration protocols such as REST and SOAP that enabled integration between cloud-based SaaS and internal applications
The relatively low cost for setting up a new customer enables SaaS vendors to offer applications using the freemium model, often with limited functionality or scope, and fees are charged for enhanced functionality or larger scope.
Some SaaS applications are completely free to users, with revenue being derived from alternative sources such as advertising.
A key driver of SaaS growth is vendors’ ability to provide a price that is competitive with on-premises software. This is consistent with the traditional rationale for outsourcing IT systems, which involves applying economies of scale to application operation, where an outside service provider may be able to offer better, cheaper, more reliable applications.
There are generaly two kinds of SaaS business:
Those with primarily monthly contracts, with the primary focus will be on MRR (Monthly Recurring Revenue)
Those with primarily annual contracts, with some contracts for multiple years. Here the primary focus is on ARR (Annual Recurring Revenue), and ACV (Annual Contract Value).
Churn rate refers to the proportion of contractual customers or subscribers who leave a supplier during a year or a month.
An acceptable churn rate is in the 5 – 7% range. Studies show that roughly 70% of SaaS companies had annual churn in the < 10% range, with 75% of those at 5% or under. So If you have a high churn rate (10% >) there’s something fundamentally wrong with your product. Don’t worry about growth or marketing at all. Instead, get back into your product and fix the problem. And to figure out what the problem is, start talking to your customers.
Getting your churn rate under control is the first critical step toward building a sustainable SaaS business.
Monthly vs. Annual Churn Rates:
5% – 7% annual churn – the good churn rate – translates to 0.42 – 0.58% monthly churn.
This means companies with acceptable churn only lose about 1 out of every 200 customers (or dollars) per month.
Customer Acquisition Costs (CAC)
CAC allows you to measure how much it costs you to acquire your new customers and how long it will take for your company to recoup this investment. As we all know, new revenue from marketing and sales initiatives aren’t recognized until 3 to 4 months after the onboarding process. Wrong marketing channels can quickly ruin profit margins. The only way to avoid this is to track the cost per acquisition of campaigns.
CAC = (marketing + sales) /nb acquired customers
This will give you the average amount that you spend for each new customer.
Cost per acquisition for individual marketing campaigns will require customer analytics. Most CRMs or social media marketing software will do the job. You will have to pull data on how much you’ve spent which is usually in many different places and you will need to track campaigns over the long term to see which ones actually bring you customers.
Average Revenue Per Customer
Pretty straightforward. It’s the average revenue you’ve already received from your customers.
Monthly Recurring Revenue (MRR)
MRR is the expected received amount every month. It is the primary benchmark for progress and sustainability of the business. MRR is calculated by totalling the monthly fees paid by all of your customers.
As you start to scale, you need to understand the changes that occur in your MRR over previous months. These changes can be caused, positively or negatively, by three factors:
Churned MRR: The amount of MMR lost from cancellation or downgrades by customers
New MRR: A number of new clients you have signed
Expansion MRR: Additional recurring revenue from your existing customers in the form of upgrades to plans or recurring add-ons.
Customer Lifetime Value (CLTV)
Average subscription length x average mthly revenue per customer.
Ideally, factor in support and acquisition costs to see if the customer is profitable in the long run.
If your CLTV is high in comparison to your CAC, you have the room to scale, potentially without additional funding.
It’s important to remember that in scale up, you don’t want to be resting on your laurels with your CLTV. You need to be building in those up-sells and cross-sells to ensure that your CLTV is constantly increasing across your client base. New releases, new products or a move to your premium plan, will all help to increase LTV and in turn, MRR.
Average Customer Rate of Return
Average Customer Rate of Return = ARR – ACS / CAC
ARR: average recurring revenue per customer
ACS: average recurring cost of service per customer
CAC: average customer acquisition cost.
Customer rate of return is a powerful metric because it measures the economics that make a SaaS business work or not.
The Marketing Funnel
Every business also needs to track its marketing funnel. Here’s what one looks like for a SaaS business:
Visit Your Site
Freemium or Free Trial Sign up
Activation (use the core feature of your product for the first time)
Upgrade to Paid Plan
Here’s what your a conversion funnel should look like:
Visited Site 2.8%–> Signed up 25%–> Activation 14%–> Billed (0.1% of total)
Make sure you’re tracking the number of people who move through each step it takes to become a customer. This will help you understand which part of your marketing system needs to be improved the most.