Essential metrics for SaaS businesses
One of the important jobs that you have to take care of as a founder of a company is to know at any stage what the health of your company is.
Is it doing well, or just average? Or is it even in a bad condition and you need to take action before it gets worse? In order to have answers for these questions it is important that you keep track of some key metrics.
These metrics are also important if you are standing in front of (potential) investors. You will need those metrics to convince them that you are actually building something that they are looking for: A business that is scalable, repeatable and profitable money making machine.
Before we start, I want to make one thing clear: I am not a banker, investor or any kind of financial person. I started one or the other company, supported some others during their early stages and I'm just generally interested in SaaS businesses — both from the product as well as from the commercial perspective
Also, note that this is all about SaaS businesses. While the basics may apply to other types of businesses as well, not everything from a Saas business can be applied to for example an eCommerce business.
MRR/ARR: The primary metric
If you are starting out as a business, there is one key metric that you should care about: Revenue, MRR (Monthly Recurring Revenue) or ARR (Annual Recurring Revenue) to be exact. (I'm going to use MRR in the rest of the article but if you adapt properly, you can also go with ARR)
Why revenue? MRR delivers a real value that you can count on. Compare it to for example "email signups": While MRR represents something that actually had some benefit on your company, those signups are just saying that something it could potentially benefit your company in the future.
Also, the MRR, as the number already suggests, captures a recurring value. Since we are talking about SaaS businesses here, it is important that we have a metric that also indicates how repeatable the return of invest is.
Lastly, as a result of the MRR capturing a real recurring value, it can be used to gather feedback about the state of your business.
Note: While in most cases MRR will be your primary metric, sometimes it also makes sense to go for another value: DAU (Daily Active Users). If you for example build a magazine or a social platform it absolutely makes sense that you check how many users keep returning to your app. If your intention is to get paid for that service directly (not through ads), you will, however, return to MRR at some point (mostly when you start monetizing), so it makes sense to keep tracking both from the beginning.
When do you start tracking?
In the early days of your SaaS, it is absolutely okay to only track the recurring revenue. But the question is when exactly you should start tracking?
If you are still in the phase in which you try to define the problem that you are solving, then stick with that. At that point, nothing else matters.
But once you start building your product, you should start tracking. Even if the numbers are going to stay at 0 for the first period of time. Staring at that blank sheet of paper should trigger you to pink about who is going to buy your product and will make you work towards that launch day with less distraction.
The bigger picture
While it is absolutely fine to start out only tracking the recurring revenue it will only show one part of the picture.
Once you launched and your first customers have arrived it is time that you zoom out and keep an eye on multiple parts of your company. As a SaaS business, you want to grow. You want to grow exponentially. But at the same time, you have to make sure that you do not only focus on getting new customers but also get the best out of the existing ones and not lose them at all.
You keep track of that, the ARR/MRR is not enough anymore. That is when the next metric starts to become crucial:
Net New MRR
The Net New MRR is the sum of the MRR that came from new customers and new MRR generated from existing customers (expansion) minus the Churned and Downgrade MRR:
NEW MRR + EXPANSION MRR - CHURNED MRR = NET NEW MRR
Looking at that number you can figure out how healthy your company and at the same time have an indication of what part of your business is the reason for the current trend.
Is the declining growth causes by less new MRR or is your churn probably growing? could you probably improve by re-thinking your pricing model and thus improve your expansion MRR?
To answer those questions in-depth you start going for some secondary metrics. Those are heavily based on your business model.
But let me explain to you some common numbers that appear in most SaaS businesses.
The sales funnel
Attracting new customers is key to a SaaS business. While every company handles the flow from a lead to a closed deal in their own way, there are some numbers all of them have to care about
First of all, you have to make sure that you can generate leads on a regular basis. If the number of incoming leads drops, it will have an impact on the NEW MRR that you have in the end.
A lead on its own is however useless. It doesn’t matter that 100 people have signed up for your newsletter if in the end, nobody pays for your product.
At that point, it is interesting to find out why none of your leads get through the funnel. Figure out of the conversion rates and keep track of them.
How many of the email sign-ups actual click on the call-to-action in the e-mail? How many follow other steps you set up for them?
In the end, you also want to know what the size of the deal is that you close in the end.
100 leads x 50% conversion x 10€ deal size = 500€
100 leads x 5% conversion x 100€ deal size = 500€
If you compare the two calculations above you will notice that the deal size covers up the lower conversion rate. The numbers rely on your field of business and model but once you start comparing your own numbers you will notice if things change that should be taken care of.
And then you will start digging even deeper. How high are my costs per lead? Which channels and sources convert better than others? Why?
The whole funnel does not end once you have your paying customer. Is your customer a candidate for upgrades?
It is easier to convince an existing customer to pay more than getting a new customer. Keep a close eye on the costs and conversion in that part of the funnel as well.
At a certain stage, you should also start thinking about price increases. You can easily increase the price of your product by 1% every year. As explained above existing customers are resistant to those changes.
But make sure that you sell it accordingly. Do not publicly raise your price every year. Going from 10€ to 11€ to 12,50€ to 15€ in B2C could even let your biggest fans churn.
Instead, introduce changes that will enforce customers to upgrade. For example, if you have a tier for 5 users and one for more than 5 users and you see that over time a lot of customers grow to 50+ users, then introduce a new cap that increases the price for 50+ users. There won’t be many users that are affected now but soon you will reach better numbers through those upgrades.
Next to growth, there is profitability. It is as crucial to keep an eye on the profit as it is important to check your growth.
So once you have a working funnel you have to ask if that funnel is actually profitable.
There are two major metrics here: CAC, the customer acquisition costs, and LTV, the lifetime value of a customer.
And we have to make sure that the CAC are way lower than the LTV. You should reach fo a state in which your LTV 3x higher than your CAC.
The lifetime value of a customer is calculated out of 3 components:
ARPA, the average revenue per account (or customer), the gross margin and then the churn rate:
You see that the Churn Rate is extremely important for the result of the LTV.
When it comes to tracking the churn, you already track one: The Net MRR already tracks the Churned MRR but it is important to also keep an eye on the customers churn rate
Let say you have 2 customers: A paying 100€ and B paying 900€. If one of both churns you have a churn rate of 50% but if A churns the lost churn value is only 10% while it would be 90% if B churned.
Therefore, it is important that, together with the Churned MRR, you also track the two different churn rates.
These will be the indicators of losing money and customers.
On the other hand, you can also burn too much money when your lead generation machine is too expensive.
CAC will show you that immediately. It is the sum of all your costs of marketing and sales divided by the number of customers.
If that number is increasing, then go to the charts of the sales and expansion funnels and figure out where you burn the money.
A rule of thumb is that you should be able to recover from the CAC in 12 to 18 months. That means if your average deal size is 100€, your cost of customer acquisition shouldn’t grow higher than 1500-1800€. Otherwise, you will run into cashflow issues.
Note: cashflow and monitoring cashflow in a SaaS business is a topic on its own and would double the size of the already gigantic article. But in the beginning, keeping the CAC under control while growing should be sufficient.
There are definitely way more metrics you can look at especially if you dig deeper into every aspect.
But these are the metrics that should be enough in the beginning. Later, you will have people in charge of certain metrics like churn reasons, NPS, cost per lead and so on. They will then report how their metrics have an impact on the metrics you look at:
- Net New MRR
- New MRR
- Expansion MRR
- Churned MRR
- Lead Flow + Conversion Rate
- CAC (and its time to recover)
- LTV (and its relation to CAC)
- Churn (Customer and Money Churn)
What about products, though?
You might have noticed that this article does not contain any product-related metrics. There are a few stats that you could keep track of such as feature usage, costs per feature or mean time to failure but even though a SaaS should always be product-driven it is the commercial part that shows the symptoms of an unhealthy business. However, every clue that you get from your metrics should always lead to questions for the product: What can your product do to reduce churn? What can your product do to increase conversion? What can your product do to reduce CAC? And so on...