The software-as-a-service (SaaS) model has practically pushed out traditional software license sales. It’s likely one of the most common ways to organize your software development business. After all, it provides a steady source of recurring profit while providing your users with scalable solutions that can be easier to implement on their platforms. But at what point is your business actually going to turn a profit?
Just like with any other business management aspect, KPIs (key performance indicators) will be your best indicator of profitability. Let’s dive into some of the most common metrics you should already be tracking to set you up for success, how to determine their formulas, and how they may apply to your business.
Why Are SaaS Metrics Different?
Before we delve into the list, it can be helpful to understand why some concepts in “traditional” license sales can’t be transferred over to the SaaS.
A vast majority of SaaS models use subscription-based pricing, but the actual details (like whether you use pay-as-you-go, tiered systems, or flat rates) will be up to the individual company. Your customers (ideally) pay for your service for months or years at monthly prices much lower than traditional license sales. In return, you’re responsible for maintaining and updating the software as needed.
This creates a feedback loop where SaaS profits feed into developing the product further. By contrast, license sales use the profits to recoup the investments or loans, or provide a foundation for the next iteration of the software. Take PC operating systems, CAD software, or even Microsoft Office as examples of the latter.
The recurring revenue loop is the major differentiator between SaaS and other software licensing models and will be the basis of pretty much every metric you’ll need to track.
Metric 1 – Monthly Recurring Revenue (MRR)
Monthly recurring revenue is a prediction of how much revenue your company is receiving each month from subscriptions. Note that MRR is an estimate of the revenue based on the current status of your subscriptions and clients and doesn’t take into account “one-off” payments like consultation fees, installations, or other services.
The simplest possible formula you might have for calculating MRR is:
MRR = Number of subscribers * Subscription cost
As a simple example, an app that you’ve priced at $4 per month will get an MRR of $60,000 if you accrue 15,000 customers.
Unfortunately, MRR is seldom this easy to calculate, as there are a few different variables you might have:
- You might have different subscription “tiers,” at which point you’d use a “SUMPRODUCT” function (as it’s called in Excel and other similar software) of the respective levels and how many clients you have at that tier.
- If you’ve implemented a yearly subscription model, the payment might go through only once a year, at which point you’d have to divide it by 12 to get the average monthly revenue for that subscription type.
- Sales and promotions can also greatly affect the monthly recurring revenue, as you need to track the exact per-month revenue per customer.
Perhaps the more important metric to track is the delta MRR, or month-over-month change of the revenue, typically in a series chart. This KPI will indicate whether your revenue has grown or fallen, which could prompt a deeper investigation.
A similar metric to the MRR is the annual recurring revenue (ARR), which lists the yearly total revenue based on the same factors. In this case, the ARR assumes that all customers will subscribe for at least a year.
Metric 2 – Revenue Growth Rate
The revenue growth rate uses the MRR for two consecutive months or the ARR for two consecutive years and calculates the percentile change between them:
RGR = (Current RR - Previous MRR) / Previous RR * 100.
The growth rate is a useful metric to gauge your company’s growth. Typically, the underlying change will come from two sources:
- Onboarding new customers
- Existing customers switching to a higher-paying tier
The growth rate is displayed in percentages, and in most cases, you can color-code positive and negative growth to easily get an overview of the months where you had a lower recurring revenue than usual.
Metric 3 – Customer Acquisition Cost (CAC)
CAC is arguably one of the most important metrics to determine before the business takes off, as it accounts for the entire marketing and sales effort that needs to happen before you get a customer. In simple terms, CAC is the total cost of your marketing and sales campaigns (including salaries and contractors, etc.), divided by the number of customers you gained from the campaigns.
In general, CAC is only really useful when you look at a specific campaign or a period.
CAC = Total costs of marketing and sales / New customers over a period
Unlike most other metrics where higher equals better, you want the CAC to remain relatively low. This indicates that you don’t need to expend much effort (or budget) to onboard customers. On the other hand, a high CAC can indicate a failing campaign.
By itself, CAC can also be a somewhat deceptive metric, as it doesn’t display the revenue you’re receiving from those customers. That is why it’s often best to use it as a comparative metric with other ones, such as MRR or the customer lifetime value (which is next on the list).
Metric 4 – Customer Lifetime Value (CLV)
Customer lifetime value, also known as long-term value or LTV, is the gross revenue you expect to receive from the average paying client.
CLV = Average duration of subscription * MRR per user
Tracking the CLV is key to determining the viability and scalability of your endeavor. More precisely, the ratio between the CLV and the CAC (CLV/CAC) is what determines whether your company can succeed. In this case, you’re looking at four scenarios:
- CLV/CAC<1 means that you’re generally spending about the same or more money on acquiring new customers than they’ll ever pay for your platform. It is a red flag that something is seriously wrong with your offer, marketing, sales tactics, or anything in between.
- CLV/CAC at around 1 is generally considered the break-even point, at least on paper. In reality, you’re likely also paying taxes and other costs that aren’t in the CAC calculation, so your business is running in a deficit.
- CLV/CAC at between 2 and 4 is considered great, with most companies wanting to stay at around 3. This means that for every buck you spend on marketing, you’re earning three from your customers.
- CLV/CAC at 4.5 and over means that you might not be tapping into your marketing properly. It might look like you don’t really need to expend any effort to market your service, but it also might mean that you’re closing yourself off to wider audiences.
Metric 5 – CAC Payback Period
This metric calculates when the revenue from a customer “breaks even” with the investment involved in onboarding them to your service.
For example, if you spend $300 on CAC and your subscription is $25, it would take 12 months for the subscription to become worth the investment (as 300/25 is 12). In other words, any subscription that lasts less than 12 months in this case would be a waste of your time and money.
Of course, this is a general simplification, and most businesses should expect the CAC payback period to be around six months. A payback period that’s too long indicates that your marketing and onboarding methods are ineffective. On the other hand, if you have a solid calculated CAC payback, and yet your customers keep leaving before that, you need to look into customer retention figures and methods to see what can be improved.
Metric 6 – Churn Rate
No business keeps all of its customers forever, and the same will go for yours. And while it’s normal to lose a few clients here and there, there are a few possibly concerning reasons for losing them en masse.
The churn rate is the percentage of lost subscribers during a certain period.
Churn rate = (Customers lost during the period / Number of customers at the start of the period) * 100
For example, if you had 10,000 subscribers and lost 500 of them in a month, that’s a monthly churn rate of 5%.
Note that the churn rate doesn’t account for the customers gained during a period – it only uses the value at the start of the period being counted and the number of lost customers. It focuses only on determining how many existing customers are unsubscribing so you can dig into the reasons why.
In general, a monthly churn rate of around 2% to 5% and an annual churn rate of 10% to 20% are acceptable.
Metric 7 – Gross Margin
The gross margin is the simplest way to determine how profitable your business truly is. It’s the difference between your revenue and the total costs of goods sold, divided by the revenue. For SaaS models, that means the infrastructure, services, and manpower required to create, deliver, and implement the service for your customers.
Margin = (Revenue – COGS) / Revenue (times 100 for percentages)
A margin of around 70% is considered healthy and allows you to reinvest the profits into growing the company, expanding your range of services, paying off debts and loans, or other administrative expenses.
The SaaS sector as a whole typically has larger margins than many others due to lower variable costs once the service platform has been built. With the platform created, there’s very little difference between scaling it to serve thousands or tens of thousands of users.
Metric 8 – Net Promoter Score (NPS)
The last metric you might be interested in is a social one, and it determines how likely your customers are to promote your service to others. The score is typically based on surveys that you’ve probably already seen before, asking for a value between 0 and 10 on how likely a customer is to recommend the service.
In most cases, people who respond with 9 or 10 are considered “promoters,” while people who answer 0 to 6 are considered “detractors.” All other answers are considered “passive users,” meaning they’ll keep a subscription but you shouldn’t expect much from them in terms of social promotions. You might think that the scoring is lopsided to the high ratings, and you’d be right. But that’s a general feature of all pointed rating systems (just look at Amazon for an example).
Then, the NPS is calculated as the percentage of promoters minus the percentage of detractors in your survey pool. The NPS score can range from -100 to 100, and anything above 0 is considered good (meaning that there’s a positive word of mouth surrounding the platform). An NPS score of 50 or above is typically excellent.
