Understanding SaaS Metrics: Key Insights for 2024

Hey everyone, welcome back to another week at Code Economics. Today, we will dive into Software as a Service (SaaS) metrics.

Understanding these metrics is crucial for anyone involved in SaaS businesses, from founders and executives to employees and investors. These metrics provide the insights you need to measure performance, make informed decisions, and drive growth.

Today’s Current Environment

We had an earnings season recently and many key SaaS companies took brutal hits in the public markets. Salesforce (CRM 0.00%↑) was the first to take a hit of 20% after its earning call in after-hours trading.

This is significant to the greater SaaS market because of Salesforce’s position as the largest pure B2B SaaS in the world. Salesforce was built during the rise of cloud computing and was one of the first companies to capitalize on it. It established itself as a SaaS leader when it was the first company to hit $1B ARR.

This drop came after its first reported earnings miss since 2006:

Why SaaS Metrics Matter

To understand the drop that Salesforce experienced and the general slump occurring across publicly traded SaaS businesses, you need to realize that SaaS businesses operate on a recurring revenue model, which makes traditional business metrics like one-time sales revenue less relevant. Instead, SaaS metrics focus on recurring revenue, customer retention, and the efficiency of sales and marketing efforts.

Key SaaS Metrics to Monitor

1. Monthly Recurring Revenue (MRR) and Annual Recurring Revenue (ARR)

• MRR: The total predictable revenue generated by customers in a month.
• ARR: The total predictable revenue generated by customers in a year.
• Why It Matters: This is perhaps the most important metric in SaaS and most companies’ “north star”. MRR and ARR provide a clear picture of the revenue generated from subscription services, which is fundamental for financial planning and growth projections. Typically when we look at the growth rate, we calculate the difference between the last 12 months (LTM) of ARR compared to the next 12 months (NTM) of ARR.

2. Customer Acquisition Cost (CAC)

• Definition: The total cost of acquiring a new customer, including marketing and sales expenses.
• Calculation: (Total Sales and Marketing Expenses) / (Number of New Customers Acquired)
• Why It Matters: CAC helps businesses understand how much they need to spend to attract new customers and assess the efficiency of their marketing and sales strategies. In the current environment, SaaS companies need to cut their spending where they can. Driving CAC down is critical in a higher interest rate environment.

3. Customer Lifetime Value (CLTV or LTV)

• Definition: The total revenue a business can expect from a customer throughout their relationship.
• Calculation: (Average Revenue per User (ARPU) * Customer Lifetime (in months or years))
• Why It Matters: LTV helps determine the long-term value of each customer and whether the business model is sustainable. A higher LTV relative to CAC indicates a profitable growth strategy.

4. Churn Rate

• Definition: The percentage of customers who cancel their subscriptions during a given period.
• Calculation: (Number of Customers Lost During Period) / (Total Customers at Start of Period)
• Why It Matters: Churn rate indicates customer satisfaction and retention. A high churn rate can signal problems with the product, customer support, or competitive pressures. Remember, churning $1 is way worse than earning $1 incremental dollar of ARR because that is $1 from a customer you are likely not getting back + you miss out on all future upsells with them. Excellent companies should have less than 10% churn in a given year.

5. Net Revenue Retention (NRR) and Gross Revenue Retention (GRR)

• NRR: The percentage of revenue retained from existing customers, including upsells, downsells, and churn.
• GRR: The percentage of revenue retained from existing customers, excluding upsells and downsells.
• Why It Matters: These metrics show how well a company retains and grows revenue from its existing customer base. High NRR and GRR are indicators of strong customer loyalty and effective account management organizations. Best-in-class metrics for these are around 120% for NRR and 90% for GRR.

6. Average Revenue Per User (ARPU)

• Definition: The average revenue generated per user or customer.
• Calculation: (Total Revenue) / (Number of Customers)
• Why It Matters: ARPU helps businesses understand the revenue contribution of each customer and track the effectiveness of pricing strategies and upselling efforts. This metric is not always relevant for SaaS products with alternative billing models like consumption-based pricing systems.

7. Monthly Active Users (MAU) and Daily Active Users (DAU)

• MAU: The number of unique users who engage with the product a month.
• DAU: The number of unique users who engage with the product a day.
• Why It Matters: MAU and DAU are indicators of user engagement and product stickiness. Tracking these metrics helps businesses understand how often customers use their products and identify trends in user behavior. Customers are way less likely to churn if they are actively using your product.

8. Payback Period

• Definition: The time it takes to recover the cost of acquiring a customer.
• Calculation: CAC / ARPU (usually measured in months)
• Why It Matters: A shorter payback period means quicker recovery of acquisition costs, which is essential for cash flow and reinvestment in growth. Good payback periods are typically anything under 18 months and anything under 12 months is genuinely exceptional.

9. Burn Rate

• Definition: The rate at which a company spends its capital to finance operations before generating positive cash flow.
• Calculation: (Monthly Operating Expenses) — (Monthly Revenue)
• Why It Matters: This is more specific to venture-backed businesses than SaaS specifically, but SaaS companies are built with the idea of growing fast initially, building up a large user base with stable ARR, and then converting that into free cash flow (FCF). This typically means that SaaS businesses aren’t profitable for years until they have built up a large user base, so it is important to see the burn rate to ensure the company has enough runway to make it to profitability.

10. Customer Satisfaction (CSAT)

• Definition: CSAT measures the level of satisfaction customers have with a product or service. It is typically gauged through surveys that ask customers to rate their satisfaction on a scale (e.g., 1 to 5 or 1 to 10).
• Calculation: (Sum of all customer scores) / (Number of respondents)
• Why It Matters: CSAT provides direct feedback from customers on their experience and satisfaction with your product or service. Usually, companies with low CSATs can attribute this to buggy software, poor customer service, or misleading initial marketing.

11. Net Promoter Score (NPS)

• Definition: NPS measures customers’ likelihood of recommending your product or service to others. It is obtained through a survey asking customers on a scale from 0 to 10.

• Customers who give a 9–10 are considered promoters and likely to share your product, passives are not factored into the calculation, and detractors are any customers who have not had an excellent experience and are unlikely to say positive things about your product.
• Calculation: (% of Promoters) — (% of Detractors)
• Why It Matters: NPS is a strong indicator of customer loyalty and potential for organic growth through word-of-mouth referrals. This is a very powerful metric especially as you move to larger enterprise customers as the referrals of other large organizations with good experiences (promoters) are very important.

SaaS Valuations in 2024

Now that we have covered a list of metrics we can use, we can start valuing SaaS businesses. These are typically valued as some multiple of enterprise value (EV) divided by their NTM ARR.

Here is a screenshot from Clouded Judgement which shows the top companies in terms of ARR multiples. These are the companies investors are willing to pay a premium for. These are all sophisticated tech products or platforms, with very sticky businesses. The benefit of sticky SaaS products is that once you have a large customer base, you will have a fairly stable ARR with very low churn.

You can see the growth rates of all these businesses are fairly high. Crowdstrike is the king with 30% growth to their ARR while having over $800M in revenue a quarter.

So what went wrong with Salesforce?

The issue is slowed growth, despite investment into AI. The common theme this earnings season is that capital expenditures into AI features have not driven revenue growth for most companies.

While Nvidia (NVDA 0.00%↑) just hit an astounding 3T market cap from selling AI computing, it has not resulted in growth for its customers as much. If you want to learn more about the AI boom that is happening, I recommend reading last week’s post if you haven’t already:

What you should know about the Generative AI Boom

AI Bubble?

It seems likely that we are in a bit of an AI bubble, where everyone is rushing to ensure they are not left behind. This has resulted in unbelievable investments in AI, especially in computing.

Companies like MSFT 0.00%↑ and GOOG 0.00%↑ are two of the leaders in CapEx for AI, but what about other SaaS companies? It doesn’t seem to have translated as well for them,

The EMCLOUD index on the Nasdaq is down over 8% YTD, despite the SPY 0.00%↑being up 13% YTD. It seems that NVDA 0.00%↑ is making most of the money in AI as the sole proprietor of CUDA-based GPUs.

Conclusion

Understanding and monitoring key SaaS metrics is essential for the success of any SaaS business. These metrics for valuing software businesses are critical for any investor or employee of one of these companies to understand.

The public current SaaS environment has been relatively choppy since the Federal Reserve has raised interest rates. So far, AI does not appear to be the savior SaaS needs to satisfy public market investors who are more interested in FCF than growth.

Stay tuned and subscribe to my Substack for more updates coming soon!