5 Metrics to Evaluate any SaaS business Effectively
A quick and easy framework forged after speaking to multiple SaaS companies over time
The title is almost self-explanatory, let’s get to it.
#1 Monthly Recurring Revenue (“MRR”)
Monthly recurring revenue (MRR) is income that a business can count on receiving every single month, and can be simply calculated by multiplying total number of paying users by the average revenue per user (“ARPU”).
MRR = # paying users x ARPU
If we do a deep dive of MRR over time, we see that MRR can actually be broken down into 4 different sub-metrics:
1. Existing MRR: # of existing customers (last month) x ARPU
2. New MRR: # new customers x ARPU
3. Expansion MRR: # of existing customers x Nominal Increase in ARPU. An example:
- 5 existing users sign up for your basic package at $120 / year. In the next month, he signs up for the premium package, which costs $200 / year
- In this case: Expansion MRR = 5 customers x (200–120) / 12 [remember we are calculating monthly recurring, and the pricing stated here is in annual terms]
4. Churn MRR: Decrease in existing users x ARPU — these are customers who fail to renew their existing subscriptions
#2 Churn and Product Stickiness
We’ve spoken briefly about churn in #1. It is important to analyse the churn rate on your SaaS platform, primarily because additional costs have to be funneled back into the business to acquire new customers. The higher your churn, the more you’ll have to spend acquiring new customers.
To calculate churn rate, look historically across a period of n months (typically across a year), and divide the total lost customers over the period by the number of customers you had on the first day of the period.
Churn Rate (%) = Churned Customers (from t=n-12 to t=n) / # Customers (at t=12)
There are more detailed ways to calculate churn. This article from Profitwell explains 3 other detailed ways to calculate churn.
Product stickiness is almost the opposite of churn. How long of a period do customers usually sign up for? Do they commit payments for up to a year upfront? How often and how many of them renew their subscriptions? We will dive more into this when we look at #5 — Retention Cohorts
#3 Customer Lifetime Value (“CLTV”) to Costs of Customer Acquisition (“CAC”)
Customer LTV is the amount of revenue generated across the lifespan of a customer. This can also include other one-time fee, such as consulting and integration fees.
To evaluate the average lifespan of a customer, look historically to see how long an average customer stays on your platform
CLTV = # MRR x Average Customer Lifespan + other one-time charges
Costs of customer acquisition typically encompasses the following:
- Marketing expenses (FB and Instagram ads, AdWords)
- Payroll of sales and business development staff hired
CAC for each customer is calculated by taking:
Total CAC spent for the month / New customers acquired during the next month
Other sources may prefer to divide both total CAC and new customers acquired on the same month. The above method accounts for a time lag between marketing costs and the actual customers onboarded as a result of marketing efforts. This will make a lot more sense as we look into each SaaS’ sales cycle (#4)
CLTV / CAC
This metric gives you clarity on the overall return on expenses related to customer acquisition. As an industry standard, a CLTV/CAC of more than 3x would serve as a benchmark for a healthy return on customer acquisition costs.
#4 Sales Cycle
It is important to understand the time it takes to onboard a new customer. This varies on your business model. For B2B SaaS, sales cycle might last for 2–4 months, or even up to a year, depending on the contract size. You should also factor onboarding time, as this would count as a cost to your overall profitability. Sales cycles for B2C SaaS are generally shorter, compared to B2B
#5 Retention Cohorts
Retention cohorts break users down into groups based on the time they onboard your platform. Such analysis measures the percentage of active users over time, which makes it easy to understand user patterns in terms of platform usage and engagement.
Retention over time varies based on the industries you operate in. In games, for example, users generally remain active during the first few months of usage, and typically fall off the platform after that. Large enterprise SaaS solutions typically show strong retention, given they often undergo a huge onboarding exercise to integrate your solution into their operating activities
This framework has been forged as a result of speaking to multiple SaaS companies over time, and serves as a useful guideline in evaluating profitable SaaS businesses.