In my last two posts I explained why LTV:CAC and CAC Payback are the two most important metrics for SaaS startups and how to use them to interpret the health and potential of your business.
But what do we do if we need to improve either of these metrics?
Unfortunately there is no easy answer. There are limitless tools and tricks, but with imperfect information there is rarely an obvious ‘right’ answer. Even if there was, the right approach would be specific to each individual business situation, so there is no generic playbook for how to improve.
In practice you have to be constantly testing and adapting, seeing what works and what doesn’t. It is a on-going tactical and strategic battle.
However, in this article I will discuss some high level steps that may help you to forge an informed path and give yourself a fighting chance of making the right moves.
Step 1. Measure
It sounds obvious, but it’s amazing how many businesses don’t track their LTV:CAC and CAC Payback. We have already discussed why these metrics are important, and if you are not tracking how they evolve on a monthly or quarterly basis, you should be.
Of course for an early stage business you can expect metrics to move around quite a bit as you make changes and your business evolves. But by measuring LTV:CAC and CAC Payback, you can see how the changes you make impact the fundamental unit economics of your business.
More on the specifics of how to actually calculate key metrics in a later post.
Step 2. Measure some more
LTV:CAC and CAC Payback are nice, concise metrics that give you an academic read on the overall health and potential of your business. But they are not actionable. To understand how to act to improve either of these two key metrics, we first have to measure their constituent components.
CAC Payback is a function of sales and marketing spend, new Monthly Recurring Revenue (MRR)landed by the sales team, and gross margin.
LTV:CAC is a function of average MRR (sometimes referred to as Average Contract Value, or ‘ACV’), gross margin and gross churn.
The simplest way to track these components is using a Monthly Recurring Revenue bridge (‘MRR Bridge’) as laid out below.
Here you can see what your opening MRR was at the start of the month and what closing MRR you finished the month on. You can see how the change between opening and closing was driven by new MRR from new clients, expansion or contraction in MRR from existing clients, and finally gross churn, which is MRR lost due to clients who have left.
It is important to track your gross margin for the month and your sales and marketing spend. I also like to track the total number of customers.
More on the MRR bridge and how to use it to actually calculate your key metrics in a later post.
Step 3. Segment your metrics
Sometimes you can improve your key metrics just by shifting your mix of customers, products or channels, without having to think about driving change in any given component.
For example, you may find that the unit economics don’t stack up when serving customers below a certain size. You may decide to change your approach by cutting sales and marketing spend to that segment, or reducing their account management. In some cases, you could decide to just stop serving customers below a minimum threshold altogether — saying no can be a powerful tool.
But to make decisions about your segment mix, you first need to be able to measure the key metrics and their components at a segment level.
Segmented metrics is probably something I would only consider for later stage businesses (post Series B) because it only really makes sense if you have enough customers and use cases to segment meaningfully and if your product, and sales teams are sufficiently structured.
There are three common axes of segmentation.
1. Customer segments
The most common type of segmentation. Typically broken down by size (e.g. small, medium, enterprise), but sometimes by vertical or use case.
2. Channel segments
It can be useful to see how your key metrics vary by channel. For example, inside sales vs field sales vs re-seller partnerships, or online marketing vs direct mail. Also up-sell vs new sales.
3. Product segments
This is less common, but in some cases where you have different sales teams selling different products, it may be worth considering the economics of each product individually.
If you measure LTV:CAC and CAC payback for each segment you might find that one customer segment, or one channel, or one product group is pulling the rest of the business down. Conversely, it might be that you have one or two star segments with stellar economics where you should be focusing all your resources.
Step 4. Get tactical
You may decide that tweaking your segment mix is not the right approach and that you need to take corrective action to drive improvements in a specific component of your unit economics.
There are too many options, and the answer too dependent on the specifics of the commercial situation, to go into detail here. But below I have laid out some of the questions you might consider when trying to improve each component of unit economics. These suggestions are by no means exhaustive.
How can we increase average MRR (‘ACV’)?
– Is our product suite and pricing optimised to encourage cross-sell, up-sell and volume increases from our clients?
– Can we add functionality or features to drive more value for, and spend from our clients?
– Is our account management team properly structured and incentivised to deliver maximum value from our clients?
– In particular, how do we recognise and compensate up-sell vs the initial sale?
How can we increase gross margin (reduce variable cost to serve)?
– Can we streamline our processes or use technology to reduce delivery and support costs?
– Can we productise further to make the delivery and operations teams more efficient?
– How can we make our account management and support more scalable? Can we productise these services?
– Can we encourage more ‘self-help’ customer behavior?
– Are we offering too much support too cheaply to certain customer groups?
How can we reduce churn?
– Can the proposition be adapted to better serve high churn customer segments?
– Are there common reasons for churn and can they be fixed?
– Are there early warning signs of churn such as falling Net Promoter Score, or usage metrics?
– If so, can we implement processes to flag these signs before it is too late?
– Can we create more ‘sticky’ functionality and features or can we do more to become more embedded in our customers’ workflows?
– Can we see a high churn ‘bedding in period’ after which customers tend to stick around?
– If so, what can we do to increase engagement during this bedding in period to maximise the likelihood that a client becomes ‘bedded in’?
How can we increase sales efficiency?
In other words, how can we deliver more new MRR for the same or less sales and marketing spend?
– Is the sales team structure and compensation mechanism optimised to match our desired customer and product segments?
– Can we tweak the sales process and compensation structure to shorten the sales cycle and increase sales cadence?
– Can we adjust our terms to shorten the time from landing a sale to revenue recognition?
– Can we improve our training and recruitment processes to reduce the ramp-up time for new sales reps?
– What is the variability in sales rep performance, what can we learn from this?
– What does our marketing funnel look like and where can we improve conversion?
– Which marketing channels are most effective, how can we optimise for this?
– Can we unlock attractive new customer segments with pricing and proposition adjustments?
Over the last three articles we have seen the importance of LTV:CAC and CAC Payback and how they can be used to indicate the health and potential of a business. Finally we have considered ways of improving these key metrics.
In reality it is a constant tactical battle which is never over. There are limitless tools and options and no easy right answer. But a good starting point is to at least measure your key metrics and their constituent components so that you understand what is driving performance. If you have sufficient scale, it can be useful to segment your metrics to see if certain customer groups, channels, or products are holding you back or driving you forward. Finally, there are a whole range of levers you can pull to try to boost the different components of unit economics.
Originally published at www.smedvigcapital.com on March 6, 2017.