Mapping Key Metrics to SaaS Growth Stages
It’s quite easy to get overwhelmed by the number of metrics a SaaS founder is supposed to measure. But, we must first keep in mind that the fundamental reason behind keeping track of metrics is to answer questions related to business growth. Coming to the growth part, it’s really tough to build a profitable SaaS business; or as Jason Lemkin puts it – your need to give at least 24 months to get to the initial traction. That means priorities change with time – at one point you’d like to know whether the business is growing or not, and at another point you’d have a different set of questions: “how fast is the business growing?”, “where is the growth leakage?”, “what type of customer is most profitable for me?”. Essentially as a SaaS business evolves and passes through different stages of growth, the questions related to growth increase and become more complex. It’s imperative to focus on the metrics that help you check the pulse of your business at each stage of growth and weed out the vanity metrics.
Now, let’s first lay down each stage of growth:
We’ll be mapping metrics to the above-mentioned stages. Before proceeding let’s look at the two key points related to SaaS metrics:
- In the very early stage or early stages, the metrics tend to be more qualitative than quantitative. These stages are more about getting high quality customer feedback and gaining deep understanding of the pain points. In the later stages, metrics become quantitative, as it is difficult to talk to thousands of customers. But, it’s essential to get qualitative feedback by talking to at least a specific set of customers.
- Metrics also gain in complexity with growth. This means you need to factor in several components of growth that are associated with each metric. For example, although the LTV can be calculated by dividing ARPA (Average Revenue Per Account) with churn rate, a better way to calculate this would be ARPA divided by revenue churn rate (considering churn of a high value customer versus a low value customer). This can be further improved by multiplying ARPA with gross margin and dividing the result with revenue churn rate.
Now we’ll explore the right metrics to map to the SaaS Lifecycle.
At the very beginning, when you are just getting started, it is essential to get the validation from an initial set of customers. The first big must is to ensure that the problem actually exists and you’re heading in the right direction in terms of solution. Hence, you should measure the number of conversions and get customers who say that they must use your solution to solve their problem. This serves as the signal of a viable value proposition to start building your idea. As this phase is highly qualitative, you’d be investing a lot in interviewing your customers to find out the appeal of your value proposition, learning more about sticky features and refining the pricing strategy.
Some of the key questions:
- How do your customers perceive the value proposition (nice to have or must have)?
- Which feature are customers willing to pay for and at what price?
- Why are some customers unwilling to pay, and how can that be changed?
You will primarily use the insights from interviews and demographic information to build a solid .You’ll know exactly where you stand when trying to find out what constitutes the problem and which solution to apply.
At this stage, you’d have figured out the right problem and proven that your value proposition has potential to resonate with customer’s work, pain points and benefits. But, you’re still not absolutely sure that you have a scalable business model. To do that you should work towards gathering evidence that your value proposition is actually creating value for customers by alleviating their pains and creating the gains they desire. In this phase, your product is beginning to gain traction in the market and you’ve gone through the long and iterative process of running tests that have validated and invalidated the various assumptions underlying your business model.
Now you should measure the following:
- Ask customers how’d they feel if they lost access to your product:
a) Extremely disappointed
b) A bit disappointed
c) Not disappointed at all
d) No need to use this product
The answer to this question must be “Very disappointed” from at least 40% of existing customers. If that’s not the case, then you need to iterate or look at pivoting.
- It needs to be established that you’ll able to sustain a profitable business. You don’t want people just to be interested in your offering, you need customers who are willing to pay for the service you provide. SaaS businesses require continuous investment to acquire new customers. But customer acquisition costs must be recouped in order to eventually obtain profitability. That’s how unit economics kick in.
Your pricing strategy should be driven by LTV (Customer Lifetime Value) and CAC (Customer Acquisition Cost). According to David Skok, LTV/CAC value for a successful SaaS business should be greater than 3.
LTV = Average Customer Lifetime x Average Gross Profit Per Account
CAC = Total expenditure on customer acquisition / Number of new customers added
Figuring out the unit economics early on adds immense value as you’ll be able to leverage that in the rest of the stages when it’s time to accelerate growth.
In this stage, your business is ready to scale rapidly. You’ve established the right way to market, optimized the sales funnel and work with well-designed processes. When new employees join, they are easily able to follow the sales script to tap into the customer acquisition channel. Now you’re planning to expand business by bringing in more revenue via upsells and cross-sells. That means you’d measure monthly recurring revenue (MRR) and set the goal to achieve the target.
Net MRR =
Monthly Revenue from New Customers +
Monthly Revenue from Expansion of Existing Customers –
Lost Revenue from Churned Customers
While increasing revenue is paramount, it is equally important to make sure that the existing customers will find value in your product. When your customers grow with your product, they should still consider it as a must have product for their business. Ideally, at this point you’d be providing improved plans to them. Focus must be on customer retention to the maximum extent and churn reduction. Note that the cost to acquire a new customer can be five to 25 times more than that of retention. That said, the ultimate aim should be towards negative churn – when expansion revenue from existing customers is more than lost revenue from churned customers.
Calculating Retention Rate:
CRR = (Number of Customers at the End of Certain Time Period – Number of New Customers Acquired in that Time Period) / Number of Customers at the Start of that Time Period
You don’t have to settle, rather keep on learning as much as you can related to your domain and thus, strive to perfect every part of your acquisition process and retention program.
At the maturity stage, a business would already have a comprehensive set of metrics and they’ll be complex. The primary reason being that the standard metrics won’t be sufficient which will lead to custom metrics and multiple combinations of existing metrics. You would be measuring MoM and YoY increments of almost every possible growth factor and cohort analysis will already be in place. Your product now caters to bigger customers with higher revenue per account and you are aiming to increase the market share in your vertical. At this juncture, it is essential to get a realistic measure of your revenue, i.e. revenue allocation as per GAAP. In simple terms, the accounting principle says in the case of subscription-based SaaS business, revenue should be accounted as and when the distinctive service gets delivered to the customer according to the contract. For example, if a customer pays you $600 for as 3-month subscription fee, you would consider $200 as the revenue at the end of each month. Note that if a consulting fee is provided by a customer to learn how to use your software, then this would also be accounted for over the subscription period. You can learn more about this topic here.
The key is to understand that ‘time’ plays a major role – how long does it take to become profitable? Gain market share? Become a viable entity and expand in international markets? Note that most SaaS companies take close to 8 years to reach maturity. In this phase, you must be working towards providing best in class service to your customers with unfazed determination to improving the true revenue numbers.
Now it’s time for you to set your guidelines for SaaS metrics. There are several other metrics like stickiness (DAU/MAU ratio), NPS, visitor to sign up ratio and so on. In each phase of growth, additional metrics would be required to measure everything about your business. Growing and measuring metrics stage by stage ensures that you’re always focused on your goals.