Key Business metrics of a Software as a Service startup

Being one of the three main categories of cloud computing, software as a service (SaaS) is where third-party applications are offered over the internet without any physical connection to a device of any kind. The industry experienced a massive growth over the past few decades leading to higher market saturation in the field. This has left SaaS companies with no options but to grow, build, and sustain.

However, this isn’t easy. Unless you know what to measure, deciding on how well a startup is laddering up is not straightforward. This is because these firms are mainly based on future revenue earned through the retention and sustainability of its customers.

Thus, all its key metrics evolve around the pivotal point of future growth. Once the company has its SaaS product developed and released into the market, comprehending the growth metrics such as customer acquisition costs, customer lifetime value, and churn rates can make a huge impact down the lane. This article is about summarizing the most important business metrics in software a service startups.

The key metrics for software as a service startups can be summarized as follows: 

  • Lead Velocity Rate
  • Activation Rate
  • Customer Acquisition Cost (CAC)
  • MRR
  • Contracted MRR
  • Churn Rate
  • Customer Lifetime Value (CLV)
  • Payback Period
  • Viral Coefficient
  • Net Promotor Score

As a Startup you need to focus on measuring and optimizing those KPIs from the early beginning.

Lead Velocity Rate

The Lead Velocity Rate or Lead Momentum is all about measuring growth in terms of qualified leads. This KPI quantifies how many potential future customers you are currently working on and how that number is growing. Venture capital funding is all about finding companies with exponential growth. The basis for your future revenue growth is the growth in your pipeline. The lead velocity rate is one of the few metrics in sales and marketing that is forward looking and can serve as a predictor for your top line growth.

(No. Leads current month – No. Leads last month) / (No. Leads last month x 100) = LVR in %

It can also help you to build a more reliable financial plan since you can generate actual data on how much of your pipeline normally converts into paying customers. If you want to accelerate your company growth this starts with increasing your lead velocity rate.

Activation Rate

The activation rate can be considered as one of the most crucial software as a service metrics out of all that is discussed here, especially as for a startup company in the SaaS industry. Here the user experience or the perceived value of the product is employed as the leading light in the dark for the business to grow.

The activation rate measures how many of your visitors are engaging with your website, product or app. Calculating your activation rate is simple if you know what to measure. Depending on your product or business model there are many activation opportunities that can be tracked, e.g. download of an e-book, signing up for trial or demo or subscribing to an email list. You can measure each activation point separately or you measure it as an overall number.

No. of activities completed / No. of website sessions = activation rate in %

Once the company identifies this ‘aha moment’ of its product, the team needs to work on enhancing the experienced value of retaining customers onboard while minimizing the time taken by new and potential users to perceive the product’s value and adapt it into using it. If the user activates quickly for the product, the probability of making them both a paying loyal customer rises high.

Activation rates are especially important if you follow a product led growth strategy.

Customer Acquisition Cost (CAC)

The acquisition of paying customers is the biggest expense for software as a service firms. CAC calculates the average amount invested in acquiring a single customer. That is, how much the company spends on its marketing and sales-related costs divided by the number of new customers gained over the given period.

Sales & Marketing Costs in € / No. of new customers = customer acquisition cost in €

Learning a company’s CAC helps them to understand the efficiency of their sales strategies and marketing channels, and thereby it supports allocating the company budget and resources effectively as a startup.

Customer acquisition costs can vary greatly depending on your target customers and your sales and marketing strategies. Whether you have a more content driven inbound lead style of marketing or build up a direct sales approach by hiring a field sales force will have a significant impact on your CAC.

High CAC are not necessarily bad per se. It´s more a question of how much money you can make from your customers (aka customer lifetime value) and whether this justifies the marketing and sales expenses.

Customer acquisition costs can be calculated in many ways depending on your sales approach as well as your marketing mix. I will leave that for a more detailed article.

Monthly Recurring Revenue (MRR)

MRR measures how much revenue the customer base of the company is generating in a month. This is a crucial metric since most SaaS companies survive on monthly subscriptions of recurring customers for earning their revenue.

Higher MRR depicts that the company continues providing the value as it was since launch, and this is why the customers keep paying every month. It also illustrates what revenue a company can expect to collect over and over while pinpointing the insights on overall sales performance.

It is important to note that MRR calculations include only software associated license revenues and not the charges earnt on the initial setup fee, Once-off add on, and other non-recurring fees.  

The metric on the overall helps the company in providing an accurate forecast, encouraging the business to focus on its short-term objectives like earning a steady revenue stream.

Contracted Monthly Recurring Revenue (CMRR)

This is an enhanced version of MRR. When looking at MRR founders (as well as investors) should also consider all known future changes in MRR, e.g. bookings with a start date in the future or known cancellations.

Therefor all these aspects must be considered in contracted MRR:

  • new sales (added mrr)
  • expansion (mrr generated through upsells)
  • contractions (lost mrr due to downrading to a cheaper plan)
  • churned mrr (lost mrr due to lost customers)

Furthermore, renewal rates (portion of the customers renewing their subscription) are also particularly important to look at. They tell a lot about the stickiness of your product and perceived value. Tracking and reporting contracted MRR growth is one of the simplest yet powerful metrics and a key metric for venture capital investors to look at.

Churn Rate

The churn rate generally refers to lost business in a specific period. In the software as a service industry it can be calculated either as the number of accounts that cancel their subscription during a given period or the lost MRR from customers stop using the product.

Based on customer count:

Customers lost in period / customers at start of period = Churn Rate in %

Based on monthly recurring revenues:

Lost MRR in period / MRR at start of period = Churn Rate in %

For early stage startups, this metric is not much of a help as they have few customers for a short time. But when the company grows, understanding and minimizing the churn rate becomes an extremely important goal. The more customers the firm gains with time, the more it needs to invest in retaining them before even thinking about growing further.

Focusing deeper into this metric, churn rate exactly shows the number of unsubscribes or rather the number of users who are unhappy with the company’s product. A high or increasing churn rate can also be a hint that a heavy competitor with better marketing skills has entered the scene.

Furthermore, churn rates observed with startups have a wide range depending heavily on factors like pricing, contract length, customers company size and age of the company.

Whether or not a churn rate is sustainable has also to do with the customer acquisition cost (CAC) and the customer lifetime value (CLV). Enterprise SaaS companies with long sales cycles and consequently higher CAC can only survive with low churn rates and high CLVs. For software companies focusing on small and medium enterprises (SMEs) higher churn rates are acceptable.

Customer Lifetime Value (CLV)

CLV is calculated by multiplying the customer revenue by customer lifetime, deducting the cost of acquiring and maintaining the same customer. This metric is vital in gaining a long-term vision of customer engagement strategies in the future.

In detail, Customer Lifetime Value stands for the value of a company’s customer measured in cash. CLV represents the total value produced by a customer over a lifetime via their account with the company. The longer they are with the company, the higher their lifetime value will be. Furthermore, realizing the CLV will also assist in deciding how much the firm can spend to acquire a customer.

Calculating CLVs is a science in itself and there are many aspects to it that would go far beyond this article. I will leave that for a more detailed post on that topic. At no time the CLV of your customers should be higher than your CAC. As a rule of thumb for SaaS companies the CLV needs to be at least three times greater than its CAC for a profitable growth rate.

Payback Period

The payback period simply measures to time needed to recoup your CAC. It can be used as profitability or cashflow KPI. I prefer to use it as cashflow focused KPI.

            Average monthly cash-in per customer / CAC = Payback period in month

Using it with a focus on cashflow does not tell you a big deal about how profitable your customers or business will be. However, it is extremely important for understanding how much money you will need to scale your business. You can have long payback periods (e.g. 24 months) and still be profitable, because your customers stay with your company for an exceedingly long time. However, for accelerating customer growth you will need much more capital to finance the payback period.

It´s also important to understand that payback periods are not only dependent on CAC and pricing but also on contracting and payment terms. Whether customers pay for a yearly contract upfront or monthly can make a huge difference on how much money you need to raise when scaling your business.

Viral Coefficient

While not being applicable to every software as a service company it can be a remarkably interesting KPI for those with built-in network effects or those using referral programs. The viral coefficient measures the number of new customers generated through existing customers. It calculates the so called virality that accelerates company growth

No. invitations sent per user x (%) conversion rate = Viral Coefficient

Calculating virality requires appropriate tracking first. Once implemented it’s a great indicator of customer satisfaction and to increase the efficiency of sales and marketing. If the product grows by itself through happy customers referring it to friends or business partners virality has a huge impact your growth trajectory.

Net Promotor Score (NPS)

The NPS is loyalty metric measuring customer satisfaction. It is applied in marketing to measure how customers are satisfied with the product as well as their degree of satisfaction. The net promoter score is an indexed survey based on the question “On a scale of 0-10, how likely are you to recommend [company] to a friend or colleague?”. Anyone with a score between 0-6 is considered a detractor. Respondents scoring 7 or 8 are considered neutral or passive while only the one rating 9 or 10 are seen as promotors.

The NPS score is then calculated as follows:

(No. of promotors – No. of detractors) / No. Total Respondents x 100 = NPS

The net promoter score can be seen as a leading indicator for the viral coefficient. The NPS is one of the most relevant instrument to analyse your product market fit.

Conclusion

Considering all the above metrics, picking up the right ones should depend on the ongoing business objectives planned. This is the real challenge. To gain the right analysis on the chosen metric set, a decent reporting system is needed to collect the right data on par with the right plan regarding finances. Measuring the right KPIs should ensure to effectively lead to benchmark the company’s progress with the employed metrics and review the assumptions on a regular basis. By doing so, a startup will understand when and where they deviate from the track.

Summarizing everything, as the company starts to scale up, the number of software as a service metrics required to track the performance will rise. However, it is still important for a business not to focus on complex metrics at the start itself.

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