SaaS Acquisition Metrics for Scaling & Growth
Before engaging in any growth customer acquisition program for software as a service (SaaS), it is essential to determine what metrics should be employed to measure the relative success or failure of any marketing program. With SaaS in particular, the cost to acquire a customer can far exceed that customer’s lifetime value (LTV) which can have disastrous consequences for any SaaS business’s profitability. By focusing on the right metrics, any SaaS business has a fighting chance to make its marketing campaigns profitable and continue to acquire customers.
Due to the complex nature of subscription businesses, the essential metrics that a SaaS business needs to focus on are all inextricably intertwined with one another. Metrics such as Customer Acquisition Cost, Lifetime Value, Churn and Monthly Recurring Revenue are all interdependent numbers that greatly influence a SaaS business’s ability to spend on marketing to acquire more customers and grow.
While there are a large number of metrics to choose from, the base SaaS customer acquisition metrics can be distilled down to a few essential indicators that must be constantly monitored and improved.
Essential SaaS Metrics Definitions
Customer Acquisition Cost (CAC)
Customer acquisition cost or CAC is defined as the amount of money that must be allocated to acquire a paying customer. For a SaaS business, these costs usually consist of some mixture of the following:
- Any paid advertising such as search engine marketing (SEM) (i.e. Google Ads, Bing Ads or Yahoo Gemini ads), display ads (i.e. banner and text ads on different ad networks such as Google display network or DoubleClick), paid social media ads (LinkedIn ads, Twitter ads, Facebook ads, etc.).
- Any marketing or sales staff salaries or agency fees needed to initiate and manage ongoing marketing campaigns.
- Any software costs to assist in the management of marketing programs such as PPC management software, social media management software, marketing automation software, CRM software and any analytics or measurement software.
- Any trade show attendance or company-sponsored events in order to generate leads.
- Any marketing collateral development costs such as content creation, white paper creation, webinars, graphic design or landing page development.
- Any fees paid to affiliates for generating trials or subscriptions.
Of course, these are just direct costs related to marketing. Some companies take an even stricter approach to include all company salaries, office expenses, utilities, rent and any other costs that must be absorbed to keep the business running.
However comprehensive a company chooses to calculate its customer acquisition costs, one thing is certain. For SaaS acquisition, calculating CAC should be the first step after the initial marketing programs have begun. Without having some kind of baseline for how much it costs a SaaS business to acquire a customer, it is difficult if not impossible to determine if a company is profitable or not.
Once these total costs have been accounted for, calculating CAC is simply a matter of adding up all of these costs and dividing them by the number of new customers acquired during a given period.
CAC = Sum of all sales & marketing costs / # of new paying customers in a given time period
Most SaaS businesses employ some kind of free trial period (often for 30 days). So to more accurately match marketing costs with paying customers, the marketing costs from any previous month must be divided by the number of new paying customers in the current month:
| Customer Acquisition Cost | Jan | Feb | Mar | Apr |
|---|---|---|---|---|
| All Sales & Marketing Expenses | $150,000 | $175,000 | $200,000 | $148,000 |
| # of New Customers | 324 | 364 | 425 | 390 |
| CAC (Previous Month Sales & Marketing Expense / # of New Customers) | $462.96 | $480.77 | $470.59 | $379.49 |
Customer Lifetime Value (LTV)
Customer Lifetime Value (LTV): Customer Lifetime Value is the profit a business makes from a given customer over the period of time that person is a customer. While LTV fundamentally expresses the value of an individual customer, it is most often viewed in aggregate across a larger group of customers in order to smooth out fluctuations in any individual customer.
To calculate Customer Lifetime Value, three inputs are generally employed:
1. ARPA (Average Revenue Per Account)
Average Revenue Per Account is the amount of revenue generated per account typically by month but it can also be yearly. ARPA enables us to analyze how much revenue is generated on a per account basis regardless of how many users a single account may have.
The basic equation to calculate ARPA is:
ARPA = Monthly Recurring Revenue (MRR) / Total # of Customers
New ARPA & Existing ARPA
SaaS companies often look at ARPA as expressed for both new customers as well as existing customers. By looking at these two metrics separately, it is possible to determine the effectiveness of cross sells or upsells over periods of time and how well existing customers are responding to these programs if they are in place.
When calculating Customer Lifetime Value it is useful to perform two separate calculations using New ARPA for one set and existing ARPA for another since they will show differences.
However, since this article is primarily focused on acquisition of new SaaS customers, we will use New ARPA in our calculation for LTV.
| Average Revenue Per Account (ARPA) from New Customers | Jan | Feb | Mar | Apr |
|---|---|---|---|---|
| New Customer Monthly Recurring Revenue (MRR) | $16,200 | $18,289 | $22,460 | $20,350 |
| # of New Customers | 324 | 364 | 425 | 390 |
| New ARPA (New MRR / # of New Customers) | $50.00 | $50.24 | $52.85 | $52.18 |
2. Gross Profit Margin
After ARPA, the second component needed to calculate LTV is the gross profit margin. If you’ve ever studied accounting or looked at a financial statement, this number is likely one you’ve seen before. Gross profit is simply the result of subtracting net revenue for a given period (usually a month in our case) from the cost of goods sold (COGS) which are the direct product costs of the company (i.e. costs not including sales & marketing, research & development or general & administrative expenses).
The gross margin is arrived at by dividing the gross profit by the net revenue. Gross margin can generally be thought of as the amount of money left over after the direct costs to deliver the product or service have been accounted for. It doesn’t factor in costs for marketing and sales, research & development, interest on debt or general & administrative such as salaries and leases on office space.
Still, gross margin is the most general overall first indicator of the relative profitability of a business and is thus often used as a general yardstick of a business’s health. A company with a negative gross profit has poor sales or a basic cost structure that is out of control (or in some cases both!):
| Gross Profit Margin | Jan | Feb | Mar | Apr |
|---|---|---|---|---|
| Revenue | $525,456 | $543,745 | $566,205 | $586,555 |
| Cost of Goods Sold (COGS) | 76,588 | 77,562 | 78,456 | 79,512 |
| Gross Profit | $448,868 | $466,183 | $487,749 | $507,043 |
| Gross Profit Margin (Gross Profit / Revenue) | 85% | 86% | 86% | 86% |
3. % Monthly Recurring Revenue (MRR) Churn Rate
Churn is defined as the absolute number or percentage of customer subscribers that discontinue using a subscription product during a given time period (a month for our purposes).
While a certain amount of churn is to be expected in any SaaS company, too much churn can destroy a business. A company’s monthly churn rate must be exceeded by its growth rate in new customer acquisition or it its costs will eventually surpass its revenue and lead to a fast demise. Any SaaS company is looking for negative churn. That is, its new customer acquisitions and hence new revenue in the form of new subscribers as well as additional revenue from existing subscribers (i.e. cross-sells and upsells) must be greater than the revenue lost from churn.
While there are a couple of ways to look at churn on a monthly basis, for our LTV calculation we’re looking for the percent of monthly recurring revenue that is lost due to churn. The formula for this number is:
% MRR Churn = (Churned MRR / Previous Month’s Net MRR) * 100
This is basically the percentage of revenue that is gone based on the previous month’s numbers.
| % MRR Churn Rate | Jan | Feb | Mar | Apr |
|---|---|---|---|---|
| Ending Net MRR | $525,456 | $603,018 | $681,474 | $760,986 |
| Churned MRR | (6,246) | (7,596) | (8,213) | (7,789) |
| % MRR Churn Rate (Churned MRR / Previous Month’s Net MRR) | -1.6% | -1.4% | -1.4% | -1.1% |
Calculating Customer Lifetime Value
Now that we have our three inputs: ARPA, Gross Profit Margin % & %MRR Churn Rate, we calculate the customer lifetime value as:
LTV = (ARPA * % Gross Margin) / %MRR Churn Rate
This calculation accounts for the cost of goods sold (COGS) by multiplying the ARPA by the gross margin and then dividing that but the percentage of MRR that is lost through churn.
| Customer Lifetime Value (LTV) | Jan | Feb | Mar | Apr |
|---|---|---|---|---|
| New ARPA (New MRR / # of New Customers) | $50.00 | $50.24 | $52.85 | $52.18 |
| Gross Profit Margin (Gross Profit / Revenue) | 85% | 86% | 86% | 86% |
| % MRR Churn Rate (Churned MRR / Previous Month’s Net MRR) | 1.6% | 1.4% | 1.4% | 1.1% |
| LTV (ARPA * % Gross Margin / %MRR Churn Rate) | $2,669.51 | $2,979.90 | $3,342.50 | $3,946.42 |
While the above calculation is the one that is generally agreed upon, LTV can also be calculated in a simpler way by simply multiplying ARPA by the average lifetime of a customer:
LTV = ARPA * Avg. Lifetime of a Customer
The average lifetime can be found by dividing 1 by the churn rate:
Avg. Customer Lifetime = 1 / Churn Rate
LTV/CAC Ratio
A SaaS business is ultimately looking to grow ARPA by acquiring new customers and earning more money from existing customers while keep its churn rate and CAC as low as possible. That’s the basic model. Tweaking the inputs to make this happen profitably is where the real challenge lies. However, for companies that rely on external funding via venture capital or the public markets, getting to profitability may be trumped by other more immediate priorities such as scaling the business quickly to grab market share before competitors do.
By themselves, CAC and LTV are incomplete in determining how healthy a SaaS business’s acquisition machine is. Together, however, they create a very simple but powerful way of measuring how well a company turns the cost it takes to get a customer into ongoing, subscription revenue.
The LTV/CAC Ratio describes the multiple of revenue above its costs from an acquisition perspective. While it’s tough to give a definitive number as to what is good number here, any company earning twice its costs in LTV (that is an LTV to CAC ratio of 2 or more) should be doing a decent job all things being said. An LTV/CAV ratio higher than 3 would be quite good while anything above 5 would be fantastic.
| New Customer Acquisition Essentials (LTV/CAC Ratio) | Jan | Feb | Mar | Apr |
|---|---|---|---|---|
| LTV | $2,669.51 | $2,979.90 | $3,342.50 | $3,946.42 |
| CAC | $493.83 | $412.09 | $411.76 | $512.82 |
| LTV/CAC Ratio | 5.4 | 7.2 | 8.1 | 7.7 |
| Months to Recover CAC (CAC/(ARPA * GM%)) | 12 | 10 | 9 | 11 |
As we can see in the chart above, this business has an incredibly high LTV/CAC ratio ranging from 5 to 8 in these months and is able to earn back its customer acquisition costs in anywhere from 9 to 12 months for the period in question—a great scenario if the company can keep churn and CAC low while continuing to grow ARPA and hence the LTV.
Conclusion
As we can see, so much of SaaS (as well as PaaS, IaaS) and any other monthly recurring revenue business models have their own unique set of metrics for evaluating success and failure. While determining and tracking these baseline numbers is essential to measuring the effectiveness of any customer acquisition effort, it is only the beginning.
Improving the LTV/CAC ratio involves a continuous iterative attention to testing marketing & sales acquisition channels, scaling the channels that improve the ratio and ruthlessly cutting the efforts that don’t.