The Fundamentals of Calculating and Interpreting SaaS Metrics
Article

The Fundamentals of Calculating and Interpreting SaaS Metrics

by Scott Rollin, Mike Bergines
September 28, 2022

As a leader in SaaS, you know that SaaS metrics beyond basic GAAP reporting are essential for getting a clearer picture of your finances and achieving better forecasting accuracy. But even if you do have SaaS-specific analysis, it is often overwhelming to wrangle all your data and make sense of it. By learning how to properly calculate and interpret SaaS metrics, you can harness your findings to grow your business.

Measuring Growth

When measuring growth, it is common practice to measure the value of your company’s total recurring revenue in either monthly or annual increments, depending on the scope of the analysis — i.e., your monthly recurring revenue (MRR) or annual recurring revenue (ARR).

Metric in Action:

Let’s say you have a two-year contract with a total value of $120,000. This contract has an ARR of $60,000 and MRR of $5,000. When measuring growth for this contract, we would see $60,000 of added ARR during the month of the sale. This metric indicates that we’ve added a new annual revenue stream of $60,000, starting in the month we booked the sale.

To understand the full scope of your recurring revenue, you must also consider the three ways recurring revenue is generated and lost: new business, expansion and churn. Each of these growth components has its own unique mechanism, so it’s important to understand their drivers and measure accordingly.

New business

One of the most important metrics for SaaS companies is the average revenue per account (ARPA) — it’s used to measure profitability based on revenue coming in from each customer account and provides insight on the SaaS services that are generating the most (and least) revenue. Measuring ARPA helps you define the value and upfront cost of a new business, and you’ll need three specific metrics to calculate it: the dollar value of New ARR, the number of new customers and the dedicated monthly new customer acquisition cost (CAC).

Once you have these, calculate ARPA by simply dividing New ARR by new customers. Doing so every month reveals the impact of strategy changes on the starting value of new customers. The resulting New ARR:CAC ratio from these bookings provides a near-term view of ROI on your CAC spend. You would look to this ratio when lifetime value (LTV) is not dependably calculable.

Metric in Action:

If your organization had a New ARR of $10,000 and a total of 10 new customers, you would divide $10,000 by 10, resulting in an ARPA of $1,000. You can also gauge monthly ARPA by swapping ARR with MRR in your calculation.

Capturing lead sources

Capturing the metrics for each new business lead source (including all inbound marketing sources and outbound sales personnel) by customer and by product gives you the data needed for clear calculations within each of those dimensions. Collecting these metrics for each lead source allows you to compare their attractiveness and the value they generate. Additionally, comparing their respective New ARR:CAC ratios allows you to evaluate each lead source’s ROI. (To be clear, however, it is often a challenge to attribute sales to one particular lead source, as any new customer demand was likely impacted by a combination of lead sources.)

For your inbound marketing lead sources, if you determine that one or more source consistently yields customers with subpar New ARR:CAC ratios, then you may want to consider rebalancing your utilization away from those sources and toward other lead sources that generate better value per dollar spent.

When evaluating the productivity of your organization’s outbound sales representatives, in addition to establishing clear measures of employee performance, you also learn your resourcing requirements for future growth. For instance, if your organization is looking to increase your outbound team’s New ARR next year, and you know the average productivity per rep (PPR) across your outbound sales representatives (measured by total New ARR ÷ total outbound sales reps), then all you need to do is divide your total ARR target by your PPR to arrive at the headcount needed to achieve the target.

The same analysis applies at the product level, whereby you learn which products generate the greatest and least value, allowing your organization to take steps to optimize your product offering.

Measuring customers

Measuring each customer individually sets the table for customer segmentation and cohort tracking. By grouping customers on demographic, industry, size, etc., you can identify how different customer segments react to your lead sources uniquely and can compare the respective value of these customer segments. This information can help you target each unique customer segment more effectively and better understand the value of targeting these segments.

To review the impact of changes to your sales and marketing initiatives, analyzing monthly cohorts of customers can help you track the effects of these initiatives on different subsets of your customers. A cohort analysis also allows you to better evaluate how the value of these different subsets changes over the course of their lifetimes. For instance, if your organization implemented a new strategy designed to increase the average starting deal size of your customers, you would compare the starting ARPA of cohorts from before the rollout against the starting ARPA of new cohorts brought on after the rollout — giving you a clear indication of whether your strategy was impactful.

Expansion

Expansion, the remaining component of a SaaS growth strategy, signifies the value generated from upsells, cross-sells and add-ons, and can give you critical insights into the health of your business.

When measuring the value of expansion, it’s important to track three key metrics: expansion ARR, dedicated expansion CAC and the resulting expansion ARR:CAC ratio.

  • Expansion ARR is the difference between the prior ARR and New ARR of a given customer. This is commonly measured as a dollar value and as a percent change from a customer’s prior ARR value.
  • Expansion CAC comprises the fully burdened sales and marketing costs dedicated to expansion efforts.
  • Expansion ARR:CAC is a ratio that measures the ROI on expansion spend. It answers the question: How many dollars of additional recurring revenue have we added to the existing customer base per dollar spent on expansion?

Metrics in Action:

If an existing customer adds new licenses to their account, increasing their ARR from $100,000 to $120,000, then their expansion ARR is $20,000 (+20%).

If this business spent $10,000 to employ the account management team that drove this $20,000 expansion, the CAC would be $10,000 and the expansion ARR:CAC ratio would be 2:1, or simply, 2.

Once you have calculated your expansion ARR, CAC and ARR:CAC ratio, you’ll measure each of these metrics by expansion lead source, by customer and by product. Measuring these values by expansion lead source helps determine how effectively each sales strategy and expansion representative can grow your existing customer base. Measuring this at the customer level with the necessary monthly cohorts and defined customer segments helps you keep track of your evolving customer base and gives you crucial insights into how you can effectively grow your existing customer segments.

Lastly, when measuring at the product level, you can get a better understanding of the products that are most conducive to expansion, the ones that are better left on the sidelines — and the ones that are holding you back.

Churn

Churn can occur for many reasons, including customers switching to competitors or a major industry disruption.

But no matter the reason, the measurements you use to calculate it stay the same. Two important measures of value lost through churn are churn ARR, i.e., dollar churn, and customers lost, i.e., customer churn. These are measured both nominally and as rates of change.

For example, if you begin a measurement period with 20 customers worth $100K in ARR and end with 19 customers worth $90K, you’ve experienced a customer churn of 1 (5%) and a dollar churn of $10,000 (10%).

Customer churn is particularly useful to track because it approximates your customer lifetime, which will help you estimate the value a customer will bring throughout the relationship. This is calculated as follows:

Customer Lifetime = 1 ÷ Customer Churn Rate

Metric in Action:

If your annual customer churn rate is 20%, then you can approximate the average customer lifetime to last five years.

Like you did to evaluate expansion metrics, you’ll also measure each of these metrics by the lead source that brought customers to the service as well as at the product and customer level. Tracking churn by lead source reveals whether specific sales and marketing strategies yield sticky customers or ones that churn more quickly, a vital insight in assessing the overall value of your lead sources.

Measuring churn at the product level, then, helps identify the stickiness of each unique product offering, giving you insight into future product planning. Lastly, capturing churn at the customer level allows you to see how various customer segments evolve over time, further informing strategies to combat churn within these segments.

Applying These Concepts to LTV & CAC

When estimating value in the SaaS space, you use two analytical pillars: LTV and CAC.

One way to view LTV is as the cumulative result of all the value drivers discussed above, spanning the lifetime of the customer. Using the metrics outlined in this article, you have the means to pinpoint specific areas within each of the value drivers (new business, expansion and churn) to improve LTV.

When measured against each other as the LTV:CAC ratio, you learn the expected ROI over the lifetimes of your customers. An LTC:CAC ratio greater than three meets the industry benchmark of long-term profitability within SaaS companies that are driving significant growth.

Capturing the LTV:CAC ratio within product, customer and sales source dimensions yields insight into the long-term financial viability of key slices of your business — the product offering, the customers to whom you market and the strategies by which you sell your product.

Additionally, when measuring the capital efficiency of your CAC spend, a best practice is to monitor how many months of recognized revenue it takes to break even on this cost (also known as your months to recover CAC or your CAC payback period). Naturally, the longer the payback period, the less efficient the investment. Like the rest of the metrics covered, it is important to capture this value across the same dimensions to identify potential areas for improvement.

We calculate the CAC payback period by dividing CAC by monthly gross profits:

CAC Payback Period = CAC ÷ (ARPA * Gross Margin (GM)%)

In this case, ARPA is measured in MRR terms, which yields the number of months needed to pay back CAC. (To calculate the years needed to pay back CAC instead, swap MRR for ARR.)

Metric in Action:

Think of calculating your CAC payback period as determining your break-even point. So, if your organization has a customer that cost $500 to acquire and contributes $50 every month to your revenue ($600 annually), your CAC payback period is .833 years, i.e., 10 months.

A well-known benchmark for this metric is 12-18 months in normal circumstances, or possibly greater than 18 months if there is easy access to capital. In essence, this benchmark indicates that gross profit from revenue streams should repay CAC spend within approximately 12-18 months to keep up with the industry standard. Keeping these benchmarks of profitability and capital efficiency in mind is crucial when vying for explosive growth.

Bottom Line

To use SaaS metrics effectively, it’s not enough to simply collect data — you need to know how to properly interpret it. Understanding the importance of the SaaS metrics you collect, and knowing how to analyze those metrics, means that you’re in a better position to manage your profitability and cash flow — and identify areas where you can grow and strengthen your business.

To learn more about making sure your SaaS company has the right processes, tools and resources to be successful, contact our experts.

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Authors
Scott Rollin - Consulting | Armanino
Senior Consultant
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