Friday, 26 August 2016

Is your SaaS business viable?

If you cannot measure it, you cannot improve it” – Lord Kelvin.

Emergence of the SaaS model has transformed the business model of software sales, in contrast with the conventional way of enterprise sales. The revenue flow is over an extended period (the customer lifetime) and traditional accounting metrics do not cover the nuances of a SaaS business. So what’s different in a SaaS business and what should be the key metrics to be tracked?

Let’s look five key SaaS metrics-

MRR (Monthly recurring revenue) – In SaaS, significant investment is incurred initially, in acquiring the first set of customers - in product development, marketing and sales. However, from the customer’s end, they only pay monthly subscriptions, over the period of usage. For a sustainable subscription based business, companies have to ensure a steady continuous cash flow from monthly subscription.Monthly recurring revenue is the monthly revenue generated from each customer whether the customer is paying annually (i.e. 12 months) or quarterly, one needs to get the equivalent monthly value. For instance if any customers is paying Rs 7500 for 6 months subscription, MRR is 7500 divided by 6 i.e Rs 1250. It should exclude OTC (one-time payment) and any other discounts.
CAC(Cost Acquisition Cost)- It’s the amount spent on acquiring a new customer
CAC = Total Sales and Marketing Cost/Number of new customers acquired.
Specific to a SaaS business, initially upfront investment is incurred in acquiring new customers, whether by deploying sales resources or marketing budgets and in accounting terms company cash flow is predominantly negative. And could take months to make the case flow positive. The faster the business decides to grow, the worse the losses become.

LTV(Life time value of customer) – It is an estimated of total subscription value from an average customer
LTV = ARPA (Average MRR per customer) * Customer Lifetime
ARPA = Sum of all customers MRR/ number of customers

For start-ups LTV > 3x (CAC) and Month to recover CAC < 12 months (source: http://www.forentrepreneurs.com/saas-metrics/)

As shown above CAC is Rs 7000 and MRR is Rs 1000, company cash flow is in negative till month of July. It shows that acquiring a customer puts lot of strain on the company cash flow and if the customer churns before July, it’s a loss to the company. Possible solutions could be to – Lower the CAC or push for a higher MRR.

The above case is just for one customer and as the number of customers increase in the start-up phase the cumulative CAC would multiply and negative cash flow could become unmanageable. A keen view of this metric would be critical during the initial stages of a start-up.

CCR (Customer Churn Rate) - Churn measures the percentage of customers who leave every month. Lifetime value at a product level is directly impacted by the churn % 
CCR = Number of customers who churned in a period / Total number of customer at start of period
If you have a high churn (double digits) then there’s something wrong with the product or customer service.

ARPU (Average revenue per user)-It’s the average revenue received from all active customers.
ARPU= SUM of all customers MRR/ number of customers.
An increasing trend in ARPU is expected, reflecting higher value usage by customers & scaling up of the product.

To continuously track of all these parameters, start-ups can use freely available SaaS service like chartmogul.com or a basic excel.

Ozonetel(www.ozonetel.com) is a SaaS (software as a service) company. We offer cloud telephony solution on a monthly and annual subscription. To help start-up SaaS companies we have made our metrics public and also shared base excel http://ozonetel.com/saas_metrics.html . Just download the base excel and start tracking your metrics.

Written by,
Abhay Kumar

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