by Nicolas Jacobeus, on 11 April 2018
If you’re building or growing a SaaS product, you likely know by now there are a lot of metrics you can use to measure how your business is doing. In fact, the sheer number of SaaS metrics can be overwhelming if you’re new to the software-as-a-service world.
Let’s step back together and look at the most important SaaS metrics for a minute.
First, it may be helpful to distinguish between SaaS metrics and KPIs. Andy Mura explains in his epic guide, “Metrics are represented by quantitative data we collect at different stages of the customer and the company journey and which are useful to measure behavior. KPIs are connected to targets and are set to measure performance.” KPIs can be thought of as a subset of metrics, but you’ll see sometimes SaaS businesses use the terms interchangeably.
Here we’re sticking to the broader category of metrics. We’re looking at basic measures of behavior.
We believe the metrics you choose to measure depend on where you are in your startup journey. We think there’s a big distinction in what a startup or new software product owner should focus on before they have found product/market fit versus metrics to track during the expansion or growth stage.
If you don’t yet have what’s called product-market fit, you don’t really need to track any SaaS metrics yet. They won’t hold much meaning at this stage, and it would be a misuse of your energy.
Sean Ellis, founder and CEO of GrowthHackers, says, “Metrics don’t matter until you achieve product/market fit – then they are critical to your success.”
More than SaaS metrics at this early stage, you need to monitor some very basic financial and customer information:
We’ll discuss some of these a bit more below. But first, how do you know if your SaaS business has reached product/market fit?
SaaS entrepreneur circles widely accept the Sean Ellis test as a way to determine whether you have achieved product/market fit. Here’s how it works. You want to ask your users:
“How disappointed would you be if you couldn’t use our product anymore?” If 40% express that they would be very disappointed, you can be reasonably sure you’ve reached product/market fit.
Does it matter which customers you ask? How many do you need to ask? How do you go about asking them?
Ask as many of your best customers as you can - those who have experienced your core product offering, used your product at least twice, and used it in the last two weeks.
Patrick McKenzie of Stripe Atlas, and founder of four previous software companies, acknowledges in The business of SaaS that product/market fit is the hardest thing to put a number on early in the lifetime of a SaaS company. “Many SaaS with product/market fit did not launch with it; it sometimes takes months or years of iterating to get there. The most important theme while iterating is to talk to many, many more customers than feels natural.”
Patrick advises further that “Low-touch SaaS entrepreneurs can make an excuse to attempt to speak with literally every person who signs up for a free trial; the economics of this are unsustainable at the price point but running a SaaS company without product/market fit is also unsustainable, so it’s entirely justified by how much you learn.”
(Emphasis provided by Patrick.) See also more on ways to survey your customers from Kissmetrics.
We can’t overstate the importance of striving for product/market fit. If you’ve had to ask, you’re probably still in the pre-product/market fit stage.
Heed the words of Sean Ellis again: “If you haven’t reached product/market fit yet it is critical to keep your burn low and focus all resources on improving the percentage of users that say they would be very disappointed without your product."
Keep your burn low? What’s burn?
At this stage, burn is simple. Your “burn” is essentially how fast you are burning through money.
How much money should your startup be spending each month?
If you don’t have product/market fit yet, then it should be as little as possible. Look for where you can make headway yourself, without hiring. Outsource carefully to people who know what they’re doing. Use equity to engage talent and bring people alongside you, and so on.
As your SaaS business grows, you can also calculate net burn: the money you are spending minus the money you are making every month. This metric simply shows how much money you’re losing, until you’re profitable. Klipfolio goes deeper on how to measure net burn here.
Keep your eye on your “runway,” too. This is how much time you have until you run out of funding, usually measured in months.
So far, these SaaS metrics are all about keeping alive and striving for product/market fit. Once you hit it, then it’s time to break out more metrics.
As David Skok reminds us, there are 3 keys to success in SaaS:
The most important metrics are going to measure those things. But how you view them may be different still depending on whether you are just beginning to scale or expanding. Here are the most important SaaS metrics to begin tracking once you’ve reached product/market fit.
Revisiting burn rate: Your thinking on net burn rate will change once you have product/market fit. You have to spend money to acquire customers with the hope you will earn it back (and more) over time. Mark Suster comments on why this is the time for a high burn rate:
“...companies who are scaling quickly in revenue and with a high gross margin often should invest as much capital in growth as they can manage responsibly because when you find a product/market fit, and your company is growing at a very fast scale you want to capture market share before competition sets in. Think DropBox, Airbnb, Uber, Maker Studios. Your goal is to invest in engineering (to maintain your product lead), new offices and locations (to capture markets before others), marketing (to capture consumer attention before others do) ... all of these activities consume cash often in advance of the revenue they generate.”
Danielle Morrill walks us through her burn rate after a remark put her on edge about the “bubbly burn” of her SaaS company. She also asks of her business, “Is more than 5% of my budget going to things outside of payroll, payroll tax, benefits and rent?” If so, look to trim overspending on some things like advertising and servers.
Monthly Recurring Revenue is the most basic SaaS metric. This is your predictable revenue stream. You will be tracking this SaaS metric from the start in its most basic form as you have users sign up. But it will become more complex as time goes on.
Because it’s influenced by so many factors, you’ll eventually want to break it down to reflect revenue from new customers and renewals, and take into account revenue changes due to customers upgrading, downgrading, or leaving.
Customer Acquisition Cost is the sum of all marketing and sales costs involved in gaining a new customer. You can begin with fairly simple math. Then, as you try new marketing channels in the expansion stage, you’ll want to break this metric out by channel. At first, it may be obvious which channels are performing, but as things become more complex, CAC will let you see which channels are performing best for you.
Lars Lofgren of KISSmetrics says in the expansion stage, once growth has begun to slow down, you’ll want to keep your cost per acquisition to one third of your customer’s lifetime value. He also advises to aim to break even on the cost of acquiring a customer before 12 months. This metric is called months to recover CAC and can be a very good predictor of how well a SaaS business will perform.
The SaaS metric “churn” refers to the effect of customers who downgrade or leave. You can look at churn rate in terms of number of customers as well as MRR churn rate, which is the revenue lost from those customers who leave.
Lars advises to pay particular attention to churn when you’re just gaining momentum. Aim to reduce monthly churn to 1-2%. If it’s above 5%, ignore everything else until you lower it.
Customer Lifetime Value is a measure of how much money you can make from a typical customer over the entire duration of their relationship with you.
This metric becomes more important when your SaaS product has reached significant growth.
David Skok goes into great detail on the math behind an accurate LTV calculation and the importance of tracking this metric over time to make sure you’re driving improvement. David says that a successful SaaS business should have a LTV/CAC value higher than 3. That is, the cost to acquire a customer should be less than ⅓ the value you will realize from that customer over their lifetime.
He says, “The best SaaS businesses have a LTV to CAC ratio that is higher than 3, sometimes as high as 7 or 8. And many of the best SaaS businesses are able to recover their CAC in 5-7 months. However many healthy SaaS businesses don’t meet the guidelines in the early days, but can see how they can improve the business over time to get there.”
But consider this: if you don’t know your basic MRR, churn or basic CAC or LTV, you’re not going to be able to calculate your SaaS Quick Ratio or Net New MRR, and there’s really no point digging into your Month-on-Month MQL Growth Rate or all the other factors you could be tracking.
To recap, focus first on MRR, churn, CAC, and LTV. As Lars put it, “Move mountains to track them before worrying about the rest.”
And if you haven’t reached product/market fit yet, don’t even bother with SaaS metrics. Focus on basic costs and becoming essential to your customers.
Want to see more about how activities break down for a new software product by stage? Check out our Power Checklist covering 50 checkpoints in 5 stages.
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