Know Your Numbers: KPIs for SaaS Startups

Let’s face it – number crunching is at the heart of any business – whether you enjoy dealing with it or not. While it is true that entrepreneurs already have their hands full, they need to take time out to understand their numbers. Relevant financial metrics indicate entrepreneurs whether their efforts are bearing fruit or if their labour needs to be focussed elsewhere. 

The big problem that arises here is that there are just too many metrics that can be evaluated. How does one figure out which ones are essential and which ones are not? The solution lies in understanding your Key Performance Indicators.

Key Performance Indicators, or KPIs, are those fundamental quantifiable values that help ascertain the performance of a company over a period. They are the best reflection of how well your startup is functioning. The KPIs for a startup may vary depending upon the industry they are in and the kind of business they are running. 

Keeping a regular track of KPIs is not only beneficial for entrepreneurs but is also helpful for investors when they study the financial health of a startup before investment. In this article, we seek to explain the KPIs that investors frequently look out for while evaluating Software as a Service (SaaS) startups. 

Customer Acquisition Cost (CAC)

The customer acquisition cost measures the average cash that a startup burns to acquire a new customer. It is a vital measure, especially for young startups, since a lot of their effort goes in onboarding clients. 

David Skok of Matrix Partners terms CAC as a “startup killer”. Although factors such as lack of market need or product-market fit are top reasons for startup failure, having a high CAC for a prolonged time without achieving increased sales in parallel is enough to kill a startup as well. 

The viability of a startup’s business model is highly dependent on having a low CAC or lowering it significantly as the company grows. The optimum CAC varies according to the industry for which the startup is building its SaaS product. 

To calculate CAC, you need to take into account the entire money spent on sales and marketing for a given period and divide it by the new customers/deals you have closed in the same time frame. 

CAC = Total Spend on Marketing and Sales / New Customers Acquired

Customer Churn Rate

The customer churn rate measures the number of customers that the startup loses over a given period. Although it seems quite apparent that a company should devote efforts to retaining existing customers, it is one aspect that is easily overlooked.

The churn rate is an indicator of dissatisfaction among clients, quality issues with the product, uncompetitive pricing, etc. 

Since SaaS businesses generally focus on subscription models, it gives startups a way to dive deeper and ascertain why their clients did not continue with them and the areas they must focus on to reduce their churn.

Bessemer Venture Partners found that for SaaS startups, an annual churn rate of 5-7% is acceptable. They also state that best performing SaaS companies had a yearly renewal rate of over 90%. 

So, although onboarding new clients is critical, existing clients cannot be ignored at any cost.

Monthly Recurring Revenue (MRR)

Monthly Recurring Revenue is a reliable estimate of the revenue a startup can expect in a month. Since SaaS companies focus on subscriptions, MRR gives a fair idea of the income generated from predictable, recurring revenue streams instead of one-time transactions.

MRR helps assess the pace at which the business is growing and the financial health of the startup. It is a standard metric that incorporates differently priced models within a company and also assists in the comparison between two different businesses. 

To calculate the MRR, you need to multiply the Average Revenue Per Account (ARPA) (paid per month) with the number of customers you currently have. 

MRR = ARPA (per month) x Number of Customers 

Some companies also choose to calculate their Annual Recurring Revenue or ARR. As the name suggests, it is a genuine estimate of the revenue that can be earned by the startup in a year.

ARR can be found by multiplying the ARPA annually with the number of customers, or by multiplying the MRR by 12.

Average Revenue Per Account (ARPA)

ARPA is a metric that states the revenue that is generated per account on an average over a given time. It can be calculated monthly, yearly or quarterly, as per convenience. Average Revenue Per Unit and Average Revenue Per Customer are the same as ARPA.

Tracking the ARPA over a long period gives an overview of the additional revenue that is brought per customer. This is vital in framing the further plan of action for a startup.

The ARPA per month can be calculated by merely dividing the Monthly Recurring Revenue (MRR) by the number of customers at that given time.

ARPA per month = MRR / Number of Customers

Two types of ARPA can be calculated – existing and new. The formula remains the same, but the startup can divide its customers into two categories depending on the periods it considers old and new.

Customer Lifetime Value (LTV)

Customer Lifetime Value measures the average amount of business a customer brings in during their association with the company. Ideally, any startup would want the LTV of a customer to be higher than the amount they spent on acquiring him/her. 

The LTV indicates the worth of a customer and also helps investors understand the value of a company. In the case of a subscription-based business, every renewal will lead to an increase in the LTV. 

To calculate the LTV, first, you need to calculate the amount of time the customer will be with you for, i.e., the lifetime of the customer. The following formula can calculate that:

Customer Lifetime = 1 / Customer Churn Rate (Monthly/Yearly)

For example, if the monthly churn rate is 5%, then the Customer Lifetime will be 1 / 0.05 or 20 Months.

After this, you need to multiply the Customer Lifetime with the Average Revenue Per Account (ARPA) to get the LTV.

LTV = Customer Lifetime x ARPA 

CAC to LTV Ratio

CAC and LTV are most useful when used together and give a much clearer picture of a startup’s position. As stated earlier, CAC is the cost of customer acquisition, while LTV measures the customer’s lifetime value. This ratio measures the success of the marketing strategy.

Ideally, the CAC to LTV ratio must be approximately 1:3, i.e., the LTV of a customer must be thrice the cost of acquiring him/her. In case the ratio is lower, say 1:1, it means that there is excessive spending on customer acquisition, but insufficient revenue is generated in return.

On the other hand, if the ratio increases, say to 1:6, it implies that more money can be spent on onboarding customers so that higher revenue can be earned.

Depending on the ratio, startups can adjust their marketing plans and campaigns to maximise their earnings. 

Number of Active Users

As the name suggests, this metric shows the number of users who actively use the startup’s product or service- more the number of active users, more than chances for a startup to perform well.

The number of active users is generally categorised as Daily Active Users (DAU), Weekly Active Users (WAU) and Monthly Active Users (MAU). The optimal frequency differs from company to company, depending on the features they value the most. 

Ideally, a startup should define an active user as one who carries out a function that has a distinct value. Simply logging in should not be counted as being active.

A more relevant metric that can be calculated from these is the stickiness ratio, which tells how many people continued using the product after the first time.

Stickiness Ratio = Daily Active Users / Monthly Active Users

If the ratio is 0.7 or 70%, it implies that out of 30 days in a month, the customers used it for 21 days, which puts the startup in a pretty strong position.

Customer Conversion Rate

The customer conversion rate measures the number of leads that convert into paying customers. Leads are generated in different ways – after face-to-face interactions, product samples, blog subscribers etc. 

The aim of a startup is not to keep generating leads but to eventually convert them into paying customers. If over time, the conversion rate is increasing, it means that the sales strategy is working well. If not, then the potential of the leads is not being tapped into.

By having a stable conversion rate, you are directly increasing your revenues, customer base and market share. Conversion rate is calculated by taking the number of customers onboarded over a while and dividing it by the leads generated in the same period.

Conversion Rate: Number of Customers / Number of Leads

For example, if a startup gets 10 new customers in a month out of 200 leads, the conversion rate is 10 / 200, which is 0.05 or 5%.

Bottomline

Key Performance Indicators, thus, help you track your most important metrics and give you a bird’s eye view of what is going right and what needs to be improved. They are your report card in a way when you go out to raise investment.

If you are a SaaS entrepreneur, be mindful of these metrics and track them consistently. And if you are worried about the additional burden of this exercise, remember that several tools can help you stay on top of things. Just know your numbers well!