SaaS is an acronym for software-as-a-service. The SaaS business model is characterized by:
Charging subscription fees (monthly or annually) for access to the service.
Hosting a solution in the cloud rather than requiring customers to perform an installation.
Examples of SaaS businesses are Dropbox, Evernote, Spotify, and Netflix.
Due to the specific nature of SaaS, let's look at three types of metrics:
Customer lifetime value and acquisition metrics
Monthly revenue metrics
Product-level metrics
Imagine that a customer has the following experience on Spotify:
He sees an ad on Google for the Spotify music streaming service, and clicks on it.
He signs up on Spotify and takes advantage of a 30-day free trial.
At the end of the trial, he decides to purchase a premium subscription of $9.99 per month.
After three months, he decides to cancel his subscription.
If you were the product manager or finance director at Spotify, you would need to measure the following things:
How much did it cost to acquire this customer? This is referred to as the CAC (cost of acquiring a customer). In this example, you could take into account you (Spotify) had to pay Google Adwords for your ad to be shown.
What is the lifetime value (LTV) of this customer? If he paid $9.99 a month to Spotify for 3 months, then his LTV is $29.97.
What is the average amount paid by each user? This is called the ARPA (average revenue per account per month). Spotify has a $9.99 / month subscription and a $14.99 / month subscription. The ARPA will be higher if more users purchase the $14.99 /month subscription. (Intuitively, when users purchase higher cost items, the ARPA is higher).
Healthy SaaS metrics
Industry experts typically suggest the following as indicators of a healthy SaaS business:
The LTV: CAC ratio is at least three. This means that the lifetime value of an average customer divided by the cost of acquiring that customer will have a result of three. In other words, the lifetime value of an average customer will be at least three times as much as the cost of acquiring that customer!
The months needed to recover CAC is less than 12. This means that whatever money you spent to acquire this customer, you can earn it back from this same customer within 12 months.
Important booking metrics include:
MRR monthly recurring revenue
MRR churn rate
MRR expansion rate
Net MRR growth rate
To understand these metrics, let's look back at our Spotify example.
If you add up the revenue you make each month from all paying users, this tells you your monthly recurring revenue (MRR).
From month to month, new users sign up and, some users cancel subscriptions. The phenomenon of users canceling an auto-renewing subscription is called churn. You want to know how new user acquisition and churn impacts your MRR each month. Therefore, you need to know your MRR churn rate (canceling users) and your MRR expansion rate (newly signed-up users).
If you want to know whether your MRR is growing or decreasing - and by how much - you need to look at the net MRR growth rate. This is the percentage increase or decrease of MRR over time. Net MRR is a key metric because it tells you how quickly a SaaS business is growing.
Imagine in the Spotify example above that your customer was listening to music every day during the first month. Then for whatever reason, he didn't use Spotify much during the second month, and didn't use it at all during the third month.
Given that he was still paying $9.99 each month, is it any surprise that he canceled his subscription? The point here is that product managers should regard inactive users as being highly likely to churn. Therefore, monitoring which users are not active provides an opportunity: you can remind them of the benefits of your service so that they keep using it! When it comes to active users, If they are using the service, it is likely they will keep paying for it.
The following product-level metrics are worth tracking:
Active users (DAU and MAU)
Stickiness
Average time spent per user
1. Daily and monthly active users
Daily and monthly active users (DAU and MAU) show you how many users are actually using your product. Of course, you need to define what this means. It could involve visiting a website, logging-in, or doing something more meaningful like listening to a song (in the Spotify case). Once you have defined what an active user is, then the daily and monthly totals of users who are active is the DAU and MAU respectively.
2. Stickiness
Stickiness refers to how "sticky" a product is. (Gee, thanks!) More specifically, this is an industry term for the level of engagement that users have with a product. Products like Snapchat, Facebook or Instagram are very sticky, meaning that users log in every day. To calculate stickiness or engagement, calculate the ratio between daily and monthly users. Stickiness = DAU / MAU.
3. Time spent in the product
In general, the more time that users spend on your product, the more they like it and the less likely they are to churn. However, it is possible that users could spend more time in your product because something is broken, page load time is slow, or they are not finding the options that they want very quickly.
Therefore, you have to make sure that this metric reflects users that are spending more time on your product because they like it, rather than because they are frustrated by it. You can do this by keeping an eye on site performance metrics, support requests for complaints, as well as frequently talking directly to your customers.
Summary
The SaaS business model involves charging subscription fees (monthly or annually) for access to a service.
Often a free trial is offered to customers to get them to try the service.
CAC, LTV and ARPU show a view of how profitable an average client is.
Monthly recurring revenue (MRR) shows the general size of a SaaS business and the growth of MRR shows how quickly the business is growing.
Monitoring user activity, stickiness and time spent on the product help you to learn when customers are not active enough (usually a sign that they will churn in the future) so you can take action.
Additional resources
Venture capitalist David Skok on SaaS metrics.
The distinction between CPA and CAC explained by online growth expert Brian Balfour.
