May 9, 2016
Know if your SaaS marketing strategy & business is financially viable
Know the effective strategies for measurable growth in SaaS companies
Know the most important focal points that could grow your SaaS business
A SaaS business has more complexities and peculiarities than other types of product and service-based businesses.
You are not likely to get accurate results if you attempt to measure the performance/success of a SaaS company with the same metrics used to measure traditional businesses.
In fact, a few cardinal variables make the biggest difference in the outlook of a SaaS company. This post seeks to provide executives at SaaS companies with insight on the cardinal variables of their industry. We will also discuss how to measure such variables and how to leverage this knowledge for the success of their businesses.
At the end of this article, you should be able to
NB: We wrote this article specifically for a SaaS company but any subscription business can apply the insights for success
The fundamental factor that separates a SaaS company or other businesses generating recurring revenue from other traditional business is that revenue comes over an extended period known as the customer lifetime.
In a SaaS business, the customer will continue using your software if they like the product and you’ll continue to generate revenue for that same period. If the customer doesn’t like your product, they’ll dump it (churn) and the resources spent to acquire the customer would have been wasted.
A SaaS business is fundamentally different from other types of businesses because you have to apply sales efforts on two fronts:
Customer retention is germane to the success of any SaaS business; hence, this post focuses on how you can understand and measure your customer retention. Below are three key factors that can reveal the viability of any SaaS business:
If you are starting a SaaS company, you can expect to record massive losses and some serious cash flow issues early in the lifespan of your company. The cash flow problems are evident when you don’t yet have enough customers paying you month by month to cover operational expenses.
The main reason for this financial problem is that you’ll be making heavy investments to acquire customers to your product. In fact, your losses and your cash crunch will tend to be amplified as your business grows rapidly.
Interestingly, investors and board members in many fledgling start up marketing & SaaS companies don’t understand this finance dynamics and they tend to advocate for a slowdown in expenses when should actually be accelerating their customer acquisition expenses.
However, you can rest in the knowledge that you’ll eventually book gains from your customer acquisition investments over the long term. You’ll get to a point in your growth story when the cash/profit from your installed base is more than the customer acquisition expenses needed to attract new customers. You’ll automatically be cash flow positive at that point, especially if you choose not reinvest in the extra cash/profit in sales and marketing.
Interestingly, most SaaS entrepreneurs/founders tend to follow the path of reinvesting cash/profits towards sales and marketing to acquire new customers. Expenses typically include spending on hiring more sales reps, increase lead generation, and upgrading servers or data center capacity among other things.
Unfortunately, investors don’t usually understand why a successful SaaS business will be facing issues of cash flow and profitability even though it is gaining traction in the market. Investors usually expect to see a narrowing of cash drain or losses immediately the product starts gaining traction in the market.
Hence, founders of SaaS companies are often saddled with the tough responsibility of taking extra time to explain to their investors why they need more funding to bankroll the next step in their acceleration and customer acquisition phase – an action that seemingly defies logic.
However, I have observed that the problem of foregoing today’s cash to chase a bigger market share is not limited to startups alone. Even established publicly traded SaaS companies often have to go through the pain of winning investors over to the idea of increased customer acquisition expenses at a time when shareholders are naturally expecting dividends of share buybacks.
From the aforementioned, it is obvious that we think a business should start reinvesting aggressively to acquire more customers and increase its install base and market share. The main reason we advocate aggressive customer acquisition initiatives one the product is proven is simply because the SaaS industry gives the winner the biggest share of the pie.
There’s no such thing as the first-mover advantage in a business where size is everything. Hence, you need to maximize every opportunity to expand your market share if you don’t want to be sidelined by newer, nimble, and hungrier rivals.
Of course, you’ll need to be able to tell all relevant stakeholders; the board, investors, Wall Street, and the media why you—a compelling story on why your rapid growth initiatives will eventually yield increased profitability down the road. If you do a great job convincing the stakeholders, you’ll be surprised at how quickly your valuations will rise to the top and your hopes of increased profitability might turn out to become a self-fulfilling prophecy.
Nonetheless, you can’t afford to start pouring money down a drain in the hopes of acquiring new customers. In the next part of the post, I’ll provide insight into how you can make sure that your growth and expansion activities will yield the desired results.
Most SaaS businesses will record losses when they are just starting out, the company will also need to increase its customer acquisition costs as it gets bigger; hence, it might be very hard for investors and the management team to know if the business will be successful down the road and if the massive investments will be worth the effort.
A smart way to test the viability of your SaaS business and its operating model is to answer the following the questions.
Will the profits from a customer be more than the cost of acquitting the customer?
You’ll need to study and understand the unit economics of your business to answer this question accurately. Good starting points for understanding the unit economic are the two metrics below:
LTV – the lifetime value of a typical customer
CAC – the cost of acquiring a typical customer
The LTV (lifetime value of a typical customer) and the CAC (cost of acquiring a typical customer) are valuable metrics that can provide you quick insight into the viability of your SaaS business. The LTV helps you know if your efforts will yield profits down the road and the CAC helps you know how long it will take you to reach profitability. Know the cost-profit ratio also helps you to make smart decisions on capital efficiency.
In the last couple of years, I have seen first-hand how LTV and CAC could be very valuable for validating the viability and profitability of a SaaS company. From my observations, the successful SaaS companies usually have an LTV to CAC ratio higher than 3 – I have seen SaaS companies with LTV to CAC ratios as high as 7.
Interestingly, successful SaaS companies are able to earn enough LTV to outpace the CAC within 5 and 7 months. Nonetheless, you should note that most successful SaaS companies don’t start out with a rock solid plan on their LTV and CAC but they usually tweak and improve their strategies along the road to profitability.
The matter of the number of months it will take you to recover CAC is most a function of time in relation to cash flow and profitability. A startup will almost always be a couple of months away from a cash crunch whereas an established company access to cheap funding; in essence, the very survival of a startup might be directly connected to how soon it recovers CAC while an established company might not be overly worried about timing. Nonetheless, it is important to note that the Months to recover CAC is a reliable indicator of the potential success of a SaaS company.
You’ll generally find two kinds of SaaS business
Every month/year, three major factors will influence how the MRR/ARR will fluctuate in relation to the revenue from the previous month/year.
Changes in new customers added
Changes in the existing install base
The sum of the aforementioned three factors will determine your Net MMM or Net ACV revenue.
When you are just starting out your SaaS business, you won’t be overly worried about churn. If you have 100 customers and you lose 2% of your customers each month – it means that 2 people canceled their subscription each month and you can easily find two new customers to replace them.
However, over the growth story of your business, churn tends to become a massive source of concern. If you have grown big to have 1 million customers in your install base and you still lose 2% of your customers each month – it means you are losing 20,000 customers and their MRR each month.
You also observe that it is much harder to replace 20,000 customers than it is to replace 2 customers even though both numbers still represent 2% of your install base at different times.
The churn rate is another part of churn that you cannot afford to ignore. The churn rate in relation to your new ARR/MRR can help you predict how fast you can grow your business. The churn rate in relation to new ARR can also help you know how big your business can grow before it peaks.
Successful SaaS businesses tend to be adept at finding ways to decrease their churn while also unlocking solutions to increase their average deal size and volume. Your SaaS business will have a healthy growth rate in as much as your ARR is higher than your churn.
To fix churn problem in a SaaS business, you might want to start by grouping your users in terms of ‘cohorts’. A cohort simply refers to a group of customers that joined your user base in a specific month. Hence, you’ll have January cohort, February Cohort, March Cohort through December.
Grouping customers into cohorts can help you know how your user base is growing or declining each month. The cohort grouping can also help you see patterns in the seasonality of your growth trends. A SaaS company can adopt two simple strategies in order to raise expansion revenue.
Both revenue churn and customer churn are important for getting a full understanding of the revenue situation of your company. However, the customer churn and revenue churn should be examined independently in order make educated decisions to prevent churn.
Let’s assume you run a SaaS business with 100 customers – 50 of those customers are individual users paying $100 per month and the remaining 50 customers are enterprise users paying $1000 per month. 100 customers in the aforementioned scenario will net you an MRR if $55,000 each month.
If you lose 10 customers out of 100 in a month, your customer churn rate is 10&. If 9 of those 10 customers are individuals paying $100 and the last one is an enterprise paying $1000, you would have lost $1900 in MRR – which translates to about 3.4% Revenue Churn. In the dynamics were reversed between the personal and enterprise users, you’ll lose $9100 in MRR, which translates into 16.55% Revenue Churn.
Your SaaS company will be in a stronger cash position if you can convince your users to pay in advance to use your product or service. Of course, you’ll need to ensure that the upfront payments don’t have negative effects on booking. Upfront payments, when properly handled can provide you with cash flow and reduce the chances of a cash crunch. You may want to consider incentives such as discounts or value-added bundles to encourage upfront payments.
Upfront payments can also help you lower your churn rate. Upfront payments also make it easier for have actual data for calculating CAC and LTV. Customers who have committed to using your product with upfront payments are not likely to ditch your service mid-month because of their money. If customers are leaving even when they have paid upfront, you may want to review the strengths and weaknesses of your product.
The “Months Upfront” metric can also help you know how well your sales forces are getting and converting new leads. However, you need to be strategic about asking for upfront payments because an aggressive push for upfront payments might push some potential users away.
Churn is a powerful tool for measuring the rate at which you are losing customers and revenue. Hence, it would be nice if there were ways you can identify customers that are likely to churn. If you know the customers posing the highest risk of churn, you can easily get your sales and marketing team to work to try to salvage the business relationship.
The simplest way to know the customers most likely to churn is to implement tracking tools to measure user engagement in your SaaS applications.
For instance, a product such as Instagram can measure likelihood to churn by looking at engagement in terms of uploading pictures, liking, and commenting on pictures. A user that has rarely uploads, likes, or comment on pictures is more likely to churn. If you sold an enterprise level SaaS product to a team with 50 members and only 8 people are using your product, you’ll know that the client is at a higher risk to churn than a 50-member team where 42 people are using your product.
In essence, you should consider creating a Customer Engagement Scorecard that you’ll use to allocate points the level of user engagement on your product. You can assign different points to the different features/usage of your product. You can always test and retest your Customer Engagement Scorecard as against actual Churn data down the road.
Interestingly, user engagement data can also help you to deduce important information about customers that you can cross-sell or upsell based on the level of their engagement.
We have already established that user engagement is an indicator of customer satisfaction and that customer satisfaction is a good indicator of possible future churn. You can survey the level of customer satisfaction with your product using the Net Promoter Score (NPS). The NPS is a standardized number that you can use to measure the level of customer happiness with your product or service.
A SaaS business with a Net Revenue Churn higher than 2% per month has a serious churn problem that must be addressed ASAP. With a revenue churn of 2% (or more) per month, you’ll lose some 22% revenue of your revenue each month.
At a 22% revenue loss, you are losing almost a quarter of your revenue and you’ll have serious financial and growth problems as your business bigger. Some of the reasons you might be having a churn problem are provided below:
The best strategy that can help you know why you have churn problem is to get on the phone and talk to your customers. If you have a serious churn problem, it might be in your best interest to have the founders make those calls. The calls could help you pinpoint the problem areas so that you can formulate effective strategies for fixing them.
During the course of operating the SaaS industry, you’ll eventually understand that you can place customers into different groups across a spectrum. For instance, you’ll do a lot of work to convince big enterprise clients to use your product but big enterprise clients often place huge orders and don’t churn frequently. Hence, you need to be able to identify your most profitable customers in relation to CAC.
Grouping customers into different segments might appear to be a laborious task in the initial stage. However, the categories will; help you identify what it working and what is not working in your business so that you can allocate resources effectively. Putting customers into different groups can also help you develop different marketing ideas that will make it easier to convert leads from the different groups.
Once you’ve completed your customer segmentation process, we would implore you to track the following metrics:
Each sales funnel will require different metrics and the metrics will vary from different companies because of the differences in the number of steps in each funnel. Nonetheless, you can measure each of the steps in the sales funnel and the overall sales process using two factors. The first factor is the number of leads that you got from each step. The second factor is the conversion rate from each funnel step.
Some valuable tools for identifying these factors include the number of downloads/installs, number of trials and closed deals, and the number of visitors. Of course, these tools might be different depending on the peculiarity of your business.
One of the key benefits of having data on leads and conversion rates is to enable you to know how to predict future trends with a degree of accuracy. For instance, if your company wants to increase revenue by $3M next quarter. Your existing data on leads and conversion rates to know the number of demos/trials you’ll need to get enough paying customers to reach your revenue targets.
The data on the productivity of your sales force will also help you know the number of sales reps you’ll need and the number of leads they’ll need to generate for you to meet your targets. Having this data could also help you to improve your staffing and allocate funds effectively for your marketing efforts.
Sales agents are often crucial to closing deals in the average SaaS business. Your sales capacity is simply the number of productive sales reps you have and it has a direct influence on your bookings. You’ll need to crunch the number from your existing data in other to ensure that you have the required sales capacity.
It wouldn’t be nice for your business to miss your revenue targets because you didn’t hire enough sales reps that could close enough deals.
You also need to understand that some of your new sales hires won’t meet their sales targets – some of them are probably learning on the job; hence, you might want to lower your expectations. You shouldn’t be surprised if your new sales reps in the fields have failure rates of 25% to 30%. However, you can expect the failure rate to be lower for your in-house sales agents.
When calculating your Sales Capacity, you can count your new sales reps as half a productive rep if you can trust them to convert 50% of their quota. The half a productive rep designation is also known as Full-Time Equivalent or FTE is some quarters.
You’ll also need to pay attention to how you’ll generate the leads that you’ll feed the sales rep. It doesn’t make sense to hire new sales reps if you don’t have a clear path on how you’ll get the leads you want them to chase.
The information provided in this segment is by no means exhaustive on managing the sales process for a SaaS company; you can find additional information in other blog posts.
Startups operating in the SaaS industry usually pursue lead generation strategies using Google Ad Words, radio/TV ads, or other PPC ads. However, in our experience understudying lead generation strategies, we’ve observed that all lead sources will eventually reach a point of saturation over time. At the point of saturation, these sources will yield lesser leads in relation to the money spent. Hence, SaaS companies must continuously review new lead sources to generate new leads that complement the declining trend from older lead sources.
The costs and conversation rates for different lead sources vary along a spectrum; hence, it’s in your best interest to know the ROI on each lead source.
SaaS companies will always have to contend with the fact that it is challenging to generate leads fast enough for the sales funnel – inability to generate leads consistently can limit the growth potential of a firm. If you are having trouble generating leads, we strongly recommend that you start allocating capital to Inbound Marketing.
(Read More: 7 Inbound Marketing Stats You Won’t Believe)
It might take some time before you ramp up leads from Inbound Marketing, but your costs will be reduced over time. More so, Inbound Marketing techniques are easier to scale for increased lead generation than other strategies. In addition, SaaS buyers will typically spend lots of time online; hence, you’ll have an incredible opportunity to soft sell your profits with Inbound Marketing content.
SaaS businesses have more need for the strength of numbers than other types of businesses. Hence, little tweaks to metrics such as conversion rate or churn rate can have massive effects on the overall state of the business. If you find a person who is passionate about numbers, spreadsheet modeling, and data crunching; they usually make a great addition to the team.
Knowing the SaaS metrics that can serve as a lever to drive growth in your company can help you make proactive decisions. I have written short notes on some of the most important metrics you must watch:
We have observed that getting the perfect pricing for your product can exponentially increase your unit economics. You’ll obtain improved MRR, you’ll find it much easier to upsell, and you’ll be able to identify the most valuable segments of your business.
An objective customer segmentation exercise will help you identify your most profitable business segments. Your customer segmentation analysis will also make it easier for you to:
SaaS businesses can seek growth and increase revenue by venturing into international markets. However, expansion into international markets should only be attempted by SaaS companies that have tested and succeeded with their product in their home market. Expansion into international markets is usually challenging because of distance, cultural difference, and language barriers.
Most initiatives for making a SaaS company profitable will take a lot of time to make an impact. Hence, it is in your best interest to plan ahead and start early implementation for any change you’ll love to see in your business. You can ideally expect nine to twelve months to elapse from the point of making a decision (such as increasing your sales and marketing spending) to when the results of that decision will have a significant impact on your bottom line.
From most of our explanations from the beginning of this post until this point, you’ll have observed that the success of a SaaS business is mostly dependent on three main factors:
Find a way to acquire a loyal user base for your product and ensure that you lock down sustainable strategies for customer retention. Customer retention is very important and there’s no point acquiring new customers only to lose them down the road. Before you start investing in acquiring customers, make sure that you have plug the leaks contributing to your churn.
Pay attention to the most important numbers that influence the overall health of your business.
Test the viability of your SaaS business using the aforementioned guidelines on LTV: CAC and Time to recover CAC. Once the viability is confirmed, push out an aggressive growth campaign but make sure you have the funds to push the growth.
We know that this article is incredibly long but we are optimistic that we have armed you with valuable information that could help you succeed in your SaaS business.
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