Google SaaS metrics. You will get at least a dozen results.
MRR, ARR, ACV, CAC, LTV and so on.
Ugh, it is kind of the worst when people speak in acronyms. It feels like you are in an episode of the Twilight Zone where everyone knows what is going on but you.
But once you learn what these stand for you start to get the idea why subscription businesses are measuring them. Each metric is used to help improve your business. Although, it does seem like a lot.
And it can be confusing. Initially it seems straightforward: all you have to do is plug in the numbers for each formula and voila! But in reality you will spend most of your time pulling data, cleaning it, interpreting it and just trying to keep things consistent. Then you get the final numbers to “just plug in.” Then the month will close again and you will be right back at the beginning again: pulling, cleaning and interpreting data.
Once you actually collect all of the data needed to calculate each of these metrics, clean the data and calculate it on a monthly basis you will soon realize that it’s a ton of work. Especially for a growing business. Who has the time?
I get it. So here I am breaking it down to the top three that you need to know so you can get the most out of your time.
Instead of being a SaaS metrics expert and dedicating a ton of time cleaning data when you could be building your business, here are the three most important metrics.
These metrics will help you to:
-Evaluate how well your business is doing
-Take advantage of growth opportunities
-Know if you should be investing more to maintain your customers
It stands for Keep It Simple Stupid. No, KISS is not a SaaS metric. But it is a helpful acronym when you are tackling any problem. Initially just try to calculate the most basic metrics the simplest way possible. Then you can start to work on the more complicated metrics and fine tune the data.
1. Monthly Recurring Revenue (MRR)
MRR is the first metric you absolutely need to know. It is an indication of how well your company is doing. And it is better than plain old revenue (I’ll explain why in a bit).
Just like the name says it is the sum of all of the monthly revenue that is recurring. A simple example is: your product costs $100 per month. You count up all of your clients and multiple that number by $100 to get your MRR.
Seems easy, right? But sometimes we can get tripped up by small details. Here are some tips for calculating your MRR, which hopefully help you to avoid getting tripped up by the small details.
- Do not include one time fees. It might seem obvious but it is easy to overlook if you are using the total amount a customer has paid. One time fees can include: set up fees, consulting fees, hardware, installation or other.
- Only include live clients. Although this dips into accounting and I don’t want to complicate it, it is important to have this clear. Live clients are those clients where everything has been set up and is ready to use AND “the keys” have been turned over to the software. (BDO has a pretty good white paper on go-live and other SaaS accounting info if you want to learn more). Only include live clients in your MRR number. There is another metric, CMRR, which is “Committed” MRR, those clients that have signed up but for whatever reason are not live yet.
- Be careful when mixing different periods. Many subscription businesses offer monthly, quarterly and annual subscriptions and or payment terms. Make sure that you are calculating those properly. Divided annual contracts by 12, quarterly by three and so on.
- Be consistent. Since MRR is not actually GAAP accounting the rules are a little more flexible. It is important to always calculate MRR (and all metrics for that matter) the same way. The value of your analysis will hinge on the fact that your data is consistent. For example, when a client goes live on any day of the month that is not the 1st day, what do you do? Do you include the first and last month, which would make it 13 months? Or do you prorate the first and last month? (<- this is GAAP) The common practice is to include MRR for each month in which the term exists. But whatever your choose, make a note of it and be consistent.
Why is MRR one of the three most important SaaS metrics?
-It enables you to evaluate how your business is doing by normalizing revenue. MRR normalizes revenue so that you can compare it month over month. If you were to use only GAAP revenue and compare months, you would have dips in months with fewer days.
Here is an example of revenue versus MRR for a $1,200 a year product.
It may only look like a couple of dollars difference, but multiple those couple of dollars by hundreds or thousands or even hundreds of thousands of clients. You cannot accurately see what is going on. Is there a dip in February? Maybe. You won’t know until you compare apples to apples. Make sense?
-Helps you to create projections (MRR and GAAP) so that you can plan to support all of your current and future customers.
-And a ton of other things, but we are keeping it simple today.
Besides, MRR is a gateway to other metrics that will be even more interesting to you like, New MRR and Expansion MRR. New MRR is the total additional MRR from new customers and Expansion MRR is additional MRR from existing customers. Expansion MRR usually comes from a customer upgrading or purchasing an additional product. Expansion MRR is getting new MRR at a no additional cost.
2. Customer Acquisition Cost Ratio (CAC Ratio)
You see Customer Acquisition Cost more often than Customer Acquisition Cost Ratio but in my opinion CAC is just a random number with no context. For example, “it costs $2,450 to acquire a new customer.” And….??? Without knowing how much a customer is paying that amount means nothing. CAC ratio on the other hand is a proactive metric. If the number is too low it tells you that whatever you’re doing is not working. Fix the product to appeal to more customers, make your marketing and sales more efficient or your product just isn’t going to work. Whatever the case action needs to be taken.
I like the CAC Ratio formula from Bessemer Ventures.
Note: One thing this formula assumes it that you have a 3 month sales cycle. If your sales cycle takes more or less time, adjust accordingly.
Anything above one means that the company should invest more money immediately and step on the gas as customers are profitable within the first year.
This ratio is essentially answers the question: Is what I am doing working?
To make it even easier, you can use revenue instead of Gross Margin, but keep a note that you aren’t taking into account how much it actually costs you to provide the service. Using revenue can become a slippery slope, but it is better than nothing. So if you don’t know your Cost of Revenue now, just use revenue so you do not have an excuse for not doing it.
CAC Ratio is essential for your to be keeping track of. It will help to guide you and enable you to take advantage of growth opportunities.
Don’t worry. It’s not personal. Or maybe it is.
It doesn’t really matter if your customer leaves because they personally dislike you, they don’t like your product or because their budget was cut.
Churn is churn.
Churn is how many clients or how much revenue you lose during a given time period. This can be a customer canceling at any time during the contract or not renewing.
Churn is calculated by number of clients or by revenue.
Churn Rate is shown as a percentage. For example 5% churn annually.
Like I just mentioned churn can be calculated on amount of revenue and or number of clients.
Why is churn so important? Subscription businesses live or die based on their churn. The more customers you are able to retain the more lucrative your business will be. If you are unable to maintain customers, you are always trying to make up for the lost customers instead of building your business. Why do you think Time Warner or whatever cable company you have makes it so difficult to cancel their service?
I hope this explanation helps in your quest to start to build out your subscription metrics.
For more insight or help on analyzing your SaaS metrics contact me at me (at) katiebronnenkant.com.