You can find countless blog posts and lists out there saying what metrics a subscription business should measure. There are tons of nice-to-have metrics, but I’d like to show you 5 metrics that are really indispensable for a SaaS or any kind of subscription business.
It’s important to notice that this lists represents my personal point of view – and probably a common sense – but since you can measure up to 100 different metrics for a subscription business it’s ok that you think a metric or two is missing and should be included on this list. Please feel free to share your thoughts in the comments.
Monthly Recurring Revenue
Monthly Recurring Revenue, almost always referred to as MRR, is probably the most important metric at all of any subscription business. It’s what makes this business model so great. Once you acquire a new customer you got an recurring revenue, which means you don’t have to worry about one-off sales every month. Different from traditional sales, it gives you new challenges such as retention and churn.
The general concept is that MRR is a measure of the predicable and recurring revenue components of your subscription business. It will typically exclude one-time and variable fees, but for month-to-month businesses could include such items.
How to calculate MRR?
The better way of doing it is to simply sum the monthly fee paid by every single paying customer of your installed base. So let’s say you have Customer A paying $200/mo and Customer B paying $100/mo. Your MRR would be $.00. See that each customers may be paying a different amount since you can have different plans or event different products in your portfolio.
MRR = SUM(Paying customers monthly fee)
Average revenue per account
An easier way to calculate it, is using the ARPA. Once you know the average revenue per account (some times called average revenue per user), all you should do is multiply the total number of paying customers by the average amount all of those customers are paying you each month. So let’s say you have 10 paying customers and an average amount of $100/mo, your MRR would be $1,000.
MRR = ARPA * Total # of Customers
How to calculate MRR Growth?
You might think that if you acquire more customers you MRR would grow, right? That’s true, but not the only aspect to be considered on a subscription business model. To analyze MRR – and specially MRR growth – we should consider three different aspects of MRR:
New MRR is the simply new revenue brought by brand new customers acquired. So let’s say you have acquired on a given month 5 new customers paying $100/mo and 2 new customers $200/mo. Your New MRR for that month would be $900.
Now image that you have 3 customers that upgrade their plans from $100/mo to $200/mo. That means you have expanded your revenue from existing customers, we call that Expansion MRR. Your Expansion MRR for that month would be $300. Keep in mind that Expansion MRR can come from upselling (customers upgrading theirs plans) or cross-selling (customers buying additional products or services).
And you should also consider churn. Churn MRR is the revenue that has been lost from customers cancelling or downgrading their plans. So let’s say on a given month you had 2 cancellations of $100/mo plans and other 3 customers downgraded their plans from $200/mo to $100/mo. You Churn MRR would be $500. It simply means that you’ll have minus $500 on recurring revenue for next month. Keep in mind that MRR churn is different from customer churn.
Finally, to calculate your MRR growth you should actually consider all these three aspects on a formula.
Net New MRR = New MRR + Expansion MRR – Churn MRR
Customer Lifetime Value
What is LTV?
Customer Lifetime Value, usually referred to as LTV (sometimes as CLTV or CLV) measures the profit your business makes from any given customer. The purpose of the customer lifetime value metric is to assess the financial value of each customer, or from a typical customer in case you’re measuring it generally.
Customer lifetime value helps you make important business decisions about sales, marketing, product development, and customer support, such as:
- How much should I spend to acquire a customer?
- Who are my best customers? How can I offer products and services tailored for them?
- How much should I spend to service and retain a customer?
- What types of customers should sales reps spend the most time on?
How to calculate LTV?
To measure lifetime value for a subscription business we need to use three variables:
- ARPA (Average Revenue per Account);
- Gross margin.
To calculate it, take the revenue you earn from a customer, subtract out the money spent on serving them, and see for how long they stay bringing you this profit before churning.
LTV = ARPA * % Gross Margin / % MRR Churn Rate
Improving your Customer Lifetime Value can have dramatic impacts throughout your business. So you should always be looking for higher ARPA (customers paying you more money), higher Gross Margin (costing less to produce) and lower Churn Rate (paying you for a longer time).
Some sources may refer this calculation as CP (Customers Profitability) instead of LTV, in a way that CP represents the difference between the revenues earned from and the costs associated with the customer relationship during a specified period; and LTV represents the present value of the future cash flows attributed to the customer relationship.
Customer Acquisition Cost
What is CAC?
Customer Acquisition Cost, or simply CAC, refers to the resources that a business must allocate (financial or otherwise) in order to acquire an additional customer. It includes every single effort necessary to introduce your products and services to potential customers, and then convince them to buy and become active customers.
Some common sales & marketing expenses are paid advertisement, sales, and marketing staff salaries, CRM and marketing automation software licenses, events, sponsorships, gifts to customers, content production, social media and web site maintenance and more.
How to calculate CAC?
Conversion rates per sales funnel stage
One way to calculate CAC is to consider the three variables that compose it. This method allows you to go into detail and might give you good insights about your sales process cost and conversions but can be tricky to get right.
- CPL (Cost Per Lead) (e.g. marketing costs);
- Touch cost (e.g. sales staff salaries);
- Conversion rates at each stage of the sales process.
CAC = (CPL per customer + ‘touch’ costs per customer) * Conversion rate
Sales & Marketing expenses
An easier way to do it is summing all of your Sales & Marketing expenses and divide it by the number of customers acquired on a given period. So let’s say you’ve spent $1,000 this month on sales & marketing and have acquired 5 new customers. Your CAC would be $200, which means you’ve spent $200 to bring each new customer in.
CAC = Total Sales & Marketing expenses / # of New Customers
CAC and LTV
It’s important to notice that CAC is fairly meaningless without knowing the LTV (Customer Lifetime Value). That is, the ability to monetize a customer. And every company is different, so it isn’t a one-size-fits-all scenario; though generally, the more expensive the product, the higher the CAC will be.
CAC plays a major role in calculating the value of the customer to the company and the resulting return on investment (ROI) of acquisition. The calculation of customer valuation helps a company decide how much of its resources can be profitably spent on a particular customer. In general terms, it helps to decide the worth of the customer to the company.
Average Revenue per Account
What is ARPA?
Average Revenue per Account (sometimes known as Average Revenue per User or per Unit), usually abbreviated to ARPA, is a measure of the revenue generated per account, typically per year or month. You could also say that it represents the Average Revenue per Customer, but remember that a customer may have more than one account depending on your product/services characteristics.
Average revenue per account allows for the analysis of a company’s revenue generation and growth at the per-unit level, which can help investors to identify which products are high or low revenue-generators.
How to calculate ARPA?
To calculate the ARPA, a standard time period must be defined. Most subscription business operate monthly but you can always calculate it yearly or quarterly according to your plans and billing options. The total revenue generated by all customers (paying subscribers) during that period should be divided by the number total number of customers.
ARPA = MRR / Total # of Customers
New Accounts vs. Existing Accounts
There is a good practice of measuring the Average Revenue per Account separately for new customers. So instead of having an ARPA metric for all your customers, you’d have two different metrics: Average Revenue per Existing Account and Average Revenue per New Account.
In that way, you can have a sense of how your ARPA is evolving and how your new customer behave if compared to existing ones. Are they more willing to accept cross-selling and/or up-selling? Measure it separately and you’ll know.
What is Churn?
Churn is the enemy of any subscription company.
In a general definition, churn is the number or percentage of subscribers to a service that discontinues their subscription to that service in a given time period. In order for a company to expand its clients base, its growth rate (number of new customers) must exceed its churn rate (number of lost customers).
Why customers churn?
Churn is inevitable. It’s impossible to guarantee that all your customers will remain to be your customers forever because churn happens for a variety of reasons. A few examples of why your customers may discontinue their subscription to your service:
- Customer out of budget/can’t afford the subscription fee;
- Customer can’t see/get the value proposition of your product;
- Your product lacks quality/features;
- Your product is good but customer service is not;
- Changed to a competitor’s product;
- Your B2B customer is bankrupted;
- Your B2B customer has been acquired.
As you can see there are some events and variables that are out of your control and there’s almost nothing you can do. But the good news is that – in most cases – customer churn reason is under your control, like product quality, price and customer service.
How to reduce churn?
Your challenge is to deeply understand your customer’s engagement and satisfaction (like measuring NPS) and then try to fix the problems that are under your control to prevent and reduce churn. Churn analysis may lead to a new product roadmap to include/exclude product features, to invest in a higher quality product support or even changing your pricing model.
The best way of doing it is by making your product indispensable. It should make part of users daily workflow. Provide frequent value that they can’t live without. A good strategy is to engage with your customers using email, SMS and any kind of notifications to remind them you’re there for them.
Considering creating an email report showing the most important information/value your product provides to them.
Customer Churn vs. Revenue Churn
It’s important to notice that Customer Churn is different from Revenue Churn. Customer Churn refers to the number of customers that have discontinued their subscription on a given period. Revenue Churn is how much those lost customers represents in revenue.
Let’s say your product has a $10/mo and a $100 pricing plan. Loosing 5 customers paying $10/mo still good if compared to loosing one single customer paying $100/mo. That’s why Revenue Churn (usually referred to as MRR Churn) is more important than Customer or User Churn.
How to calculate Churn?
For example, if 1 out of every 20 subscribers to your service discontinued his or her subscription every month, the churn rate for your service would be 5%. See that churn rate must be calculated for a given period, usually an year or a month.
To calculate churn, all you should do is to sum the number of customers that have discontinued their subscription on a given period. In case you sum all the churned customers in a month you’ll have monthly churn, or if you sum all the customers churned in a year, you’ll have yearly churn – and so on.
Churn = # of Churned Customers
Or you can calculate churn rate, representing the percentage of churned customers compared to a total number of customers.
Churn Rate = # of Churned Customers / Last Month Total # of Customers
Let’s say that 3 customers have discontinued their subscriptions to your service on a given month. Now let’s consider that the first customer was paying $10/mo, the second was paying $50/mo and the third was paying $100/mo.
Your revenue churn would be the sum of this subscription fees that will no longer come into your pockets next month, so $160.
MRR Churn = SUM (MRR of Churned Customers)
MRR Churn can also be represented in a percentage, referring to how much it represents of your total MRR.
MRR Churn % = Churned MRR / Last Month’s Ending MRR
Negative Churn is the dream of every SaaS/subscription entrepreneur. It happens when the expansions/up-sells/cross-sells to your current customer base exceed the revenue that you are losing because of Churn.
Getting to negative churn requires that you can do one or more of the following three things:
- Expansions: pricing model that increases according to usage growth;
- Up-sell: customers moving to a more highly featured versions;
- Cross-sell: customers to purchase additional products or services.
Keep in mind that is not easy to make negative churn happen. As David Skok has said in his blog post “Why churn is critial in SaaS”, in the first 12-24 months of your business it is frequently too early to figure this out. At this stage, it is more important to get broad customer adoption, and that often means simple pricing that leaves something on the table for your customers.
What’s an acceptable Churn Rate?
Off course the best answer for this question is “as low as possible”, but we know things are not that simple.
An acceptable churn rate depends on two main factors: your target customers and your company’s size/moment. Keep in mind that – if you’re doing a good job – your churn rate tend to drop over the time, so this references I’m about to give you should be considered for companies around 2 years old.
Very Small Business
If you’re selling to in selling to VSBs (very small nusiness) even the most valuable services will churn at a significant rate no matter what. Unlike large companies, a VSB will have very little upsell opportunities unless the company itself grows, and many will go under or change business direction.
Small and Medium Business
If your selling to SMBs (small and medium business) an acceptable churn rate reference would be around 3-5% monthly, but you really should target zero or negative churn. Another good reference would be < 10% annualy for a more healthy business.
If your targeting big corps with tickets higher than 5-digit/mo your churn rate should be under 1% and going down proportionally to your revenue growth. Enterprise SaaS is only a success if you are adding more net revenue from large-ish customers each year than you had the year before.