SaaS: metrics to achieve growth

ARPU: Average Revenue Per User

ARPU is the average amount of revenue you earn monthly from each of your active customers. MRR / # active customers = ARPU

For example, if your monthly recurring revenue (MRR) is $100,000, and you have 1,000 active customers, your ARPU is $100 [$100,000 (MRR) / 1,000 (active customers)].

ARPU is calculated based on active customers, not the total number of users. A big mistake SaaS companies make when calculating their ARPU is dividing their MRR by the total number of users. ARPU is based on revenue. Since free users do not contribute to your revenue, they should be excluded from your calculation.

One of the most obvious reasons to track ARPU is because it directly correlates to your MRR. If you are able to increase your ARPU, you increase your MRR (assuming you connect customers/users).

ARPU also gives you insight into the long-term viability of your business and your ability to scale. For example, with an ARPU of $5, it becomes very difficult to scale because you depend on having a large number of customers. And the more customers you have, the more resources you have to devote to support and engineering. It can then be difficult to make your business profitable.

Churn

Churn is the percentage of customers or sales lost in a given period (usually monthly). Most SaaS entrepreneurs monitor two different types of churn.

Customer churn: percentage of customers lost

(# cancelled customers last 30 days / Active customers 30 days) * 100

Revenue churn: percentage of revenue lost

(MRR Lost to Downgrades & Cancellations last 30 days ÷ MRR 30 days) * 100

In most cases, when you hear a SaaS entrepreneur talk about churn they are talking about losing customers. But revenue is equally, if not more, important. In fact, with customer churn we only consider customers who cancel their account altogether. Churn on revenue gives a more realistic picture given we can take into account downgrades, for instance.

SaaS companies depend on long-term customers to grow. The longer your customers pay, the better. If you are not able to control your churn, it will eat away at your revenue to the point where your business becomes unsustainable. No matter how many new customers you can acquire every month, if you fail to retain them long-term, you are basically on a hamster wheel going nowhere.

It is important to actively analyse and reduce your churn. Even if you have a low churn rate (say 2% or less), you need to constantly look for ways to keep it as low as possible.

For most SaaS companies, a churn rate of 5-7% is considered “healthy”. Once you start hitting over 10% monthly churn on a regular basis, it is a sign that something is wrong and you really need to do a deep dive into what is going on with your business.

MRR: Monthly Recurring Revenue

MRR is the amount of revenue you get from your customers every month. However, MRR is different from your company’s total revenue. For example, if you have a SaaS business and also sell additional one-off services, such as setup fees, consulting or other one-off payments, these should not be included in your MRR. As the name suggests, MRR only includes revenue from recurring payments/subscriptions.

MRR can be divided into two groups:

• New MRR: Monthly Recurring Revenue from new customers.
• Expansion MRR: Monthly Recurring Revenue from existing customers.

It’s probably no surprise, but you need MRR to keep your business running. If your MRR is increasing, it means more revenue is coming in every month. You are bringing in more revenue than you are losing, and hopefully you have healthy MRR growth.

But if you have long periods of declining MRR, you need to look into what is going on. Are customers churning faster or more than usual? Are you not bringing in as many new customers? Are you missing opportunities for expanding MRR?

The more you understand where your MRR is coming from and how it is evolving, the easier it is to create a strategy for growth.

Contraction MRR

Contraction MRR is MRR lost from existing customers. Lost revenue can come from customers downgrading their plan, reducing the number of users on their plan, not being able to pay, or anything else that reduces the amount of money an existing customer pays you monthly.

Contraction MRR does not include customers who have cancelled. It should only include lost revenue from customers who are still active.

In most cases, contraction is a value issue. People feel they are not getting enough value from their current subscription to justify the price (for whatever reason), so they reduce their value or make other discounts.

Expansion MRR

MRR is additional MRR that comes from existing customers. It can come from users who upgraded their account, bought an add-on product, added additional users to their account or anything else that increases the amount of money they pay you each month.

In some cases, you can build MRR’s add-on capabilities directly into your business model. For example, if you sell a B2B SaaS product aimed at teams, you can charge per seat. As your client’s team grows, they add additional users to their account, creating expansion MRR.

CAC: Customer Acquisition Cost

CAC is the amount of money you spend to acquire a new customer. To calculate CAC, divide all customer acquisition costs by the total number of customers acquired in a given period. This is the basic formula:

Total CAC cost / number of customers acquired.

Not all SaaS entrepreneurs calculate this total CAC cost the same. Some will include everything like advertising expenses, salaries and tools, and others prefer to just include advertising expenses. The former is a bit more complicated to do, and the latter is a bit less detailed.

CAC is important because it helps determine the profitability of your business. If you spend more to acquire customers than the revenue they generate, you are not making money. Even if your MRR increases every month, you won’t make a profit unless you can get more money from clients than it costs you to acquire them.

LTV: Lifetime Value

Customer lifetime value (LTV) is an estimate of how much revenue you will make from the average customer before they cancel.

Average monthly MRR per user / User Churn Rate

If your CAC is greater than your LTV, or you just want to increase your LTV, there are plenty of things you can do:

• Adjust your pricing
• Shorten your churn time
• Optimise your CAC
• Increase your expansion MRR

Quick Ratio

Compared to the other metrics on this list, quick ratio is a pretty traditional metric. But sometimes it is necessary just to check how things are going and how your growth trajectory is progressing. The Quick Ratio (also called the Acid-Test) is a number that indicates how efficiently your business is growing at its current sales and churn rate. Generally, the higher your Quick Ratio, the more efficiently you can grow your SaaS business.

(New MRR + Expansion MRR) / (Contraction MRR + Churned MRR) = Quick Ratio

The purpose of the Quick Ratio is to tell you how efficient and sustainable your growth is. Your Quick Ratio should not be the end result for your business, as there are many factors at play. But it can give you a good idea of where your business is going.