As a Founder or operator of a SaaS business you have a number of questions on your mind. One of the biggest questions is most likely, “how does my business stack up to other businesses like mine?”. In other words, “am I out-performing, performing or under-performing compared to my peers and competition?”
These questions can be tough to really understand given how busy you are operating your own business. The good news is, you don’t need to boil the ocean when it comes to finding the right metrics to measure the performance of your business. Based on our experience at ASG, we’ve identified five standard metrics that can be used to evaluate the health of any SaaS business.
1. Retention is key for growth.
Put simply, net revenue retention and customer retention answer the question: are your customers — and their money — coming back month over month or year over year?
Net revenue retention answers the question of what happens to your revenue if your company doesn’t gain another customer. This metric is one of the most important aspects of a healthy SaaS business.
How do you calculate net revenue retention? Let’s look at an example.
- If your prior month ending MRR (monthly recurring revenue) was $1,000
- Your current month increases in revenue from your existing customer base (upsells, price increases, growth in users, etc.) was $700
- Your current month decreases in revenue from your existing customer base (shrinkage in users, etc.) was $400
- Your current month lost revenue was $200
- Then your net revenue retention in the current month would be 110% (1,000 + 700 – 400 – 200)/1,000 x 100
Customer retention tells you how well you’re able to retain your customers from one period to the next.
How do you calculate customer retention?
- If the number of active customers in the prior month was 100
- Your lost customers in the current month was 5
- Then your customer retention in the current month would be 95% (100-5)/100 x 100
At ASG, rates greater than or equal to 100% for revenue retention and 90% for customer retention are indicative of a healthy SaaS business.
2. The Rule of 40: what’s more important – growth or profit?
Spoiler: it’s both. The Rule of 40 metric asks you to think about the tradeoff between revenue growth and profit margin (EBITDA) in your business. Conventional wisdom says if those two numbers add up to at least a score of 40, you have a healthy SaaS business. Let’s look at how to calculate the Rule of 40.
Revenue growth rate is the percentage at which revenue was added this year over last year.
How do you calculate revenue growth rate?
- If current year annual revenue is $5,000,000
- Prior year annual revenue was $4,500,000
- Then your annual growth rate is 11% ((5,000,000/4,500,000)-1) x 100
When we talk about profit at ASG we typically refer to EBITDA. EBITDA is earnings before interest, tax, depreciation and amortization. It’s a way to measure profit without having to consider other factors such as financing costs, accounting practices, and taxes. Profit margin in this case is equivalent to EBITDA margin.
How do you calculate EBITDA margin?
- If your EBITDA is $1,500,000
- Your revenue is $5,000,000
- Then your EBITDA margin is 30% (1,500,000/5,000,000) x 100
How do you calculate your Rule of 40 score?
- Combining the revenue growth rate and EBITDA margin noted above gives you a Rule of 40 score of 41 (11% + 30%) x 100
3. NPS matters. Happy people (employees and customers) create a strong business.
Employee Net Promoter Score (eNPS) is a metric used by employers to assess employee loyalty and satisfaction.At ASG, our philosophy is that culture leads strategy. Each quarter we send out an engagement survey that includes an eNPS question. We believe that if your employees are engaged and working well together, that energy will positively impact every part of your business.
What eNPS is NOT is a popularity contest. Sometimes as a leader you have to make tough choices that people don’t always like. eNPS may temporarily suffer. But the key is, as a leader, do people trust you even when they don’t fully understand why you are doing something? If the answer is “yes” then your eNPS will bounce back over time.
How do you calculate eNPS?
- eNPS starts by surveying your audience (in this case your employees) and asking: “On a scale of 0-10, how likely are you to recommend [your company] as a great place to work?”
- The “promoters” are those who answer 9 or 10. People who answer 7 or 8 are “neutral.” Anyone in the 0-6 range is considered a “detractor.”
- To calculate eNPS you take the % promoters minus the % detractors. For example, if you surveyed 10 employees and four of them answered with a 9, four with a 7 and two with a 5 your eNPS would be 20 (40% promoters minus 20% detractors).
At ASG we consider 50 a strong eNPS score.
Keep in mind, eNPS is based on a single question and is not the whole picture when truly seeking to understand how engaged your employees are. Think about creating regular touch points throughout the year (both in person and through an employee engagement survey) to gather more specific and actionable feedback for how you can improve as an organization.
Customer NPS tells you how likely your customers are to recommend your product or service to a friend. Research indicates there is a high correlation between a company’s growth and its customer NPS. Happy customers usually mean strong customer retention as well as referrals for new business.
How do you calculate customer NPS?
- Customer NPS is measured in a similar manner as eNPS. It starts by surveying your audience (in this case your customers) and asking: “On a scale of 0-10, how likely are you to recommend that a friend use [your product/service]?”
- The calculation of customer NPS is the same as eNPS. It is the difference between the % of promoters minus the % of detractors.
At ASG, we consider 50 a strong customer NPS score.
Research indicates that organizations with high eNPS and high customer NPS typically tend to perform at an above average level financially as well.
4. Lifetime Value (LTV) to Customer Acquisition Cost (CAC)
LTV to CAC helps you determine if you’re getting your money’s worth out of your sales and marketing investments. A lot of early stage businesses track average revenue per customer or account. With just a little more effort, you can calculate LTV/CAC, a more useful metric that helps you answer questions like, “Should I hire more salespeople or put more money into digital marketing?”
In SaaS businesses, an LTV/CAC ratio of three or greater is generally considered attractive, and companies with an LTV/CAC ratio greater than five are considered to have particularly sticky, high-value customers.
How do you calculate LTV?
- If your ACV (annual contract value) is $10,000
- Your gross margin (revenue – cost of goods sold / revenue) is 85%
- Your customer churn (number of lost customers in a given period divided by your starting number of customers) is 15%
- Then your LTV is $56,667 ($10,000 x 85% / 15%)
How do you calculate CAC?
- If your sales and marketing expense for a given period is $1,000,000
- The number of new customers added in that same period is 100
- Then your CAC is $10,000 ($1,000,000 / 100)
How do you calculate LTV to CAC?
- LTV to CAC ratio equals 5.7x ($56,667 / $10,000)
5. Sales and marketing efficiency (or SaaS magic number)
Said simply, this “SaaS magic number” helps you determine how many dollars of ARR (annual recurring revenue) you create for every dollar spent on sales and marketing. This metric gives SaaS operators and investors a tangible metric on which to base plowback decisions, particularly in the go-to-market side of the business.
A ratio of 1.0 indicates that your sales and marketing investments will pay back in one year. It’s generally accepted that any ratio greater than 0.75 is a “green light” for further sales and marketing investment.
How do you calculate the SaaS magic number?
- If your current period ARR (annual recurring revenue is your monthly recurring revenue x 12) is $6,000,000
- Your prior period ARR was $5,000,000
- Your current period sales and marketing spend is $1,000,000
- Then your SaaS magic number is equal to 1.0x ($6,000,000 – $5,000,000) / $1,000,000
Now that you are aware of these five metrics, the next step is collecting the data to measure them. Many Founders we meet are running lean teams with very few resources dedicated to measuring the financial performance of their business. Spending the time and resources to get your hands around the data needed to calculate these metrics is worth it.
Once you start calculating these metrics, you’ll soon see real value from them. Armed with the data that matters most, you’ll feel more confident in making day-to-day decisions, correct quickly when you get off course, and make smarter choices about where to invest additional resources for future growth. In addition, you will know how you stack up against your peers and competition.