Growth isn’t easy, whatever the business you’re building. Startups have the added pressure in that they need to sustain growth and retain customers over a long period of time. In more traditional business models, the majority of the revenue is collected at the time of purchase. For e-commerce businesses, this is only a small fraction of the revenue. For SaaS startups, revenue should be distributed more evenly over an extended period.
“Without continual growth and progress, such words as improvement, achievement, and success have no meaning.”- Anonymous
What are SaaS Startups?
A SaaS startup is a company that has a business model where customers assess the application over the internet. SaaS means software as a service. The software resides on a server that the customers are able to use online.
If customers are not happy with service delivery, they quickly move to the competition. This would cause you to lose money on the upfront sales and marketing investment you have already done. If too many customers are churning before you are able to earn back your investment, the business would not be sustainable.
Decisions you make today would drive future performance. This is why it becomes imperative for startup founders to take note of retention. Often, traditional business metrics are not always accurate in capturing the challenges startups face. As a result of this, the key metrics that startup founders need to understand center around recurring revenue.
It is important to understand critical metrics such as customer lifetime value, customer acquisition cost, and churn rates. Knowing this is critical for any business that relies on recurring revenue.
There are two types of churns: customer churn and revenue churn. When we talk about customer churn, we are talking about the number of accounts that leave our service on monthly basis as a measure of the overall count of customers. Revenue churn is a measure of the amount of revenue that leaves your service each month as a percentage of the overall revenue.
For most software-as-a-service startups, it is more useful to measure revenue churn. This gives a good indication of the health of the business. A 3% churn rate quickly turns into 31% annually if care is not taken. The more customers you have, the more you need to invest in order to retain the customers before even thinking of growing any further.
This is arguably the most important metric. The moment when customers realize the value of your product for themselves is important. They justify their decision after they have experienced your product.
It takes a combination of nuanced user interviews and behavioral analytics to find out which actions are responsible for customer retention. When you identify this, you want to optimize your onboarding process. You should also shorten the time it takes for new users to activate and start getting value from your product. This will help them to begin adopting your product more deeply.
Monthly recurring revenue
This is a measure of how much revenue your customers are generating monthly. When you multiply this value by 12, it gives you the annual recurring revenue. Although you can work your MRR manually, you could benefit from real-time tools.
ARR = 12 * MRR
Recurring revenue makes the SAS business model appealing. So long as you continue providing value with your service customers continue to pay you monthly. Unfortunately, many young startups fall into the trap of undervaluing their services. As such, they do not charge enough and the business is not sustainable. You need to continue modifying your pricing structure until you are charging enough to get consistent growth.
Cost of acquiring customer CAC
The CAC is a measure of the amount you spend on sales marketing and other associated activities to get a new customer. You can find out this figure by taking note of the total amount you spend on sales and marketing on a monthly basis. This includes salaries and other related expenses.
The cost of acquiring customers is closely linked to the lifetime value you will gain from each new customer period for your business to be viable you need to make more profit from your customers than it costs you to get them. That means that the LTV needs to be greater than the CAC much greater for that matter so that you are able to be profitable remain profitable in the long run. One useful rule of thumb is that lifetime value should be at least three times the amount you spent on acquiring a customer.
One challenge that many businesses face is that the cost of acquiring customers is often much greater than the monthly revenue. Sometimes it takes months to recover that investment.
Customer lifetime value
LTV is the total revenue generated by a customer over the lifetime of the account. The longer the customers continue using your product from month to month they hire the lifetime value would be.
Customer lifetime value is one of the most important metrics you need to measure because it gives you a bird’s-eye view of the customer engagement strategies. It allows you to predict how valuable customers will be to your business over a period of time.
One good way to attack the inevitable effects of change is to focus on expansion revenue. Expansion revenue covers the increase in monthly recurring revenue when an existing customer upgrades to a higher plan. This can push your churn rate into the negatives. Negative churn occurs when the rate of expansion of existing customers is more than the number the value you are losing from customers that leave. So the people that signed up for hire value products we are able to cover for the churn.
A good strategy to improve cash flow and increase the average lifetime value of customers is to encourage them to sign up for an annual subscription. This makes the entire year of payments available for your company immediately and also saves the customer or monthly recurring fees. The customer has the motivation to stay for the year because she’s saving 40% on an annual subscription.
In practice, not all customers are created equal. The metrics stated above will help you understand which customer segments are more sustainable and profitable and you can tailor your effort and resources can focus your resources on this segment.