The subscription economy is quickly growing and as more businesses continue to be built around the model, important metrics aimed at measuring the performance of the businesses are coming up. In the SaaS industry, metrics like MRR (Monthly Recurring Revenue), ARR (Annual Recurring Revenue), CMRR (Contracted Monthly Recurring Revenue) and others have become standard. However, which of these metrics is really important in measuring the performance of your business?
Unlike traditional software vendor business that has been with us for a long time, the SaaS industry is still young and CEO’s are looking for effective ways of measuring their performance and value. For SaaS businesses, calculating sales is not as easy as it is for traditional vendor software businesses that only look at the sales made. With things like pre-booking and canceling common in the subscription economy, founders have to adopt different metrics to measure their successes, if any.
Tien Tzuo, Zuora’s CEO, says that SaaS businesses should only focus on three vital metrics. It is easy to get caught up with different metrics and lose focus on your core business objectives. In light of the different SaaS metrics, focusing on only three vital ones will give you a good idea of the health of your business. The three metrics are:
- Retention Rate – The ARR you are left with every year.
- Recurring Profit Margin- The ARR, less the number of canceled subscriptions and the non-growth spend.
- Growth Efficiency: The amount it costs to get $1 annual contract value (ACV).
From the above metrics, retention rate and growth efficiency make sense considering their importance in the SaaS Magic Number. If you are not familiar with the SaaS Magic Number, it generally shows how efficiently a SaaS business is growing its recurring revenue compared to its sales and marketing costs. Let me explain this in the easiest way.
The formula for calculating the magic number is: X = (A – B)*4/C
Where X= Magic Number
A= Last Quarter Recurring Revenue
B= Quarter-Before less Last Recurring Revenue
C= Quarter-Before less Last Sales and Marketing Expense
Generally, if X is greater than one, you need to pump more investment in sales and marketing. If X is less than 7, you should take steps to lower your customer acquisition costs.
Back to our three SaaS metrics, the recurring profit margin is one of the metrics looked into when evaluating SaaS companies. Most successful SaaS companies can still be much profitable and retain their revenues even if they cut spending on sales and marketing. The recurring profit represents this number.
The three SaaS metrics were arrived at after comparing three successful SaaS businesses; NetSuite, Salesforce, and SucceessFactors.
From the data of the three companies, the following can be deduced:
- Growth efficiency averaged at 1.1
- Renewals averaged at 90 percent
- Recurring profit margin averaged at 50 percent
With the above ideal model, what should you do to get a similar model for your business?
1) Improve recurring profits margin
To maximize your recurring profit margins, you can automate your quote-to-cash renewals. This will mean a more seamless process and also eliminate manual errors. You should also eliminate cash payments in favor of credit card payments.
2) Sustain high retention rates
3) Streamline your business for growth efficiency
As a start-up, there are many things about your business that may change along the way. Be ready to fine tune your strategies to increase customer value.
Which other SaaS metrics apart from the three do you think are crucial to the operations of your business? Please use the comment box below to comment.
Source: Zuora @ AlwaysOn 2012