Traditionally, the success of software-as-a-service businesses is measured by a set of key metrics that includes Customer Lifetime Value (LTV), Customer Acquisition Cost (CAC) and customer turnover (churn). SaaS companies need to understand these metrics in order to measure the growth and health of the business. A combination of common knowledge and some business-specific reasoning should give you a sense of whether your SaaS metrics jive with where you want your business to head.
The utility of these common SaaS metrics can be tested by enterprise SaaS companies with medium to high price points – for example, those with an average annualized deal size of €22,300 ($25,000 US) or more per customer. However, these metrics don’t always tell the whole story. You may have a deep understanding of your cost to acquire customers (CAC, the combination of sales and marketing expense that goes into winning a new logo), but your service may be one that customers don’t switch away from often. That leads to a low churn rate and a high lifetime value compared to more “normal” SaaS businesses, at least at first glance. In some situations, however, measuring these metrics can be hard and make steering the business difficult.
For example, if your SaaS business is relatively young, not enough time has passed to understand the true LTV of your customers, so you have to resort to guessing, setting five-year horizons or making other approximations to bring LTV into a “reasonable” range that investors won’t regard skeptically.
As a result, while investors are interested in the metrics listed above, there are many cases in which there are more useful metrics to focus on to actively steer the business. In fact, there are a number of leading indicator metrics you can observe in something closer to real time that help you understand how you’re likely to grow, how your customers are doing and how your business is scaling to meet demand.
Here are three leading indicators to measure to best understand the direction of your SaaS business:
1. Sales Pipeline Health
Understanding your opportunity creation pipeline is critical. How many new qualified opportunities are entering your sales pipeline? Of course, it’s necessary to also understand your pipeline’s conversion: How many opportunities typically convert? How long is the sales cycle? How large is your average deal? But once you’ve been in business long enough to develop a basic understanding of the dynamics of the sales pipeline, a key driver is simply how many qualified potential customers you’re engaged with.
You need discipline in the data set, and in how you define qualification of a sales opportunity, for this metric to be accurate. Pick well-defined criteria for converting leads into qualified opportunities—BANT (Budget, Authority, Needs and Timeline), for example—and stick to them. Review opportunity creation often, and if you’re seeing stagnation over the course of a few weeks, ask why. Dig in deeply and do something about it. And if you see an extended drop-off, or a sustained acceleration, then adjust your plans – your business is going to be slowing down or speeding up when sales cycles start to come due.
2. Risk of Churn
Churn is a key input to the dynamics of any SaaS company, indicating how likely your customers are to walk or reduce their scope. The trajectory of a company that churns five percent of revenue each month is dramatically different from that of a company churning 0.1 percent. And if you’re an enterprise SaaS business with relatively few customers and fairly large deals, then early in your business, before you’ve established a solid understanding of long-term churn rates, any churn can be painful, even life threatening. So, don’t wait for it to happen: measure it in advance by gauging the risk that your top customers will reduce their spend or, even worse, leave.
One way to prevent high churn rates for a young company is to guesstimate churn risk of top customers. When is the contract coming due? What are the contract’s renewal terms like? What kinds of customer support interactions are you seeing from the customer? Is the customer using the service and getting what they’re paying for? How does the account manager “feel” about the customer’s state of mind about the services they’re buying from you? (This last one sounds wishy-washy, but it is a hugely important indicator.) All of these are indicators of churn risk and should be easy for you to track for your largest customers. Review churn risk regularly – at least monthly. If there are a couple risky indicators, then strategize on how to improve the relationship with the customer and do what you can to prevent churn before it becomes a problem. And when a customer leaves or downsizes (it’ll happen eventually), find out why and feed that input back into your churn risk reviews.
3. Capacity Usage
When you can’t deliver on a big deal because you’ve overcommitted your service’s resources, it’s embarrassing and bad for business. By the same token, nothing frustrates your revenue team like telling them to slow down or to hold off on selling that big account because your platform isn’t ready for the workload. Unless you’re dealing with customers with needs well outside your normal bounds, this should never happen – especially if you’re managing an effective sales pipeline. You should be anticipating growth in the use of your services and scaling in advance to meet that growth, ideally with some headroom for quick expansion.
The way you will approach measuring capacity usage will depend on your business, the service model with which you deliver and the service delivery pipeline for your products. However, one thing is clear: you must have a model, even a simple one, for resource usage, and you need to drive that model based on anticipated growth in time to procure and deploy capacity in advance of that growth.
It pays to think about capacity even if you have a service offering that’s quite simple in its technical infrastructure and architecture – for example, a database backend with some application servers in front. How many requests per second can you handle with a single server? What overhead is incurred with horizontal scaling? What sort of headroom do you need in place for “burst” events? Are you using a cloud provider that enables you to auto-scale stateless components of your application, or do you have a more serious lead-time for provisioning and deploying resources?
Your capacity model comes first. Identify the key resources and interdependencies in your systems and how they relate. Then, drive the model based on forecasts. Here, you’re deriving a leading indicator that can help you decide when to procure resources, when it’s time to devote operations or engineering effort toward vertical scaling, or when you’ll hit a “ceiling,” requiring architectural changes.
The capacity model extends beyond your technology systems and includes people systems as well. What are the triggers for hiring new sales staff or customer support reps? How long does it take to onboard new staff and bring them fully up to speed? Building these models and measuring indicators of usage can help you effectively steer the business.
Measure and Prepare
No matter what kind of SaaS business you run, there are key metrics that will help you check on the health of the company. To really get a current view of how things are going, don’t stop your analysis at the standard SaaS metrics. Go farther and find the higher-frequency metrics that will give you greater visibility into your business’s trajectory. Being able to see ahead will give you the opportunity avoid any unpleasant surprises and prepare for growth at the right time.
Kris Beevers, CEO and co-founder, NS1
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