As the Software as a Service (SaaS) business model soars in popularity, companies face a big dilemma of how to establish metrics to run the businesses in a manner that maximizes value.
The value of starting a SaaS business is to show investors that there is a large addressable market, a high likelihood of the team being able to execute, and low investment risk due to the amount of base revenue and traction that is recurring. To protect annual recurring revenue (ARR), there are various metrics that management should be measuring. Often companies do not maximize their highest potential because Key Performance Indicators (KPIs) are not established across all departments to measure business activity from the very start.
This article will discuss some of the KPIs that every SaaS company should measure. A management team that only looks at these measurements at a single point in time will miss unlocking their true value. It’s important to track KPIs over time to reveal insightful trends that allow you to see if there is forward or backward progress. A downward trend indicates a decision needs to be made to intervene so it doesn’t create problems in the future. This is the reason it is so important to establish the KPIs from the very beginning. Oftentimes companies find themselves having to look backward in time to try to find and recapture this data, and this causes a lot of wasted time and resources.
Another critical item is establishing the KPIs in the system of record. The ultimate goal is to capture all your data in a CRM system that is linked to the financial system of record. This makes the data easy to present and share with management as well as the entire company. Time and resources are also saved by minimizing the need to create manual spreadsheets that have a larger chance for an error.
The following are the KPIs that all SaaS companies should track:
1. Net Retention – this measures the health of the current customer base. In order to calculate this, you take your current customer base ARR from twelve months ago and compare it to what it is today.
World-class retention is over 110% and tells a management team that most of their customers stay engaged and are actually growing. Growth within existing customers indicates stickiness and customers are more apt to stay engaged over the long term.
If this percentage is under 100, it tells management that they are losing revenue from current customers that were signed up over a year ago instead of growing their portfolio with these customers. This shows adoption is low and customers are lowering the number of licenses or deleting products they no longer need. For additional clarity, think of this as your “organic” ARR growth that needs to exceed your partial churn and your full customer churn in a given year.
Leadership must put resources towards improving the current environment for customers so they sign up for more products or seat licenses. Marketing and sales departments should work together in establishing internal campaigns to attract customers to re-up rather than delete products. They also should put training programs in place for customers to increase their product knowledge of customers.
2. Churn – this measurement tells management how many customers they lose on a yearly basis. There are many ways to calculate churn, but the most effective way is to look at the revenue dollars lost compared to the total ARR of the company twelve months ago. Anything below 5% is world class and anything above 10% creates a red flag for management and investors.
Another important factor in calculating churn is to see the correlation between the churn revenue percentage and the number of churn customers. To calculate the number of churn customers, take the total number of customers twelve months ago compared to how many customers churned during that time. If the results show a high percentage of customers that have churned but the revenue churn is still less than 5% then the problem is not as bad as one would think because the smaller customers are going away.
In this scenario, management may create a program to retain specific customers that are under a certain revenue threshold. However, if the revenue churn is higher than the customer count churn, this is more problematic because the company is losing bigger customers. Leadership needs to focus on that so the trend doesn’t continue.
3. ARR Backlog – If there were no more sales and every customer stayed with the company, this would be the annual recurring revenue that is guaranteed. This is a great measurement for banks and investors that are looking at the company.
To calculate ARR backlog, take the current monthly recurring revenue (MRR) plus any revenue that wasn’t recognized that month because a new deal was signed in that month, less any revenue recognized that month that was ultimately churned during that month, and multiply by 12.
What most investors do is take a churn factor based on trends and then add new business factors to get a reasonable backlog going forward. Trends are very important for this metric because if management sees ARR backlog going down each month then something needs to be done. The new business coming in is not fast enough to offset the churn from existing customers.
There are many sales metrics for new business and existing business customers that also should be looked at when running the SaaS sales organization.
4. New and Existing Bookings – this is the entire amount of the first year of revenue. In SaaS business models, there is usually a one-time, non-recurring revenue (NRR) for implementation services. It’s important to separate the NRR from the MRR because the focus for maximizing value is MRR.
Management should also provide guidance to the sales team on the ratio between MRR and NRR because, in selling, the main goal is to maximize the MRR as that creates future health for the business. The NRR goes away after year one. There also should be discount percentages established upfront because if the sales team continues to discount ARR it may cause issues with creating a high ARR backlog. Companies should incentivize their sales personnel to sell more MRR. It’s amazing the results that are achieved when employee compensation is well aligned with management goals.
5. Stages 1-5 Sales Pipeline – each company should establish parameters for their sales pipeline and put opportunities in the right categories as they reach certain stages of their sales cycle.
This is a key activity because it helps with forecasting. Once you collect a couple of years of data, a company can review each stage of the pipeline and predict the dollar of bookings that will eventually close as well as the length of the sales cycles. This creates predictability and assurance that the goals established at any given time are reasonable. Management also can make decisions on headcount, forecasting, training, etc. if they have good pipeline data to analyze.
Everyone in the company can help establish metrics and hold themselves to achieving maximum MRR.
Office administrators may greet customers by phone and in person and if they are not cordial that customer might churn. The employee in charge of collections has to deal with customers every day and has to try to collect money. Going about it the wrong way could cause a churn. The existing and new business sales teams have to work with marketing in maximizing ARR. The engineering team must make sure the product is up to date so customers don’t get bored and want newer or better technology from competitors. The customer support team answers the phone and has to solve customer issues in a timely manner. The executive team needs to ensure everyone is always on the same page.
It’s very important all of these teams have access to KPI data so decisions can be made promptly and efficiently. Without the KPI information, companies are not able to make these very important decisions timely. It is never too early to start!
Click here to subscribe to receive our future articles.
About the Authors:
Dan DeGolier is the founder of Ascent CFO Solutions and a Fractional CFO with nearly 30 years of experience. He is passionate about working alongside leaders of companies to help them “upward” to their highest potential. Jeanne Prayther has been a CFO of multiple SaaS companies, including Prolexic Technologies, which was acquired by Akamai, and e-Builder Inc., which was acquired by Trimble Inc. She has used her experience to lead many training sessions and focus groups to assist with the implementation of SaaS metrics.