KPI stands for Key Performance Indicators – the most important metrics you need to track to see how your business is doing. However, there are hundreds of KPIs you could track, and your business model will determine which ones you should track. It is recommended to track no more than 10 KPIs at a time to make it easier to know how your business is progressing.
As for recurring revenue and SaaS models, they have become one of the leading models in today’s global business ecosystem. And since these business models have proven very effective, more and more companies have begun to spring up around them. Therefore, selecting the right KPIs and properly reporting on them can actually make or break a business in today’s increasingly competitive market.
Different Types of Recurring Revenue
Recurring revenue is an important factor when determining your business value. Companies valued based on their revenues are those that have recurring revenue streams because their predictable revenues are expected to continue in the future. However, there are different types of recurring revenue streams, and some of them are more valuable than others.
- Hard contracts. These are considered to be the “holy grail” of recurring revenue. Most cable and Internet packages or mobile phone service plans are hard contracts that guarantee a predictable revenue stream. For example, many mobile phone companies give customers free phones as long as the customer locks into a 2- or 3-year full-service contract.
- Auto-renewal subscriptions. Also known as an “evergreen” recurring revenue, this type of subscription goes on until the customer decides to stop it. Most SaaS businesses are perfect examples of auto-renewal subscriptions. Customers often hesitate to stop or cancel their subscriptions (even when they don’t need them) to avoid the hassle of having to sign up again.
- Sunk-money subscriptions. Besides making the initial purchase, customers are also required to buy proprietary accessories to continue using the platform.
- Standard subscriptions. These are finite subscriptions that can be renewed at the end of the contract. Standard subscriptions are considered better than having a loyal customer base who continue buying your products or services because of brand loyalty.
- Sunk money consumables. Sunk money consumables are similar to sunk money subscriptions, but the term applicable to platforms that don’t require proprietary accessories to operate. As a consumer, you don’t just buy a product but a platform – for example, you don’t want to buy coffee anymore and start making your own, so you buy a coffee machine. However, you will need other accessories from different manufacturers to make it work (e.g., descaling kits, coffee pods, etc.).
- Simple consumables. These are products or services purchased on a one-off basis – disposable items (like toothpaste or shampoo) that customers buy regularly, but are not loyal to a certain brand.
Most Important KPIs for SaaS and Recurring Revenue Models
SaaS and other recurring revenue business models are attractive to entrepreneurs and investors because their revenue stream is predictable; customers pay on a monthly, quarterly, or annual basis. In a recurring revenue business model, customers will pay for the product/service over a given period of time, known as the customer lifetime. If end-users are satisfied with the service, they will keep using the product/service for a long time – the longer a customer stays there, the more profit they will bring to the business. But if customers are dissatisfied, they will cancel their subscription, stop paying, and churn out quickly.
The two key success factors for recurring revenue companies are customer acquisition and customer retention.
- Customer acquisition. The first critical component of any business model (and even more critical in a recurring revenue model) is the acquisition and onboarding of new customers. To acquire new customers, SaaS companies often spend several thousand dollars, and they don’t see a payback on that cost for a few months. However, the more customers they manage to acquire with the same marketing spend, the lower their payback period, and the higher their ROI for each customer acquired.
- Customer retention. Once acquired, it is important to retain those customers. If your company spends so much money on acquiring customers who then churn out (stop doing business with you) after a few months, your company has lost money on that customer. Customer retention rate goes up as churn rate goes down, and with customers that keep using your services for a few years, your company will have a profitable base of recurring revenue.
In a recurring revenue business model, your company’s customer acquisition and service delivery expenses will outstrip the revenue earned in the previous period. This is because the expenses to acquire customers and deliver the service are up-front, while customers pay on a monthly basis and over time.
Now, let’s take a look at the key metrics that every subscription business needs to measure frequently.
1. Monthly Recurring Revenue (MRR)
For a recurring revenue business, all the investment is upfront, so the business being built needs to be sustainable. Before it acquires its first customers, it needs to have a product or service, as well as spend some money to acquire those customers. Furthermore, your customers will be paying monthly subscriptions, which are much smaller amounts of money than they would otherwise pay to a normal software business. You will be receiving a steady influx of cash in the long run, but you need to survive long enough to see that happen.
That is why tracking MRR is important when building a sustainable business – it’s the amount of revenue you expect to receive every month. To calculate this number, you will need to dive into your finances, but it’s one of the most important benchmarks for progress.
2. Customer Acquisition Costs (CAC)
How much does it cost to acquire new customers? How much value do they bring to your company? Customer Acquisition Cost can provide answers to these questions. When combined with Customer Lifetime Value (CLV), the metric can help guarantee that your business model is viable. Calculating CAC involves many assumptions and valuables, so it may be one of the most challenging to record accurately. Since it includes any cost involved in attracting new customers, making accurate CAC calculations means knowing what went into marketing, product R&D, sales meetings, distribution channels, etc. Simply put, if you spend $50,000 in a month and add 100 new customers, your CAC would be $500.
3. Months to Recover CAC
This metric helps determine how long after you have closed an account you will recoup the total CAC. Essentially, it shows how quickly a paying customer starts to generate ROI for your company. As your business grows, you want that number to get smaller over time. To calculate it, take your CAC and divide it by the product of MRR and your gross margin (CAC / MRR x GM).
4. Customer Churn
Maintaining existing customers is important to any recurring revenue business, and your customer churn rates show how many clients you have lost within a certain period. Monitoring this number is vital to tracking your business’ vitality and saving your company from complete disaster. It can help you understand customer retention by providing insight on activity across specific periods or dates. For recurring revenue businesses, a high churn rate is something one wants to avoid. It can be calculated according to revenue or from the number of customers on a monthly basis. When calculating churn on a monthly or quarterly basis, go beyond the mere customer count and identify the personality of a churned customer or other unique characteristics that can help you understand why they left.
5. Customer Lifetime Value (LTV, CLV, or CLTV)
Customer Lifetime Value shows what your average customer is worth. It is the average amount of money that your users pay during their engagement with your business. CLV shows you an accurate picture of your growth. Calculating it involves several steps:
- Finding customer lifetime rate by dividing the number 1 by your churn rate
- Finding your ARPA (average revenue per account) by dividing total revenue by the total number of customers
- Calculate CLV by multiplying customer lifetime by ARPA
These steps are simplified because churn patterns and ARPA are varying elements of the formula. To assess CLV as accurately as possible, you need nominal calculations (e.g., the sum of all contracted sales) and more complex formulas. It is also recommended to calculate CLV per customer segment to get more accurate and meaningful results.
6. CAC-to-CLV Ratio
The CAC-to-CLV ratio shows the total amount of money you spend to acquire your customers and their lifetime value in a single metric. It displays the health of your marketing strategy so you can change campaigns that aren’t working well or invest in strategies that are. To find your CLV-to-CAC ratio, simply compare the two metrics. A healthy recurring revenue business should have a CLV that’s at least three times greater than CAC. If the ratio is 1:1 or 2:1, you are spending too much money. On the other hand, a higher ratio (e.g., 6:1) would mean that you’re spending too little and missing on business opportunities.
7. Average revenue per account (ARPA)
Also known as Average Revenue Per User (ARPU) and Average Revenue Per Customer (ARPC), this is a straightforward metric that shows the average revenue your company has received from its customers. To calculate your ARPA, just take your MRR from a particular period and divide it by the total number of customers within that same period.
8. Tracking channel growth
Even if you found the perfect marketing channel to grow your business, you should know that that growth won’t last forever. Every marketing channel has a ceiling that you need to track and estimate in terms of growth rate and nominal revenue.
9. Expenses per customer or employee
To determine when and where there is financial headroom to make targeted investments, you should add up all your operating expenses and divide the amount by the number of customers or staff members.
Company leaders bring two types of decisions in any company or line of work: instinct-based and data-driven decisions. A few decades ago, before the age of digital transformation, people used to rely mostly on their business instincts. They used their experience and counted on some luck to lead them to business success. Today, we can collect and analyze enormous amounts of data to detect changes and trends and use it as a base for decision-making. Making data-based decisions can result in consistent and exponential growth for the whole company. Of course, every business out there encounters various problems on their way to success, and to be able to handle them, recurring revenue businesses must track these key KPIs to make the right decisions.
Essential Baseline KPIs for Every Early-Stage SaaS or Recurring Revenue Business
Product-oriented and on-demand service business models can’t rely on the same financial strategies. Traditional (product-oriented) software companies use large upticks in revenue to mask their loose accounting practices. However, the recurring revenue business model cannot afford such luxury and needs a well-aligned accounting and finance function. Their success is not that dependent on sales closing large deals but on back-office finance and accounting teams that are able to provide stable processes.
The most important baseline KPIs for a SaaS startup or any early-stage recurring revenue business venture include:
- Upfront investment. For recurring revenue businesses, there needs to be a significant upfront investment. Companies need to build the product before they can acquire customers and start generating revenue. However, SaaS companies don’t require significant upfront investments to start operating. An on-demand service provider doesn’t have to worry about saving money for research and development support due to less capital-intensive distribution and shorter development cycles.
- Real–time capital planning. SaaS business leaders need access to the most recent financial data, as well as the tools to manage it. SaaS businesses depend on subscription numbers, so having the most up-to-date picture of business performance enables CFOs to allocate investments with accuracy and know where to target expensive upgrades.
- Renewals. In the SaaS world, companies might have a head start due to lean initial costs. However, they must keep bringing in new customers and work on retaining them for as long as possible. They need to keep an eye on their retention rates and have several customer retention strategies in place.
Tips for Using Data-Driven KPIs
To use data-driven KPIs to your advantage – to lower costs and maximize your revenue – you should:
- Record the data carefully
- Track and measure KPIs
- Analyze historical financial data and learn how to apply it to your day-to-day planning and operations
Optimize your pricing strategy to maximize revenue and profits.
Thinking that greater revenue means greater profits is a mistake that many CEOs tend to make. If your business is generating a lot of revenue, but there are still cash flow shortages, it means that your pricing needs to be adjusted. Before setting the right price structure, you will have to consider all the expenses. Following these KPIs is essential when it comes to determining the right price of your products or services.
Evaluate revenue stream by using individualized profit and loss statements.
Another false assumption that CEOs and CFOs often make is that their biggest client is also their best client. Once you run a profitability report for each one of your customers, you’ll see that your biggest customers are not as profitable as you thought. These reports will help you detect low margin clients that are killing your profitability.
Manage margins to secure profitability.
To measure your company’s success accurately and gain a better understanding of your actual profits, you should analyze your profit margins. To do that, you should track:
- Gross profit margin – revenue minus the cost of goods sold
- Contribution margin – revenue minus the variable costs
Measuring and understanding the right KPIs can reveal a lot about your customers, employees, departments, services, jobs, product lines, and many other elements within the organization that are causing you to lose money or generate profits. Accounting and financial forecasting become much easier when enterprises can count a significant portion of their income as recurring revenue. However, you should know that not all types of recurring revenues are created equal.
When reporting on key data for SaaS and recurring revenue businesses, there are a number of nuances to consider. These metrics can be applied across all company types and industries and should be monitored regularly. Furthermore, it is critical to put the necessary reports in place and set benchmarks for each KPI. Begin by looking into your last quarter or year’s data to set a baseline to measure against, then use that baseline to evaluate whether you are stagnating or growing.
Without the right tools for the job, keeping track and understanding any of these metrics would be impossible. Consero is a provider of Finance as a Service which is a robust financial solution that can help leaders make data-informed decisions to grow their business. We are a reliable partner that can help you stay up-to-date on your company’s financial health, freeing you from the accounting process. Feel free to request a demo today!