SaaS Metrics That Matter: The Key to Predictable Growth

The SAS Business Model and Metrics

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The Importance of Metrics

"If you can't measure it, you cannot improve it," as Lord Kelvin said. Understanding metrics is crucial for improving SAS businesses. Regularly measuring key numbers focuses your team and aligns them towards specific goals. Therefore, selecting the right metrics is vital. Be aware that metrics change based on your company's stage, a topic covered in more detail in my Startup University presentation at 12 o'clock. SAS businesses are highly sensitive to small changes in key variables. Understanding these variables is key to unlocking growth.

Valuation of Public SAS Companies

Valuation is determined by two factors:

• Growth rate (as a percentage)

• Operating profit (as a percentage of revenue)

Add these two percentages together to get a strong predictor of profitability. This illustrates the "Rule of 40," which suggests your growth rate plus profitability should equal 40%. For instance, 50% growth and -10% profit, or 10% growth and 30% profit, both meet this benchmark.

Building a Repeatable, Scalable, and Profitable Growth Machine

The goal is to create a "repeatable, scalable, and profitable growth machine." This is easily said but challenging to achieve. If successful, you’ll have defined a cash-generating machine, where every dollar invested returns significantly more over time. Growth investors highly value this.

The key indicator of successful repeatable and scalable growth is consistent growth in bookings, not just revenue or ARR. Exponential growth, driven by understanding and scaling the growth process, is what you're aiming for.

Measuring Bookings: Net New ARR

The correct way to measure bookings in a SAS business is to focus on Net New ARR, which comprises three components:

1. ARR from new customers
2. Expansion ARR from existing customers
3. Reduction due to churned customers

Track these metrics regularly and reliably. A monthly chart visualizing these components is essential for understanding business performance and identifying areas for improvement. Review these numbers as a time series to observe growth patterns.

The SAS Business as a Funnel

The entire SAS business model can be simplified into the concept of a funnel. Extend the funnel to include the backend of onboarding, retention, and expansion. Funnels are governed by simple math.

Funnel Math: Calculating Bookings

The formula for calculating bookings:

• Bookings = Leads x Conversion Rate x Average Deal Size

In the early stages, focus on lead flow and conversion rate. Deal size becomes more important later on. In a basic example (website -> free trial -> closed deal), track visitors, trials, and closed deals as a time series. Also track the conversion percentage of visitors to trials over time to see improvement. Conversion percentages are best calculated using a cohort analysis, tracking a group of users (e.g., January visitors) over several months to determine their full funnel conversion rate.

Salespeople and Bookings

When salespeople are involved, growth is often less continuous due to ramp-up time and capacity limits. If you do not hire enough salespeople you will limit growth because you won't have enough capacity to talk to your leads that are coming in there.

Revised Formula:

• Bookings = Number of Salespeople x Productivity Per Rep (PPR)

Hiring salespeople on time is extremely important.

Recruiting is a crucial skill to develop in-house; don't rely solely on external recruiters.

Productivity Per Rep (PPR)

PPR is impacted by hiring the right people, and quality onboarding and training. Monitor PPR with a time series graph. A chart showing each salesperson's performance against quota (green for above, red for below) is insightful. Ideally, you want a majority of green salespeople. A useful target is to have 75% of reps above 75% of quota, and 50% above 100% of quota.

Profitability: Unit Economics (CAC and LTV)

Once the funnel is working, assess its profitability by examining unit economics.

• CAC (Customer Acquisition Cost)

• LTV (Lifetime Value of the Customer)

For a viable business model, LTV must be significantly greater than CAC.

Lifetime Value (LTV) and Churn

Customer lifetime is calculated as 1 divided by the churn rate. Churn is a critical driver of profitability and company valuation.

There are two types of churn:

• Customer Churn: The percentage of customers lost.

• Dollar Churn: The percentage of revenue lost.

Track both separately. Negative churn is a very powerful concept for a SAS business.

Negative Churn

Negative churn occurs when expansion revenue from existing customers exceeds the revenue lost from churned customers. This is very powerful. Variable pricing (different product editions, user-based pricing, usage-based pricing) is often necessary to achieve expansion revenue.

Even if you don't have variable pricing, if you're an early-stage startup it's a secondary thing that comes along later on once you've got your business running it up and running here but I believe that negative churn is crucial for success. Consider a company with 2.5% monthly revenue loss. At $10M ARR, they need to acquire $3M just to maintain the same level. At $100M ARR, they need $30M.

The benefits of negative churn are immense: a business with 2.5% negative churn can reach $400k ARR after 40 months, while a business with 2.5% churn might only reach $150k ARR.

SAS Unit Economics and Cash Flow

Traditional accounting metrics (P&L, balance sheet) don't work well for SAS businesses because of the initial high costs of acquiring customers, which are recouped over time, resulting in negative cash flow. This is known as the SAS cash flow trough. The faster you grow, the deeper this trough gets. Acceleration of growth will often be accompanied by squeeze and profitability and cash flow.

To assess whether the business will eventually become profitable, use these guidelines:

• LTV should be at least 3x greater than CAC.

• CAC should be recovered in 12-18 months.

Using Unit Economics to Understand Customer Segments

Unit economics can reveal insights into customer segments. For example, a segment with a low LTV/CAC ratio may be unprofitable.

Salesperson Unit Economics

Pay salespeople around $100k on target and set their quota at 4-6 times that to ensure profitability.

The Power of Upfront Annual Payments

Receiving cash upfront through annual payments has a significant positive impact on cash flow, and can avoid the cash flow trough.

Summary

Simplify your SAS business by focusing on the funnel.

• Bookings (Leads x Conversion Rate x Average Deal Size)

• Customer Happiness, Retention, and Negative Churn

• Profitability (Unit Economics, Gross Margin)

• Cash Flow (Collect Cash Upfront)