Subscription-based businesses are very complicated, especially when compared to traditional businesses. The metrics greatly differ when it comes to SaaS businesses and it is important to understand the variables that matter.
What Makes SaaS Unique?
SaaS businesses are different because your revenue comes over a specific period of time that’s known as the customer lifetime.
You cannot be sure of how much revenue a customer will bring you as he or she may unsubscribe if you are not able to deliver. This uncertainty creates a different dynamic and puts SaaS businesses into a complicated category.
At the end of the day, the purpose of any business is to maximize profit. This can be done by:
- Acquiring new customers
- Keeping old customers
Believe it or not, custom retention is a bigger challenge than custom acquisition. Let’s have a look at three metrics that actually matter:
- Acquiring Your Customers
- Retaining Your Customers
- Monetizing Your Customers
The SaaS Cash Flow Trough
It is common for SaaS businesses to face big losses in the first few years of business. It is quite understandable why this occurs.
You invest a huge amount of money when you start a business but it takes a long period of time to recover it since you only recover a portion of your investment every month.
Many board members do not understand how the system works. They want to earn more profit but the faster your business grows, the greater are your losses. Things can take a while to settle.
This period can be difficult for any business as it can result in cash flow issues. This simple example will explain the scenario to you.
Say it costs $5,000 to acquire a new customer and you only bill $250 per month. Keeping this in mind, it will take 20 months (about 1.5 years) to recover the amount. Your profile will come after 20 months, only if you are able to retain the customer.
This is the impact of one customer on cash flow. Imagine the hole if you acquire ten customers in the first month. You’ll spend $50,000 on the acquisition phase and recover only $2500.
Growth may sound like a bad idea at this point since you’re spending so much on acquiring new customers but it’s important if you want to succeed. Your profits will eventually come, it’s all about being patient.
Is Your Business Financially Viable
It can be difficult to calculate the potential of a SaaS business due to the dynamics involved. You will have to answer the following question to understand the feasibility of your business model:
- Will the profit derived out of each customer be greater than the cost of acquiring each customer?
You will need the following two values to calculate it:
- The cost of acquisition of a customer (CAC)
- The lifetime value of a customer (LVC)
Here are some tips on how to calculate the two values. Most successful businesses have a CAC and LVC ratio of 4 or higher. Some businesses are able to recover the amount within the first year of operations but it can take some businesses longer than that.
It is the duty of the manager to know when to grow business, how to reduce acquisition cost, and how to retain customers. This, however, is easier said than done.
SaaS businesses can be divided into two types. The right approach depends on what type of business you have. These include:
- Monthly Contracts (Customers are charged a monthly fee)
- Annual Contracts (Customers are charged a yearly fee)
Some businesses may offer both the options to their customers.
Why It Is Important to Retain Customers
It does not matter how big or great your business is, you will always lose customers. However, the number of customers you lose is important.
Let’s say your churn rate is 4%. This may not be an issue if you have only 50 customers. A rate of 2% means you’d lose only two customers per month. It is easy to find two new customers so this may not be a problem for you.
But what happens when your business grows and you have 5 million customers? A churn out rate of 2% means losing 100,000 customers per month. This is a big figure and it can highly impact your profits since it may not be possible to find 100,000 new customers every month to even out the loss.
What to Do To Balance it Out
Your concentration should be on two things:
- Increasing Revenue
- Consider upgrading the pricing scheme and using an option that allows you to earn more when customers use more of something. This small guide on how to increase SaaS business revenue can be of help.
- Find more customers and work on retaining your old customers. You can also indulge in a bit of upselling to make more revenue.
- Decreasing Costs
- See how you generate leads and find out the most effective method in terms of ROI. You should use more resources on the method that offers the highest ROI as it would help you reduce acquisition cost.
Consider choosing new marketing methods. Sticking to the old may not always be effective.
Opt For a Payment Schedule That Helps You
Most SaaS businesses ask for advanced payments so that they always have the cash to meet sudden demands. However, doing so may often affect bookings in a negative manner.
Understand your customer base and consider offering perks in order to get paid in advance, especially for the whole year. This is the easiest way to reduce the cash flow problem as you’d recover money right away.
Do the maths and find out what’s more profitable, waiting the whole year to recover $3000 or giving a 10% discount and getting $2700 when you get a new customer.
As highlighted in this Saas Business model blog, it is all about incremental improvements. You have to be on your toes constantly as losing a single customer can result in a loss.