For aspiring entrepreneurs in the Software-as-a-Service space, David Skok’s blog – For Entrepreneurs – is an absolute must read. If you’ve never read it before, it features a wealth of lessons and case studies from David’s own impressive entrepreneurial background that maps out the journey to SaaS success. David has a talent for synthesizing complicated MBA-level concepts – complete with mathematical formulas and financial data models broken down into digestible and understandable nuggets.
These highly informative nuggets should be shared broadly, even beyond his blog’s readership! What better medium to share these great SaaS lessons than via Twitter? Since David Skok hasn’t tweeted out these 5 SaaS rules yet, let’s do it for him!
Here are 5 SaaS rules David Skok should have tweeted by now:
There is no metric more essential to a SaaS company’s success than its LTV:CAC ratio – the Lifetime Value of a customer, compared to the Cost to Acquire that Customer. The way SaaS pricing models are set up, customers become more valuable the longer they pay you, delivering monthly or yearly subscription fees. The other side of the equation is how much it cost you to acquire that customer in the first place – this includes the cost of marketing campaigns that brought the customer in, the salaries (and time) the sales rep spent on closing that deal, and any onboarding costs accrued, among others. Improving that ratio is one of the most important things you can do for scaling the success of your SaaS startup.
Many companies focus on improving their LTV – preventing unhappy customers from cancelling their subscription. They tend to ignore the CAC portion of the equation. David suggests you also find ways to reduce your CAC – such as by improving your marketing conversion rates by A/B testing, finding new channels of leads for your sales team, or making sure that your sales compensation plan is aligned to onboard successful customers.
What exactly is a good LTV:CAC ratio? That depends entirely on your company and the type of market it is servicing. For an early-stage SaaS startup looking for some reasonable benchmarks to strive for, David suggests getting your LTV to be at least 3x your CAC, and you’ll be in good shape.
Months-to-recover is a related metric; it refers to when you’ll achieve profitability on a particular customer. If you spent $1,000 acquiring a customer and it takes you 2 years to see that return in investment, you’re not in great shape. David stresses that it should not take you more than 12 months to recover your CAC.
Customer churn – and preventing it – is what keeps startup founders up at night. How can they ensure that their SaaS product is so good that customers can’t stop using it? Preventing customers from leaving is part one of creating a great LTV story. David believes that more SaaS companies should not only focus on preventing churn, but actively working toward getting negative churn. What is that exactly? This formula will explain:
Negative Churn (Monthly Recurring Revenue) = [New Customers (New MRR) + Existing Customers (Expansion MRR)] – Churned Customers (Lost MRR)
It’s important to separate customer churn – the actual number of customers who cancel – and revenue churn, the amount of money that churns. If you have a customer churn rate of 10% on 100 customers, that isn’t great. But what if those 10 customers that left contributed only $250,000 in revenue, out of a total of $10 million in revenue? That puts your revenue churn rate at just 2.5%, which is quite a bit better than your logo churn. Get to negative revenue churn by not losing your most valuable customers and finding sources of expansion revenue. What’s that? Well, I’m glad you asked!
Expansion revenue – expanding the revenue you bring in from the customers you already have – is one of David’s favorite things. It is much easier to get more revenue from a customer who’s already happy with your product than it is to convince a new opportunity to begin using a new product. The acquisition cost on expansion revenue is much lower, helping to improve your LTV:CAC ratio. Some good sources of expansion revenue include:
- Creating a pricing model with a variable axis, i.e. paying per seat, per user, per license or per use.
- Build upsell opportunities. Create more highly featured – and more expensive – version of your product, so that the initial sale is a tease for greater things to come.
- Think cross-sell, selling your customers on other products in your line once you already have them in the door and interested.
In their early days, startups will lose money; that’s just the nature of what happens, when acquiring market share is the most important priority and faster growth will lead to steeper losses in the short term. At this point, SaaS startups will find themselves in what David calls the Cash Flow Trough, where the company has to pour money into Sales and Marketing to acquire customers, but won’t see the returns until much later. This waiting period – where their available cash is being spent on acquiring customers – can make new founders nervous.
David preaches patience when you’re in the Cash Flow Trough; have faith that those returns will bear fruit in due time. In the meantime, you can try to mitigate the cashless impact of being in the Cash Flow Trough by asking customers for upfront payments, instead of a monthly schedule. That would give you more working capital to invest in growing your company.
These are 5 SaaS rules that David vehemently believes in, and that he probably should have tweeted out by now. If he hasn’t, let’s go ahead and start spreading these great rules and messages on social media today!