Are SaaS Metrics Really That Important?

“Let’s visit HOW they inform decision-making”

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Are SaaS Metrics Really That Important?

“Let’s visit HOW they inform decision-making”

I was recently on a webinar hosted by a SaaS industry influencer and when asked about which SaaS metrics were most important he responded “beyond revenue growth and profitability” nothing else really matters.  He then proceeded to highlight why the majority of advice on SaaS metrics on LinkedIn is irrelevant.

As someone who spends 100% of my time on researching, analyzing, advising and commenting on SaaS metrics and even created a company to benchmark SaaS metrics this comment went against everything I believe and work to help the industry share and leverage best practices of making metrics-informed and benchmark-validated decisions.

However, since I talk about being “objective” on decision making by using data, metrics and applied evidence…I knew it was best to evaluate a few sample SaaS business decisions and determine if they could be effectively made without the use of metrics.  

Those scenarios and the associated use of metrics are highlighted below.

 1️⃣ Should we invest more in new customer acquisition?

In my experience, growth stage investors quickly move from analyzing the "get the meeting, table stakes" metric of "Growth Rate" to analyzing how efficiently capital is used to acquire, retain, and expand revenue.

Investors, CEOs and CFOs alike are responsible for generating returns on the capital invested in the company as measured by enterprise value creation.  In turn, company leadership needs to understand the returns on capital (budget) allocated to the pursuit of new customer acquisition and the associated ARR. Consider the business decision required from the below question:

Question: How much new ARR can be generated from investing $10M in Sales and Marketing for new customer acquisition pursuits?

How can the CFO and the head of Sales and Marketing answer this question without understanding the unit economics? From my experience they can’t!

Answer: Last quarter (4 quarters) for every $1 we invested in Sales and Marketing we acquired $.75 in New ARR from new customers.

Other variables and factors will come into play such as which ICP or other target customer segments are we targeting which will require more detailed analysis of customer acquisition unit economics by segment, and even by source. But at the top level, using the New CAC Ratio which measures how much Sales and Marketing expense was incurred to generate $1 of New ARR from new logo customers is a great place to begin when answering the question above.

Metric(s) Used: New CAC Ratio

2️⃣ How much do we need to invest to generate an incremental $4M in qualified pipeline to generate $1M incremental ARR?

I still remember the time when a board member asked me “how much would it cost to increase pipeline generation next quarter by $4M to generate $1M more in new customer ARR”?

I did not know the answer and said that I would have to analyze it before I could just blurt out a number.  Imagine my embarrassment when I invested 30 minutes of a board meeting showing dashboards and historical trends - but could not answer a pretty basic question.

The key was I was not tracking cost per qualified opportunity or cost per dollar of qualified pipeline, so had no real idea.  Even though we could get caught up in channel by channel performance, or hedge by saying it would be impacted by which channels or programs we were to use - the truth was we were not tracking channel or program source efficacy for pipeline generation.

So if your CFO asks your head of Marketing or CRO the below question - how would they answer?

Question: If we invest an extra $1M in pipeline generation - how much qualified pipeline could we generate?

Answer: Over the last 4 quarters for every $1 we invested in Pipeline Generation (Demand Generation + SDRs) we generated $4.4 of qualified pipeline which resulted in $.88 in New Logo ARR (Metric Used: Variable Pipeline CAC)

Metric(s) Used: Marketing CAC Ratio, Pipeline Generation Cost per Qualified Opportunity, Pipeline Generation Cost for $ of qualified pipeline

3️⃣ How do we increase our Customer Lifetime Value to CAC ratio to 4x

This is not a topic or question that a B2B SaaS operator cares too much about until an investor asks the question during due diligence or possibly it comes up in a board meeting. However, since this metric is a strong indicator for gross profit and cash generation capacity over time, it is an important investor metric.

So, when an investor suggests that your CLTV:CAC ratio should be at 4, how do you evaluate if that is possible, and where to focus resources to increase the metric?

Let’s use the below question to identify the importance of metrics:

Question: If we invest an additional $10M in Sales and Marketing this year, how much return would that generate on a gross profit basis over the life of each incremental customer we won?

This goes beyond the question of how much revenue would be closed in the first year after investing the $10M, it requires understanding multiple variables including: 1) Customer Acquisition Cost; 2) Churn Rate; 3) Gross Profit; 4) Average Revenue Per Account including expansion revenue

Answer: Over the last 4 quarters for every dollar we invested in Sales and Market in pursuit of New ARR we generated $4.2 in Customer Lifetime Value

If we invested $10M in Sales and Marketing, holding all outcome metrics constant we would generate $42M in Gross Profit over the average lifetime of the average customer which is 7.14 years using our Gross Revenue Retention rate of 86%. That return on the $10M investment returns a 22.26% annual return over the lifetime of the new customers. 

If we use a projected enterprise value to revenue multiple of 6x, that $10M investment would generate $52.5M in revenue which translates into $315M of incremental enterprise value which is an annualized return of 28.52%

Metrics Used: CAC, Gross Profit, Gross Revenue Retention.

4️⃣ How much do we need to invest to increase expansion ARR from 30% of New ARR to 40% of New ARR while holding the new logo ARR level?

Expansion ARR has become a very popular area of increased focus over the past two years, especially as new customer acquisition has become harder.  You can see the percentage of total new ARR that is generated by expansion ARR by company size in the chart below.

However, one of the least measured and understood metrics is how much investment is required to expand existing customer ARR by one dollar?  Without that metric - how would one answer the below question?

Question: How much expansion ARR can we expect from our “enterprise customers” next year? How much would it cost to increase that by $1M ARR?

With the challenges of new customer acquisition in 2023 and 2024 the above is a question being asked in executive team meetings across the industry, and is not something that can be answered by knowing expansion ARR quantity over the past “x” years alone.

Answer: Last year "Enterprise Customers" had an NRR of 121% and a 91% GRR. If we continue to track those metrics, it would suggest our $10M in existing customer ARR last year would result in $12.1M ARR this year. On a more granular basis, this would extrapolate to $9.1M in retained ARR and $3M in expansion ARR for our “enterprise customers”.

Last year we had an expansion CAC Ratio of $.81, and a Customer Retention Cost Ratio of $ .08 for our enterprise customers.  Using a straight line extrapolation, it would suggest we would need an incremental $810,000 investment in Sales, Marketing and Customer Success to grow an incremental $1M in expansion ARR. 

Metrics Used: Net Revenue Retention, Gross Revenue Retention,  Expansion CAC Ratio and Customer Retention Cost Ratio)

5️⃣ How should we determine the right mix and balance between growth and operating profitability?

Public company SaaS metrics and their associated benchmarks provide forward-looking insights into what investors are valuing and the associated weight on topics like Growth vs Profit. As an example you can see the below table from Meritech Capital that highlights the impact on EV:Revenue Multiples using historic values.

Source: Meritech Capital Session at SaaS Metrics Palooza

Question: How do we decide the right balance and trade-offs between growth rates and operating profitability?

Naturally, a company’s cash balance and associated cash runway will impact this decision, but the answer can be highly informed based upon understanding the metrics and associated benchmarks.

Answer: Using a non constraint based model, the above chart suggests the optimal balance is 20-30% growth and 20-30% Free Cash Flow Margin which results in a median 14.8x enterprise value to revenue multiple.

Reaching that level of Free Cash Flow Margin, which last year was 8%, will be very difficult for us to achieve while not impacting growth materially.  Based upon the latest public cloud benchmarks, we recommend a growth rate target of 28% which is reasonable based upon our 28% growth rate last year, and targeting a 11% Free Cash Flow Margin which would place us in the segment that results in a 9.6x Enterprise Value to Revenue multiple for public SaaS companies.

How does the above answer sound compared to something like, yes profitability is important but we do not want to sacrifice growth?

Summary:

Revenue Growth and Profitability are the ULTIMATE outcome metrics. However, in isolation provide little value in making decisions that are specific to questions that touch on the tough areas such as where, when, and how much to invest to optimize efficient revenue growth.

In order to determine which SaaS metrics are the highest priority to your company, I recommend starting with developing a SaaS Metrics Framework that is specific to your company priorities. I provided the Benchmarkit Framework based upon the five pillars of enterprise value in a previous edition of the SaaS Barometer which can be accessed by clicking here.

As a point of clarification, some of the above examples, questions and answers will require additional analysis to determine if a company’s product portfolio, organizational structure and other factors such as the concept of “incrementality” may factor into ultimate answers and decisions.

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