Difference Between SaaS model and Traditional Software Licensing Model
But how does one measure business success or performance in a SaaS model? Unlike the traditional business model, the revenue stream for SaaS companies is on a monthly subscription basis.
Let’s take for example Microsoft who is a world leader in office productivity software. Microsoft sold its software products like MS Office for years with a one time cost per license. If anyone needed to buy MS Office, they would buy it off the shelf and pay for that package a retail price.
SaaS companies have a different revenue model. The customer has to pay a monthly subscription fee for the product or service. For example, Google’s G Suite is a cloud-based office productivity solution with monthly billing.
Now, of course, Microsoft has seen the benefits of the SaaS model. Microsoft developed a competitive SaaS product- the OS365 office productivity solution. OS365, a cloud-based product, saw its release in the year 2011. Microsoft’s evolution from traditional software licensing model to cloud-based services has had a more than significant impact on its revenues.
Performance Measure of SaaS Model Companies
Now that we have seen that the cloud-based revenue model is starkly different from the traditional software licensing model, how does one measure performance for SaaS companies? It is seen that traditional metrics are inadequate to measure the performance and growth of SaaS companies. Traditional performance measuring systems simply do not meet the needs of a recurring revenue model.
“The only constant in the technology industry is change”
-Marc Benioff
Key SaaS Metrics
So what are the key SaaS metrics to measure business performance? In the SaaS business model, the below-listed metrics are a critical measure which provides insight into the company’s future potential as well as financial stability.
- Monthly Recurring Revenue (MRR)
- Average Contract Value (ACV)
- Customer Acquisitions Costs (CAC)
- Customer Lifetime Value (CLV)
- Churn and Retention
- Lead Velocity Rate
Monthly Recurring Revenue (MRR) / Annual Recurring Revenue
Monthly recurring revenue (MRR) is the income that a SaaS company is assured every single month or annually from its subscription customers. This income is from services that have been billed and paid for on either a monthly subscription or annual lump sum amount. In a SaaS company, the income the company brings in consistently every month is a measure of performance.
Annual Contract Value (ACV)
Annual Contract Value is the average annual revenue from each customer.
For example: ABC Cloud Streaming Services charges each customer 1250/- per month for its video streaming service.
So the Annual Contract Value per customer for ABC Cloud Streaming Services would be:
Rs.1250.00 X 12 Months = Rs.15000/-
Customer Acquisitions Costs (CAC)
Customer Acquisitions Costs (CAC) is the total cost of sales, marketing and advertising activities that is required to acquire a customer. CAC can be calculated by dividing the total cost of sales & marketing expenses by the number of customers acquired in the same period of expenditure.
Let us take a hypothetical example:
The below table is the total sales and marketing costs of ABC Cloud Streaming Services:
ABC Cloud Services has acquired 15000 customers at a total cost of Rs. 5,350,000.00
CAC= 5,350,000.00/ 15,000= 357.00
So Customer Acquisition Costs for ABC Cloud Streaming Services is Rs.357/-
With the advent of digital marketing or marketing using online platforms such as Facebook, Google and a myriad of others, we are able to accurately calculate the marketing costs in comparison to traditional marketing & advertising media such as television and print.
Hence the cost of acquiring a customer through social media marketing as well as internet advertising can be calculated with a fair level of accuracy.
Churn Rate
The percentage of customers that cancel their subscription over a given period is known as Churn Rate, referred to as “Logo Churn.” Since SaaS companies depend on a subscription-based revenue model, the churn rate is a very important metric. Minimising churn rate should be high on the priority list.
Retention Rate
The percentage of customers the company manages to retain over a given period is known as Retention Rate or “Logo Retention”. An increase in retention rate will naturally result in higher profit margins through increase in Customer Lifetime Value.
Both Churn Rate as well as Retention Rate are very important metrics to measure the health of any SaaS company.
Customer Lifetime Value (CLV) or LTV
In the simplest of terms, Customer Lifetime Value (CLV) is the total revenue the organisation earns from the customer until the subscription is cancelled. The total revenue generated by an average customer over their entire lifetime is CLV/LTV. Why is CLV/LTV important in measuring business performance? The priority of any organization should not be merely to achieve a sale, but to retain the customer for longer durations and achieve valuable CLV/LTV. In some cases, higher CLV/LTV can be increased by seeing to it that the customer “upgrades” his product resulting in additional revenue for the organisation.
For example, ABC Cloud Streaming Services has two pricing structures for customers.
- Basic Plan: Rs.600/- per month
- Premium Plan: Rs.1250/-per month
Over a period, the customer should see the benefit of moving to the “Premium Plan” thus increasing revenue for the organisation. So it can be seen in the long term that an existing customer is just as or more important than a new customer. A customer may move to the “Premium Plan” once he has utilised all the features of the “Basic Plan” and is “looking for more” from the product.
Sales Pipeline
A Sales Pipeline is the various stages a prospect goes through before he may or may not become a customer.
The various stages of a Sales Pipeline may differ on a case to case basis but it has some common features:
- Lead Gathering
- Lead Qualifying
- Proposal
- Deal Closing
Lead Gathering
The organisation does a set of lead generation activities to publicise the existence of its product. A prospect may search for information on better ways to “manage teams” on a search engine before he chances upon Microsoft’s product for Team Management in the search engine results.
However, at this stage, the prospect may not need the product and is just looking for information on the same. But now he is aware that Microsoft has a product which resolves one of his pain points while managing teams. The prospect leaves his contact information on the Microsoft product information page seeking more information on the software. This stage of collecting leads or contact information is known as lead gathering.
At this stage, the prospect is a Marketing Qualified Lead. The prospect shows interest in the product but is not convinced of the need to buy it.
Lead Qualifying
In this stage, the sales representative of the organisation to whom the lead has been passed on assesses the prospect based on various factors:
Whether the prospect has a requirement for the product.
Whether he has the budget to purchase the product.
Whether he has the authority to make a purchase decision.
This may vary on a case to case basis and a qualified lead is a prospect which is likely to become a customer.
So the prospect who was seeking information on “managing teams” is now aware that there is a product which can resolve issues faced by him. He goes on to seek more information on the product. This is where the sales representative assesses whether the prospect has the budget and authority to take the call on purchasing the product. This stage is lead qualifying.
An important SaaS metric here is Lead Velocity Rate
Lead Velocity Rate is the percentage increase in qualified leads. This increase may be measured on a monthly basis. From lead velocity rate, we can forecast the top-line growth of the organisation.
Proposal
The sales representative ascertains that the prospect needs the product. Does the prospect have the budget as well as the authority to buy the product? If the prospect meets the criteria the sales representative places a proposal as per the needs of the qualified lead. This is where the sales representative pitches the qualified lead. The pitch is to convince the prospect of the benefits and value of the product which helps him resolve his pain points.
In this stage, the qualified lead should sign-up for the product demo. The product demo convinces the prospect that it meets his needs after he tries out all its features.
At this stage, the prospect may assess and compare with products of competitors. Now, the prospect is a Sales Qualified Lead (SQL) as he has shown real interest to buy the product.
Deal Closing
Deal closure is the final stage where a prospect is convinced of the merits of the product and purchases the same. This is where a prospect becomes a customer.
A Sales Pipeline may have more stages as well as overlapping areas and it may not be as simple as the examples above. It’s very important for organisations to document the stages a customer goes through before he goes on to become a customer. From the data available from various stages of the Sales Pipeline, we can identify various aspects such as:
- How many leads are generated
- How many leads are Marketing Qualified Leads
- At which stage do leads lose interest in our product
- Are the prospects convinced of the benefit of our product after the demo
- At what stage does a prospect become a Sales Qualified Lead
- What is the length of an average sales pipeline life cycle
SaaS Metrics is critical in identifying the chinks in the armour of our sales pipeline and enables the organisation to make informed decisions. A broad spectrum of industries apply SaaS metrics and each industry or business may have a unique sales pipeline. Finance heads as well as product managers do not ignore SaaS metrics. Growth hackers use it to discover new opportunities and avenues for growth. Use SaaS metrics data and growth hacking techniques, to expand your user base and to grow at an exponential pace. No matter the size of your organisation, or the growth stage, it is an indispensable tool. It’s never too late to use SaaS metrics for your organisation.
