Two SaaS Metrics you can't ignore

Even though so many people do

When I had an agency I was largely responsible for new business. But I never once analysed whether my time was well spent. I just assumed that we had to win new business and I was there doing it so I just had to do whatever it took. But when it comes to SaaS, this approach can easily trip you up.

The two SaaS Metrics you can’t ignore, IMHO, are ‘LTV:CAC’ and ‘CAC Payback Period’. Obviously, growth, burn, retention, EBITDA are all super important, but to my mind, if your LTV:CAC/CAC Payback are out of kilter, then your business is screwed. These metrics are immensely important when considering the long-term validity of your product and Go To Market. But what I’ve found, especially for companies who sell at a higher ticket, is they are often ignored.

What is LTV:CAC and CAC Payback Period and how are they calculated?

Just as a reminder, LTV:CAC is the ratio between your average customer lifetime value (LTV) and the amount it costs on average to win each customer; Customer Acquisition Cost (CAC).

Lifetime Value can be calculated by Multiplying the Average Gross Contract Value for a given period by the Percentage Revenue Churn in that same period.

For example:
Average Monthly Contract Value = $1,000
Gross Margin = 80%
Average Monthly Revenue Churn = 2%

LTV = ($1,000 x 80%) /2% = $40,000
So in this example, your LTV would be $40k and so at $800/month your average customer would be with you for 4 years and 2 months.

Customer Acquisition Cost is the cost of your sales and marketing salaries and any other marketing costs such as ad spend, sponsorship, exhibiting at events etc. divided by the number of customers acquired during the period.

For example:
Sales Salaries over 3 months : $60,000
Marketing Salaries over 3 months: $30,000
Ad spend and sponsorship for 3 months: $22,500
Number of customers acquired in that period: 9

CAC = ($60k+$30k+$22.5k)/9 = $12.5k

LTV:CAC is the ratio between the two.

In the above example:
LTV/CAC = $40,000/$12,500 = 3.2
LTV:CAC = 3.2:1

CAC Payback Period is the amount of time it takes your customers to ‘pay back’ the CAC.

For example:
CAC = $12,500
Average Gross Contract Value (revenue multiplied by gross margin) is $800/month

CAC Payback Period = $12,500/$800 = 15.6 months

What does’Good’ look like and why does it matter?

In terms of LTV:CAC anything that is 3:1 or above is good. A good LTV:CAC ratio is a predictor of future profitability. It will be almost impossible to have a profitable business if your LTV:CAC is lower than this. In the above example, we got a LTV:CAC of 3.2:1. so that’s a healthy LTV:CAC

In terms of your CAC Payback Period, ideally it should take your customers no more than 12 months to pay back the initial cost to acquire them. If you are selling at enterprise level, it could be a bit longer. If LTV:CAC tells you whether or not your business has a model that will deliver profitability in the future, CAC Payback indicates how long it will take you to get there. If your CAC Payback is 2 years then you’re going to need 2 years worth of cash to carry that customer until they start contributing to the business. In the above example, we ended up with a Payback Period of 15+ months.

What does that tell us? Although the LTV:CAC ratio was good, our payback period wasn’t. There could be a number of reasons for this, but in a fast-growing company, it is often a case of longer lead times. So in that period, where we won 9 customers, the sales cycle may have been kicked off over 6 months ago by a smaller (and cheaper) team. But if this is the pattern for this business, we may need to consider how much additional investment we will need to manage cashflow as it will take longer to see a return.

A Cautionary Tale

When I was in my agency, we had a Joint Venture with a client. It wasn’t SaaS, but it was a classic case of us not appreciating the LTV:CAC. The business was B2C and sold a service that was pretty much a one-off purchase. So the Lifetime Value in this case was about $1,000. However, acquiring customers was expensive. The only way we could do it at the scale we needed was through TV advertising. But that ended up costing us about $1,000 per converted customer, too. Which gave us an LTV:CAC of about 1:1. Which meant that delivering the service cost us money. All our revenue was immediately consumed by the CAC. Unless we could work out how to either drastically reduce our CAC or increase the price we charged, the business could never ever work.

Why are these metrics overlooked?

In my experience, the more ‘enterprise’ the sales, the more overlooked the numbers. Why? Well, if you are selling $100k licences you probably feel like you have a lot to play with. By contrast, if your annual licence is only $1k and you are running Google Ads campaigns, then you know that you don’t have a lot to work with to get that customer in the door and convert them to a sale.

But the folly of not being all over this is that what you think is investment in growth, could be investment in growth that has no way of ever becoming profitable. It could be that you’re being lulled into a false sense of security because revenue is growing or another part of the business is super profitable and masking what’s happening with the SaaS. It could be that you’re just looking at the SaaS’s impressive Gross Margin and can’t believe that it could be anything but a brilliant revenue contributor. All these things could be concealing an uncomfortable truth.

Anyone can grow a business with unlimited budget, but at some point it has to be able stand on its own two feet.

Bonus ‘Gift’

This may or may not be a gift depending on whether or not you like this stuff(!), but I created a very simple calculator where you can add your own assumptions in and it will calculate your LTV:CAC and CAC Payback.

Head here, make a copy and knock yourself out. You’ll see that I’ve pre-populated the ‘Instructions and Assumptions’ tab with the example numbers I used above as a starting point.

Any questions just shout :-)