Summary: The SaaS Metrics That Matter by Ethan Ruby and David Sacks

Only a handful of metrics really matter incl. ARR, NRR and MAU.

Original article: The SaaS Metrics That Matter by Ethan Ruby and David Sacks (published October 2021)

Motivation: authors explain metrics that help measure how well a startup is doing financially.

The authors identified the following metrics as the most relevant Key Performance Indicators for investing in SaaS businesses:

1. Growth: Key metrics include Annual Recurring Revenue (ARR) or Monthly Recurring Revenue (MRR), Compound Monthly Growth Rate (CMGR), MRR components, and customer concentration.

   1. Revenue growth is the best proof of product-market fit

   2. Recurring revenues are those that matter most - usually, professional services don’t count toward ARR

   3. Example of CMGR: you began the year at $100k ARR and ended at $1M ARR; this way, you get CMGR of 21% (outstanding result). CMGR of at least 15% below $1M ARR and 10% above $1M ARR is desirable for startups seeking Series A or B funding.

   4. MRR Components can be split into customers retained, expanded (upsell), new sales, and resurrected (former customers came back).

   5. Customer concentration means that it’s a red flag if most revenues are coming from very few large customers, as it implies significant risk.

2. Retention: Net Revenue Retention (NRR) and Logo Retention are crucial metrics for understanding customer retention. Aim for 120%+ Dollar Retention and Logo Retention above industry benchmarks (90-95% is common for enterprises, 85% for mid-market, and 70-80% for small businesses). Dollar Retention is much more important than Logo Retention.

3. Sales Efficiency/Unit Economics: Analyze sales efficiency using New Sales ARR vs. S&M Expense, CAC, New ACV vs. CAC, CAC Payback, and Magic Number.

   1. New Sales ARR vs. Sales & Marketing (S&M): ideally, New Sales ARR is equal to or greater than S&M spending (incl. personnel).

   2. Customer Acquisition Cost (CAC) - S&M expenses in the preceding period (month or quarter) are divided by the number of new customers in the current period. The lag is intended to reflect the time it takes for S&M investment to materialize in new sales.

   3. When you compare the Annual Contract Value (ACV) of new customers to their CAC, ACV should be > CAC, meaning that customer acquisition does not cost more than the first year’s revenue.

   • CAC Payback: to measure how long it takes for a customer to pay back its CAC, divide S&M spend by MRR x Gross Margin. “Lower-margin products with high CAC do poorly on payback.”

   • Magic Number: the Net New ARR in a period divided by S&M expense from the prior period. Ideally, it’s > 1.

4. Margins: Aim for a Gross Margin of at least 75% and assess Lifetime Value (LTV) to ensure long-term company health.

   1. COGS = Cost of Goods Sold; typically includes hosting costs, operations, and software needed

   2. Gross Margin = margin - COGS

   3. Low Gross Margins can indicate Mechanical Turk problem = company using humans as a substitute for product capabilities (indicates that this SaaS resembles more a consulting business than a pure software company)

   4. LTV = Lifetime Value; measures cumulative gross profit of an average customer in a cohort

   5. LTV incorporates CAC, NRR, and Gross Margin to show overall company health.

      1. If NRR > 100%, LTV can increase indefinitely.

      2. If customers churn, LTV will flatten out and stop increasing.

      3. LTV of healthy cohorts grows to at least 3x original CAC over time.

5. Capital Efficiency: Use Burn Multiple to evaluate capital efficiency

   1. Burn Multiple is Net Burn divided by its Net New ARR in a given period

   2. It measures how much the startup is burning to generate each new dollar of ARR

   3. The lower the Burn Multiple, the more efficient the growth is — Burn Multiple < 1 is exceptional, and < 2 is still quite good.

6. Metrics like DAU/WAU/MAU (daily/weekly/monthly active users) provide insights into user engagement, with desirable ratios being 40% DAU/MAU and 60% DAU/WAU during non-holiday weekdays.

   1. Why it matters? Free trials or freemium users are more likely to convert to paid accounts when they have high engagement.

   2. SaaS startups often want to remove the noise created by free users. The resulting metric of “Paid Engagement” would show activity levels for paid seats.

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The authors recommend their tool, SaaSGrid, to help calculate those metrics.