This summer, I have been interning at Cisco in a Product Management role for a SaaS product. In the recent past, Cisco has been making rapid progress to transition to SaaS business. I spent some time last week finding the best practices for tracking metrics for SaaS business, and I was positively surprised by the breadth of research and material out there. Multiple VC firms including Scale Venture Partners, Andreessen Horowitz, and Bessemer Venture Partners publish benchmarks and trends. However, with so many dispersed sources with varying credibility, it becomes to get to all these benchmarks (and best practices) and put it in the right context.
Therefore, I decided to write a blog sharing the gist of my research. I believe anyone looking for what metrics to track in SaaS business and their benchmarks will find this helpful. For startups, these metrics would be a good place to evaluate their performance and figure out what problems to attack.
Top Metrics to Track
There are so many metrics out there, and hence it’s critical to track metrics that are actionable. Otherwise, it just becomes an academic exercise.
In the book “Lean Analytics“, the author highlighted the nature of the metrics: comparative, ratio or rate, leading (instead of lagging), and casual (instead of correlated). It’s not surprising that most of the popular metrics are either ratio or percentage, as these are often normalized for scale and can be easily benchmarked.
There are multiple frameworks to identify the metrics you want to track. I have already discussed Pirate Metrics in the past. Here, I will explain the Lifecycle view of SaaS metrics:
Lifecycle Dashboard for SaaS
Similar to Pirate Metrics, given my Dave McClure, in the picture below, I have highlighted a framework to map out the B2B SaaS metrics. It’s important to have at least one metrics for each bucket.
Some interesting metrics for which benchmarks exist but aren’t tracked often include Magic Number, Quick Ratio, and Net Dollar Expansion Rate. We will look at the definition of some of these metrics in the next section.
Before delving into the definition, I also want to talk about the debate between ARR and MRR. While most companies use MRR, it’s not the perfect metric in every case. Let’s understand why.
ARR vs MRR
For some companies, it makes sense to track ARR instead for MRR even for churn, expansion, and contraction. That’s when these companies have an annual contract. In this case, there isn’t an option for the customers of these businesses to discontinue doing business with the firm until completion of a year. Hence, it doesn’t make sense to measure metrics such as Logo Churn, which measures the percentage of customers who, given a chance, chose to discontinue doing business with us on a monthly basis.
List of a few metrics with the definition
In this section, we will look at the definition of metrics. However, I must highlight that metrics need to be defined based on business context. For example, understanding what constitutes one-time revenue and what’s recurring is critical for defining MRR. While there are defined guidelines, it’s important to have agreed definition for each metric in the organization. Let’s start with simple Leaky Bucket analogy, given by Dave Kellogg, to understand the basic metrics for SaaS business.
A SaaS business could be modeled as a “Leaky Bucket“. The water inside the bucket (ARR) is increased by selling to new customers (New ARR) or selling more to current customers (Expansion ARR). The leakage in the bucket (ARR Churn) reduces the ARR.
- Monthly Recurring Revenue (MRR): Total monthly recurring revenue earned from the subscription. It’s important to not include any one time charge in calculating this figure.
- Expansion MRR: Addition to monthly recurring revenue from the existing subscription. This does not include revenue from the new subscription.
- New MRR: Addition to monthly recurring revenue earned from new subscriptions acquired during the period.
- MRR Churn: MRR lost from cancellations and downgrades from the existing customers.
- Net New MRR: It’s a combination of three different components that changes MRR every month: New MRR (+) Expansion MRR (–) MRR Churn.
These five are the top metrics for SaaS company and would ideally be first set of metrics one needs to evaluate.
- Contraction MRR: Monthly recurring revenue lost due to cancellations during the period
- Gross MRR Churn Rate: It’s the percentage of MRR lost from cancellation and downgrades. These metrics point to the dissatisfaction of the current customer.
- Net MRR Churn Rate: Net percentage increase or decrease in MRR from the existing subscription. It takes into account the MRR gained from expansions and upgrades from your remaining customers. The difference between Net MRR Churn Rate and Gross MRR Churn Rate is that the latter doesn’t take into account expansion revenue from the existing customer base.
A net negative churn rate is great, indicating growth contributed by the existing subscription base. If this number is positive, it’s not a good sign for business – revenue contribution from existing customers is shrinking faster than it is expanding.
Net MRR Churn Rate = [(Contraction MRR – Expansion MRR during a period) / (MRR at the beginning of the period)]*100
- Logo Churn: This rate tells us the percent of customers who, given the chance, chose to discontinue doing business with us.
What’s the difference between Logo Churn and Gross MRR Churn?
Logo Churn (or customer churn) measures the ratio of the number of customers who churned to the total number of churnable customers. In contrast, for calculating MRR churn, we just sum up the MRR of the churned customers and divide it by the sum of the MRR of all churnable customers.
- Net Dollar Retention Rate: Net dollar retention tells you what percent of revenue from current customers you retained from the prior year, after accounting for upgrades, downgrades, and churn.
Net Dollar Retention => (Beginning of Period Revenue + Upgrades -Downgrades – Churn)/Beginning of Period Revenue
For example, during IPO Quarter, Box reported that it was able to grow $ 100 from its customers from a year ago to $ 136 i.e. net dollar retention of 136%.
- Magic Number: It’s the annualized change in revenue between two quarters divided by the sales and marketing expense of earlier two quarters.
Magic Number = (Change in subscription revenue between two quarters *4) / (S&M spend for the earlier of the two quarters)
One of the key measures of business is how efficient it has been in pursuing growth. When a business spends on sales and marketing efforts, the results start reflecting in revenue in the following quarter. Therefore, it makes sense to measure the ratio of sales and marketing expense (for a quarter) to the change in revenue for the following quarter. This metrics could predict which company has a profitable business.
One of the virtues of this metric is that it is a GAAP based number it is freely available for all public companies, and hence it could be benchmarked with similar companies.
Benchmark for top metrics
A good metric is one for which you can draw a line in the sand based on trends and benchmarks. As different companies report different SaaS metrics, it’s tough to find a benchmark for every metric. However, in the investing world, thumb rule exists to identify profitable SaaS business.
A few SaaS billing platform and VC startups have created dashboards for benchmarking startups. Here are a few good resources:
- Baremetrics: This company has created an open benchmark based on 800 startups that use Baremetrics. This report has done a good job a job of categorizing metrics based on MRR size. Often, retention becomes more important for firms with high MRR.
- The state of cloud report from Bessemer Venture Partners. This report presents a good analysis of SaaS companies such as Twilio and Slack, which recently went public.
This graph was one of the most interesting parts of the report. I was really wowed by the pace at which Slack scaled from USD 10M to USD 100M.
- Scale Venture Partners has created Scala Studio, a tool with a collection of benchmarks from 300 public and private companies. This I believe is a good resource for a SaaS company of any stage.
How to create a dashboard for SaaS metrics?
There are quite a few SaaS billing solution providers, who help with tracing right metrics. Even general product analytics firms such as Mixpanel and Amplitude could be used for tracking some SaaS Metrics. I really liked the Chargebee dashboard. Their dashboard (Revenuestory.io) is well organized and covers all the metrics we discussed.