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How do you know if your SaaS business is healthy?
You need to start with the unit economics, which are the key to understanding how you will (or won’t!) make money.
At Southgate Labs we’ve had the opportunity to work with a number of growing ventures, and one thing they all have in common is that keeping on top of the maths is hard work – the calculations are confusing, it’s hard to even find a consistent formula, and a lot of what is written about this stuff is pretty dense and academic, plus there is a long list of different metrics to calculate.
All of this makes it hard to know if the business is growing well or not. So, we decided to build a tool to try and make this all easier. It’s called Dr. SaaS, and you can find it here:
It asks you to enter some information about your subscribers, revenues and expenses, and then does all of the maths for you. All of the details are explained in plain English, so you can get started quickly and easily. And, once you’re done, a diagnosis is generated based on the information you enter, highlighting healthy areas, and also areas where there’s room for improvement. It gives you an honest assessment – if things are not healthy this will help you identify the problems early and make the changes that are needed. And, once done, you can also share the details online and invite others to view the diagnosis – it’s a good way to quickly share a snapshot of your progress with your team, your advisors and your investors.
For example, check out this diagnosis of the mythical Dobalina Inc, as an example.
We’ve been using Dr. SaaS ourselves, in various forms, for a while now, so it’s good to finally launch it for you to start to use today.
Please try it out, recommend it to others, and let us know what you think so we can make it better.
How does this work?
To understand your unit economics you need to answer three questions about your venture:
1. How much does each customer pay?
2. What does it cost to get a new customer?
3. What does it cost to provide your product or service?
Then, once you know those values, you can think about what it would take to have a profitable venture:
4. How many customers are needed to cover your fixed costs? (the break-even point)
5. How much cash do you need to get to that point?
In a traditional business model this is all reasonably straight forward – when you make a sale the revenue and the costs of goods sold are normally obvious, so all you are left to do is divide the amount spent on sales and marketing by the number of sales made to get an average cost of acquiring a customer, and you already have a pretty good picture of the health of the business.
However, with a software-as-a-service business model, where customers are paying a monthly or annual subscription, it quickly gets much more complicated. In order to calculate the revenue from a new customer, you need to know not only how much they pay, but also how long they are likely to remain a customer. Likewise, to determine what it costs to provide the service, you need to consider the total cost over the whole time they are a customer.
To complicate this even more, there is a long and confusing list of metrics used:
ARPU = average revenue per user (or customer!), normally per month or per annum
Churn = the rate at which your existing customers cancel their subscription (sometimes also expressed in terms of tenure, or life expectancy of a customer)
CAC = average cost of acquiring a new customer, ideally including all sales and marketing staff costs
CTS = average cost to serve, again ideally including all customer support staff costs (sometimes also called COGS or cost of goods sold), normally per month or per annum
LTV = expected lifetime value of a customer
Burn = the amount of cash you spend each month
Runway = the amount of time you have left before you run out of cash, given your current burn rate
Dr SaaS has been designed to cut through all of this. You only need to enter your subscriber numbers (i.e. how many subscribers you have, how many new subscribers you added in the last month and how many subscribers cancelled?) and some details from your accounts about how much you earned and how much you spent (i.e. how much did you spend acquiring new customers, how much did you spend supporting existing customers and how much did you receive from them in subscription revenue?) We even help with suggestions about where you look to find these numbers.
With those details we can calculate the amount of money you can expect to earn from each new subscriber. The graph will look something like this:
This shows the total revenue you will earn from the subscriber over their lifetime as a customer (the big green bar on the left), less the amount you spent acquiring them as a customer (your sales and marketing costs, including staff costs) and the amount you will spend supporting them while they are a customer (your operations and support costs, including staff costs). What’s left is your gross profit per customer the (hopefully!) green bar on the right. If you spend more to acquire and service customers than you earn from them then the gross profit will be a red bar.
Every SaaS company is different, and there is not one right answer with this stuff, but it is important that you know your numbers and then think about what you need to do to improve those as you grow.