The CEO of Zuora has a nice slide deck online titled The Only 3 SaaS Metrics that Matter where he talks about the subscription economy, gives the three metrics, and provides benchmarks from publicly traded companies. The three metrics are straightforward and make sense:
- Retention Rate – How much of your Annual Recurring Revenue (ARR) you keep each year
- Recurring Profit Margin – ARR less churn less non-growth spend (growth spend is money spent on sales and marketing)
- Growth Efficiency – How much does it cost to acquire $1 of annual contract value?
Retention rate is a common one as is growth efficiency in the form of the SaaS Magic Number, although I like that growth efficiency is much easier to understand than the ratio of sales and marketing spend from one quarter compared to recurring revenue growth in the next quarter.
The middle metric, recurring profit margin, is a great idea and not mentioned enough. One of the reasons successful SaaS companies have such great valuations relative to other companies with similar revenues and profits is that many SaaS companies could be much more profitable and still retain their revenues if they cut back on sales and marketing — recurring profit margin represents this number.
Here’s a quick SaaS startup example for recurring profit margin:
- $1 million in annual recurring revenue
- 85% renewal rate
- $50,000 profits (so, $950,000 in annual expense)
- $300,000 spent annually on sales and marketing
- Recurring profit margin: 1,000,000 times .85 minus the difference between total expenses and sales and marketing expense (950,000 – 300,000) = $200,000 or 20%
Another way to calculate recurring profit margin is by taking away the sales and marketing expense (e.g. $300k), subtracting out the annual recurring revenue amount from customers that leave based on the churn rate (e.g. $150k), and adding in existing profits (e.g. $50k). Startups that spend an unusually large amount on sales and marketing, have high renewal rates, and still break even, will have excellent recurring profit margin metrics.
What else? What are your thoughts on SaaS recurring profit margin metric?