SaaS businesses face unique challenges in the marketplace. Unlike software businesses that use GAAP principles to calculate profitability, SaaS companies have to look at metrics like churn and recurring revenue to determine their profitability. A higher churn means losses to a SaaS business, and so does unplanned aggressive growth. How do you handle aggressive growth and still remain profitable? The answer lies in upselling and upgrades.
True, the costs of running a SaaS company may be lower than that of other businesses since it is service that is sold rather than a product. However, the sales characteristics in the business e.g. bookings, cancels, upgrades, etc. mean revenues and growth have to be measured differently to determine the profitability of a business. SaaS CEO’s have to find ways to reduce costs to ensure long term profitability of their companies.
Many SaaS companies find themselves in financial murk after a couple of years when the metrics they have been watching do not seem to make sense anymore with regards to the performance of the company. SaaS companies that rely entirely on recurring revenue (annual recurring revenue or monthly recurring revenue) to measure their performance often end up seeing increased customers numbers and increased losses.
Why would a company that has many users, therefore more revenues, end up making huge losses? The reason is simple: with increased recurring revenue (customers), comes increased cost of doing business. Unless the cost of doing business is reduced, a company that is experiencing rapid growth in subscription sign ups is likely to end up with large operational costs.
Customer Growth and CAC
While SaaS is a low commodity business, the fundamentals of business still apply. Reducing the cost of doing business by leveraging on economies of scale and automation are crucial for a company to be profitable. Capital spent on development, customer acquisition and support can be used more efficiently by building efficient processes that will save your team and company time and money and increase efficiency.
However, it is the cost of customer acquisition (CAC) that a SaaS company needs to critically look into to ensure it is on the path to profitability. With other metrics constant, the CAC is the most crucial metric that determines profitability. Therefore, a company on an upward growth trend has to find ways to reduce the CAC, which can otherwise eat into the MRR (Monthly Recurring Revenue).