SaaS Unit Economics - Part 1 - Retention Rates
Understanding the unit economics of a Saas business is critical to developing scalable growth, positive operating cash flow and capital efficiency. It will also help maximize the value of your company when exploring a sale or looking for additional growth capital. One of my favorite write-ups on Saas unit economics is from Shea & Company (disclaimer: I have no affiliation) because of its detailed illustration of how to calculate the metrics. What follows in this blog post is my own B2B saas example with numbers that I created (ie. all fictitious, but based on reality) to help explain the importance of this type of business analysis.
Let’s start with some assumptions:
|MRR as of 12/31/16||$221,053|
|ARR as of 12/31/16||$2,652,635|
|# of Customers as of 12/31/16||100|
|Avg ACV of Customers pre-Jan 2017||$26,526|
|Starting ACV for New Logos||$24,000|
I have modeled out sales growth assumptions for 2 years: 2017 and 2018. In addition to growth from new bookings/logos, MRR growth will come from contract expansion on renewal (ie. new seats added, tiered pricing increases based on higher usage). Conversely, if customers want to downgrade pricing, there is an option to decrease the contractual cost of subscription service. Here are some charts to summarize the data.
In part I of my overview of SaaS unit economics, the focus will be on retention rates: gross $ retention rate, net $ retention rate, and customer retention rate (1 - % churn).
|Gross $ Retention Rate||Measures recurring revenue retention by subtracting price decreases, contract reductions and churn for the same cohort.|
|Net $ Retention Rate||Measures the change in recurring revenue for the same cohort from one year to the next. Includes expansion, reduction and churn.|
|Customer Retention Rate||Measures the % of customers still paying for software in a given year.|
I am going to pick the 12 month period ending March 2018 to evaluate this company’s performance. Here is a MRR waterfall to illustrate the impact of new logo growth, expansion, reduction and churn. We can see from the chart that the company’s MRR grew by 74% year-over-year. Most of the MRR growth is coming from new logos. Let’s look at the retention metrics to help us understand the health of its installed customer base.
Gross $ and Net $ Retention
We see in the highlighted bold text that the company’s gross $ retention was 86% for the annual period ending March 2018. The quarterly annualized figure was 93%, which shows that trends have improved over the past 12 months. (Annualized numbers are useful to see trends, but can be impacted by seasonality.) Net $ retention for the annual period ending March 2018 was 105% and the quarterly annualized was 110%. It is important to note that these retention numbers are quite good given the annualized gross $ retention is greater than 90%. The annualized net $ retention of 110% shows that the installed base of customers is paying more per contract net of churn.
Quarterly annualized customer retention for March 2018 was 93% while the number for the LTM period was 87%. Similar to the gross/net $ retention numbers, the annualized percentages here show a positive trend. In Dec 2018, the model shows some convergence towards 90%, which implies that less seasonality with the results.
The implied LTV for the March 2018 period is 7.5 years vs. 13.8 years for the annualized March 2018 number. Looking at the forecast though, we see that implied customer LTV will probably be closer to 10 years.
In sum, for this company, it appears both the MRR growth rates and underlying business appear to be quite solid. In the next couple of blog posts, I will look at sales efficiency, CAC, CAC payback periods, gross margin, etc because operating efficiency is as important as topline growth.