At DVC, we have invested in several companies with recurring SaaS or subscription models. From Bulu Box to Whimseybox and InfoChimps to Tripleseat, we have invested in startups whose focus is to acquire, retain, and then monetize those recurring customers.
I recently read an article by David Skok entitled SaaS Metrics 2.0 – A Guide to Measuring and Improving what Matters. It summarized some of the situations and questions that we face with our companies whose goal is to grow and maintain their recurring revenue base. I will try to summarize some of the more important points from this article as well as relate those to our companies.
Subscription models are fascinating because the revenue for the service comes over an extended period of time, hence, the customer lifetime. In most cases, the cost to acquire a customer is 2x to 10x the monthly revenue stream expected from the customer. Thus, if it costs you $10 to acquire a customer and you receive $2 per month without any type of cancellation, you will be paid back 5 months from today, of course that is ignoring the time value of money. If you pay $10 to acquire another customer and the customer only lasts one month, you are now in the red $8. If this happens with a large portion of your customers, an entrepreneur can burn through capital very quickly. Project managers and investors use the concept of net present value to describe whether or not an investment makes sense. This basically states that if the cash coming in is greater than the cash going out over the life of the project, adjusted for time and the opportunity cost of that capital (hiring key employees or development expenses of the product), than the investment is profitable.
Although this is not a perfect measure for every SaaS business, David gave two general guidelines to know whether or not a SaaS business is viable:
1) Customer Lifetime Value > 3x Cost to Acquire a Customer
2) Months to Recover the Cost to Acquire a Customer < 12 months
Before you dive into your business, run your pro-forma against the two guidelines above to see if your numbers are even reasonable. While developing your marketing plan, consider the cost to acquire customer and the customer lifetime value that you will receive from that customer. Above all, focus on selling to, serving, and satisfying your customers.