Learn about the most important SaaS metrics for founders in 2023 with the CEOs of the most metric-oriented company, monday.com, and the founder of SaaStr.
Jason Lemkin, Founder of SaaStr, and co-founders and CEOs, Eran Zinman and Roy Mann of the wildly successful monday.com chat with Startup For Startup about ARR, NRR, CAC, and what it takes to beat the odds in a tougher environment.
For a quick recap on SaaS metrics:
What is ARR in SaaS?
ARR stands for Annualized Recurring Revenue, although its real-world definition has evolved over time. As you’ll learn further down in this article, ARR now means any type of software-related revenue with 100%+ Net Revenue Retention (NRR), even if it’s not truly recurring.
You can read more about real-world ARR examples here.
How Is CAC Calculated In SaaS?
CAC stands for Customer Acquisition Costs and measures how much it costs to buy a new customer. Lemkin and the Monday team share how this manufactured metric doesn’t determine cash flow and what metrics you can use instead.
Read More: What’s The Right CAC These Days?
The Number One Thing That Has Changed In SaaS Since 2005
“The number one thing that has changed over my entire journey with SaaS since 2005 is efficiency,” shares Lemkin.
In the early days of SaaS, efficiency mattered because there was no capital. Even up until 2018-2019, when values were smaller, you could only raise so much over the lifetime of your company, so you had to be efficient.
Then the Boom happened, and everyone could justify insane investments, and it warped everything. The only thing that mattered was revenue.
Now that things are settling, private and public companies have to prove efficiency.
And it’s possible!
Salesforce finally got efficient at 20-something billion in revenue.
So now we must be smarter about the most important SaaS metrics because they matter again.
CAC and CLTV Are Manufactured Metrics
It’s important to understand that these terms aren’t GAAP metrics. There are no legal definitions, including NRR.
For VCs with large funds or founders with a war chest going big, a 2-3 year payback is sometimes fine.
If you’re a service now and sign five years up front, there’s no problem over three years.
The thing is, though…
You can have pretty good CAC and long CLTV and go bankrupt.
Another problem with CAC and LTV is that it doesn’t measure cash flow.
Sometimes you can spend a lot on customers and have reasonable LTV, but that doesn’t tell you how fast you get the cash back you spent on marketing.
For Monday, they didn’t care about GAAP return on CAC. They cared about cash in the bank — how much they spent, when they spent it, and how fast the actual money came back.
They were more efficient as a company over time in terms of cash flow.
There are two points.
- Instead of focusing on CAC, pay attention to turning those metrics into actual cash.
- The SaaS community is maturing, less money is spent on acquiring customers, and more is spent on retaining existing ARR. CAC measures how much it costs to buy a customer, so we need to mature into more advanced metrics that measure how much it costs to acquire and maintain a customer.
Being Over-Metric’d Could Lead To No Pipeline
One of the challenges today is being over-metric’d. As we transition from the exuberance of 2021 into 2023, marketers have become super short-term focused.
If you’re Monday back in the day doing all digital and YouTube AdWords, that’s fine. You can still measure something in the funnel. That works for a hyper-SMB model.
But it can be quite destructive for mid-market and enterprise.
Monday does bigger deals today that might take a year to close, leading to super myopic marketing.
So marketers who are being judged on results this month instead of this year could lead to pipeline drying up for sales teams.
“Hurray for cutting marketing spend and getting instant ROI, but if your sales teams have no pipe going into the second half of the year, you aren’t going to hit your plan,” says Lemkin.
This is where metrics can take you down.
Find a way in the middle where marketers can spend the budget the best way they can. You have to measure it and trust your team to spend the yearly budget.
A Niche Metric For SaaS For Long Term Health
An interesting niche metric to pay attention to in SaaS is the ratio of revenue growth to new customer growth on a percentage basis.
Investors like to see at least a 2:1 ratio.
If you grow 50%, add at least 25% new customers. If you’re growing 50% and adding 10% new customers, you’re fatiguing your base.
No one gets in right in sales and marketing, but if you can put a little more budget into growth vs. new acquisition, magic can happen.
ARR Has Become Corrupted
Should all SaaS companies measure ARR?
Well, we can all agree that ARR has become corrupted over the years. It used to stand for annualized recurring revenue, and then fintech exploded, and they wanted to claim ARR, even though fintech revenue isn’t recurring.
Hybrid models started claiming ARR when it wasn’t.
And then VCs got drunk during the Boom and funded all revenue the same. If you see a unicorn go bankrupt, it was likely a hybrid model or non-recurring revenue.
So, founders, you may notice that you get a great multiple for ARR as a SaaS company because it comes with stability, revenue growth, and so on.
But ARR should always be stable.
If you’re not pure software, you’re playing by a tougher set of rules nowadays.
During the Boom, no one looked under the hood or cared. But if you fool people early on, it will bite you later. One of the great frauds was manipulating ARR in 2021.
And if your ARR ever goes down, it’s not ARR. That means you need to segment your business and be honest about margins. Just like CAC can kill you, low margins can kill you.
The One Metric Only Founders Can Own — Customer Centricity
Folks have been under pressure, and a lot of shenanigans and borderline unethical price increases and behaviors are happening.
Trying to lock companies into multi-year deals quickly can make them less customer-centric until they run into a huge churn wave down the road.
If you want retention and stickiness, you have to be a great partner to your customers, especially during tougher economic times.
The one metric founders can and need to own is customer centricity. No one else will do it for you. You can brute force high NRR with deals and threaten people with out-of-bound prices, but that will hurt you in the long run.
Customer centricity is the secret founder metric. It’s too easy to let customer happiness drop because it takes stress out of the system short-term.
It’s hard to go long-term, but if any company can be 5-10% more successful at anything, it can change the trajectory of the company, even one as successful as Monday.
Gross Retention vs. Net Retention — Which One Is Better?
Gross retention is what percent of revenue or logos you retain without upsells vs. net retention, which is the percent of existing logos or base you retain plus upsells.
When SaaS started, it took a while to understand that NRR was a profound metric.
And it’s one of the most important SaaS metrics that everyone reports — not ARR or CAC, but NRR.
The Monday team says gross retention has to be stable, but the number of it varies. Because if you have 3-year contracts with 97% gross retention, and raised money like crazy, you could still be crushed because you didn’t see the churn until years later.
This is why you have to segment all of these metrics. Always segment small, medium, and large.
If you don’t segment, you’ll miss trends.
How Founders Can Optimize For Cash Flow
You don’t need 20 people in finance or operations or the best accountants to optimize for cash flow.
You only need to do this one exercise that always works.
So what is it?
An L4 analysis.
L4M stands for the Last Four Months.
Just take your financials on the first of every month. It should only take 15 minutes. All you need is:
- Your topline
- Your bottom line
- How much your revenue grew
- How much you burned
Then you average the growth rates of both. The growth rate of top line and burn rate for the last four months and then roll it forward 12, 18, or 24 months.
That should be your real operating plan, no matter what anyone tells you.
If it says you’ll run out of money in 12 months, you will run out of money in 12 months.
The accuracy of the L4M model is so high. It doesn’t care about your excuses. It’s always correct.
You may not like what it says, but it’s better than a multimillion-dollar team or the most expensive CPA.
When talking about cash flow, no other metric matters.
If your burn rate is growing 3% a month, it’s going to keep growing at that rate unless you make changes.
One of the biggest dangers with founders is getting a crap model from a finance team. The worst mistake a lot of founders make is waiting to hire a VP of Finance or Director of Operations — some smart kid or spreadsheet jockey who knows how to manipulate the inputs.
You don’t want manipulated numbers. You’ll blow the top line and the cash.
The Most Important SaaS Metrics Takeaways
The biggest tip Jason Lemkin offers is to go long. Be honest about how long you want to commit. Is it a decade or twenty years?
If you’re willing to commit for one or two years, your outcome or path will be different, and 99.9% should not commit for 20 years.
If you have 120% NRR and great founders, you can go as long as you want in this world. It may be challenging, but you can push through the pain because no one can stop you.
Eran Zinman, CEO of Monday, says to measure everything you want to become good at and then start improving on it today.
And finally, Roy Mann, CEO of Monday, says that the journey has never been easy. Even if a company looks successful, it’s always tough. You have to be persistent about measuring and improving to become successful. And even then, it’s still hard.