Profitably running SaaS
For a SaaS business to eventually be profitable, Life Time Value (LTV) should be 3x-5x greater than Customer Acquisition Cost (CAC) and it should not take more than 12 months to recover CAC.
Netflix’ Q2 2006 quarterly earnings report and Q2 2006 quarterly earnings call with Reed Hastings and Barry McCarthy tells us a bunch of data we can use for a large-scale SaaS example.
The newer quarterly earnings reports are interesting, too, but the 2006 version explicitly details churn and Customer (they call it Subscriber) Acquisition Cost. The raw data:
Revenue $239,400,000.00 Costs $227,177,550.00 Customers 5,169,000 Churn 4.30%
And the calculations:
CAC $43.95 ARPU $46.31 LTV $1,077.08
We can see that Netflix makes more Average Revenue Per User (ARPU) than they spend in acquiring each user (customer) each quarter, the best formula for profitability. Not only that, but at at a quarterly churn of 4%, each user is expected to be a customer for 5 years and bring in over $1,000 revenue.
However, Netflix was already very established by 2006. For earlier stage SaaS businesses, they have to deal with a SaaS cash flow trough, so comparing CAC to LTV is an earlier indicator that the business will be profitable.
In addition to consulting and workshops, we built SaaS apps like Airbrake and Trajectory.
There are some common themes among these apps:
- They were all solving our own problems.
- We were the first customers.
- They are intended for designers and developers like ourselves.
- They are all hosted web services.
- They are all multi-tenant applications.
- They are all subscription-style services (monthly billing).
The last few loosely define SaaS (software as a service) products.
We still have a lot to learn about running these SaaS products well but we’re fans of the model. We provide a free trial for each service and try to provide something for which users will want to pay a nominal monthly subscription.
Three revenue models
Lee Hower and Rob Go have written that there are only three revenue models on the internet:
- media models (primarily ads)
- transaction models (primarily e-commerce, also lead generation)
- subscription models (primarily user-paid)
This SaaS section refers to the third model.
Freeium is not a business model. By definition, free is not revenue. Freemium is a marketing tactic.
Our newest products are not freemium. They are free trial. We moved in that direction because free-forever options can have negative market position and added overhead problems.