Venture Capitalist at Theory

2 minute read / Dec 1, 2018 /

# A New Way to Calculate a SaaS Company's Efficiency

There many ways of measuring a SaaS company’s efficiency: magic number, payback period on cost of customer acquisition, lifetime value to cost customer acquisition ratio, quick ratio. These metrics primarily focus on measuring efficiency in customer acquisition. But, a software company’s true efficiency also have to include the cost to service contracts. A SaaS company’s revenues are a collection of annuities, contracts that pay fees on an ongoing basis. And the goal of a subscription businesses is more than to acquire those streams, but to nurture and sustain them.

One way of measuring this is by calculating the company’s cost per recurring gross profit dollar (CRGPD). In other words, how much must a business spend in order to generate one recurring gross profit dollar over the course of a year?

‘Cost_per_Recurring_Gross_Profit_Dollar = (Cost_of_Acquisition /Annual_Revenue_Retention + Cost_to_Serve) / Gross_Profit’

If a company suffers a high churn rate, the business must acquire an initial customer and then pay again to acquire another customer later that year to replace the gross profit contribution of the churned customer. To figure out total CAC over the year, we divide the CAC by the annual revenue retention of the business. Plus, we have to add in the Cost to Serve, which are the cost of customer success. And last we divide by the gross profit dollars generated.

Unlike CAC Payback Period or LTV/CAC which are unit metrics that measure efficiency on a per customer basis, CRGM measures efficiency on a per dollar basis. Why does this matter? It’s akin to the difference between churn on a customer basis and churn on a dollar basis. Both are important, but measure different things.

Imagine a business that has a CAC of \$1000, an ACV \$2500, a gross margin of 80%, customer success cost of \$500 and a churn rate of 10% per month. The payback period is 5 months, sales efficiency is 2, which are great, but the LTV/CAC is 1.2 but the churn is off the charts.

‘CRGPD = (1000/.28 + 500)/2000 = 2.0’

In other words, to sustain a recurring gross profit dollar, this business must invest \$2 each year.

Imagine the same company with 0.5% monthly churn, and the CRGPD falls to \$0.8. This more efficient business can invest about 40% of the dollars to maintain that annuity stream.

The CRGPD measures the company’s efficiency in acquiring and sustaining a gross profit annuity stream. The smaller the figure, the more efficient the business.