Unit Profitability: How profitable is our growth? Flashcards
What does Gross Margin % measure?
Profitability
Measures GAAP Revenue minus the cost of “delivering” the service to the customer
* Gross Margin % must be quite high in order for a SaaS company to have a chance at being profitable at maturity
* Investors are really focused on gross margin profile as without a high enough GM% you won’t have room to support profitability at maturity after the burden of Operating Expenses
Calculation specifics:
* COGS includes all costs required to deliver the service to customers (after building the product), including:
* Hosting and infrastructure (servers, connectivity, security)
* Third party fees (credit card / processing fees)
* Customer Support headcount (non quota carrying)
* Deployment and implementation resources
* Partner payouts
What does “Customer Acquisition Cost (CAC)” measure?
Unit Profitability
Measures the average amount spent to acquire a new customer.
* CAC is a KEY METRIC for unit economics
* All SaaS businesses must ensure they are earning more from their customers than the amount paid to acquire them
* Customer industry/market will likely determine what a “good” CAC is - tough to generalize
* Key input for LTV/CAC and CAC Payback metrics
Many ways to calculate CAC:
* Blended CAC: overall average CAC across all marketing channels
* Paid CAC: CAC isolating spend and customers acquired from all paid marketing channels
* Channel-specific CAC: CAC isolating spend and customers acquired from specific marketing channels (e.g., Google ads, Facebook ads, etc.)
* Time-adjusted CAC: S&M expense is lagged based on sales cycle length
Calculation specifics:
* Can be calculated quarterly or on LTM basis
* Make sure sales cycle length is reflected for time-adjusted CAC
* Keep an eye on seasonality when reviewing CAC results
What does “CAC Payback Period” measure?
Unit Profitability
Measures the average amount of time (in months) to recover acquisition costs per customer.
* Metric captures the “break even” point in months when customers become profitable
* The more quickly you can recoup CAC spend the more capital efficient the business is and the less dependent it is on new capital to scale
Many ways to calculate CAC Payback:
* Blended vs. paid CAC payback
* Channel-specific CAC payback
* Time-adjusted CAC payback
* CAC payback including Expansion ARR
Calculation specifics:
* Standardized to measure # of months
* Can be calculated on a monthly or LTM basis
* ARR is gross-margin adjusted because it takes some cost to deliver the service
* Apply subscription gross-margin % to ARR
* Time-adjust S&M spend to align with sales cycle length
* For some companies consider including Expansion ARR in denominator if you think S&M spend includes a material portion related to upsell/cross-sell ARR
What does “Customer Lifetime” measure?
Unit Profitability
Measures on average how long our customers keep paying us (in years) based on an annualized logo retention assumption.
* Not a meaningful metric on it’s own - key input to LTV metric
What does “Lifetime Value (LTV)” measure?
Unit Profitability
Measures how much total gross profit we can expect from each customer over their lifetime.
* Not a meaningful metric on it’s own - key input to LTV / CAC metric
* Investors can get nervous underwriting LTVs that reflect very long periods of time but can get more comfortable with looking at this metric on shorter time periods (vs. unbounded)
* Some investors like to look at a 3-year and 5-year LTV which represents sum of 3-5 years of forecasted NRR affected New Logo Gross Profit
* Limitation of this approach is that NRR used to create 3-5 year LTV forecast remains static into the future
Calculation specifics:
* Apply subscription gross-margin % to New Logo ARR
* Most often professionals referring to LTV will quote it in terms of “per customer”
* GEIG formula image is missing divisor of # of customers
* Should be LTV = (Customer Lifetime * New Logo ARR * Subscription GM %) / # of New Logo Customers
* When calculating LTV/CAC ratio, you’ll want the LTV and CAC terms to both be expressed in terms of “per customer” (in which case the customer terms will cancel each other out) or in aggregate
What does “LTV/CAC” measure?
Unit Profitability
Measures for every dollar we spend to acquire a customer, how much gross profit will I make over their lifetime?
* LTV/CAC is the gold standard of unit economics
* Cohort-based LTV/CAC is most accurate
* LTV/CAC tells you: over the long-term what is my margin potential?
* The higher the LTV/CAC metric the better the chance over the long-term things will even out and you will have really strong margins
* It could just take you a while to get to high margins depending how quickly you can grow and how quickly you are generating cash
* Can tolerate lower LTV/CAC metric if we are getting paid back super quickly (low CAC Payback) and vice versa
* If you have super high LTV/CAC it might be OK that it takes longer to recoup those costs (high CAC Payback period) so long as we get paid a bunch over our customer lifetime on average
* There will just be different cash flow dynamics for companies based on different profiles of how LTV/CAC and CAC Payback metrics line up
Calculation specifics:
* When calculating LTV/CAC ratio, you’ll want the LTV and CAC terms to both be expressed in terms of “per customer” (in which case the customer terms will cancel each other out) or in aggregate
What does Margin Structure measure?
Profitability
Measures what % of revenue goes towards S&M, R&D, G&A expenses or FCF.
* Typically calculated on LTM annual or quarterly basis
* Free Cash Flow defined as CFO - CFI
