SaaS Unit Economics – A Deep Dive for CEOs

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This week, we’re doing a deep dive into SaaS unit economics (ARPA, Churn, Lifespan, LTV, CAC) and the optimal ratios for scaling up to $50M in ARR and beyond. 

Now for the good stuff… let’s jump in to today's featured article…

SaaS Unit Economics: A Deep Dive for CEOs

By Ryan Allis, Former CEO & Co-Founder of iContact

After ten years of building, I sold my SaaS business (iContact) for $169 million.
 

One of the biggest things I learned along the way was to pay very close attention to our unit economics – and to follow a math-based system for scaling up customer acquisition within our unit economic targets.
 

I wrote this article as guide to scaling up your SaaS firm by getting really good at calculating and understanding your own unit economics. I hope it’s helpful!
 

The Key SaaS Unit Economics 

In any recurring revenue business, there are a few key unit economics which help you understand the profitability of each individual customer. Let’s begin with some definitions.
 

• ARPA - Average Revenue Per User (or per customer) per month. Sometimes called ARPU if it's on a per user basis.
   
• Account Churn - The monthly % of accounts that cancel. When calculating average lifespan, be sure to use account churn % not revenue churn percentage.
   
• Lifespan - The average # of months a customer stays a customer (estimate by dividing 1/Monthly Account Churn Rate)
   
• Lifetime Value - Total revenue across an average customer’s lifetime (ARPU x Lifespan)
   
• Customer Acquisition Cost - The average amount spent on sales and marketing per new customer.

These five metrics allow you to know whether to invest more in sales and marketing or invest less — whether it’s time to go big — or go deeper with making your engine better first.

What Were Our Actual Numbers? 

At iContact our ARPU was $59/mo, our account churn rate was 3.2% per month, our average customer lifespan was 32 months (1/0.032), our lifetime value (LTV) was $1860, and our CAC was $650.
 

This meant our LTV:CAC ratio was a healthy 3x. It could have been much higher, but our internal metric was to spend as much as we could in a channel as long as we were getting 3:1 LTV:CAC or better. While some early stage SaaS VCs today are looking for ~6:1 LTV:CAC ratios, the reality is that after you take their funding and invest it in growth, you’ll likely end up closer to a 3-4 to 1 LTV:CAC ratio.
 

At iContact we essentially built a system that traded $650 in upfront sales and marketing costs for $1860 in revenue. We paid the Google, LinkedIn, Facebook, G2, and our reseller partners an average of about $500 per new customer, spent about $150 in sales comp costs to get them closed and signed – and there we had it – a system that would generate 4,000 new customers per month, over-and-over again!
 

Throughout this process, we got very good at the process of customer acquisition and SaaS unit economics. We were essentially turning $1 in spend into ~$3 in revenue (and $6 in added enterprise value), over and over and over again.

At a high level, if your company’s account churn is under 3.5% per month and your CAC is less than 1/6th of your LTV, it’s time to scale up your sales and marketing efforts — and grow faster.
 

If your account churn is over roughly 3.5% per month, you’re in a yellow zone and it’s important to slow down and focus on product improvement, account management, integrations, and stickiness before you scale up your paid sales and marketing engines any further.
 

You should always work on reducing churn — it’s an ongoing process. But once you get your customer life to be above 30 months (which happens at 3.5% monthly churn), it’s critical to begin rapidly scaling up the top of your funnel while you make continual improvements to the bottom of the leaky bucket of account churn. 

In addition to looking at payment months, look at LTV:CAC ratio. If your expected average lifetime revenue (LTV) from an incremental new customer is more than 6 times your upfront cost of customer acquisition, scale up that system all day long.

LTV:CAC ratios depend on whether you're venture-backed or trying to be profitable. Here's a good rubic for LTV:CAC ratios:

• 8:1 Ratio = Optimizing for profitability
• 6:1 Ratio = Optimizing for a balance of profitability and growth
• 4:1 Ratio = Optimizing for growth (usually VC-backed)

The Actual Unit Economics for Our Two Market Segments: SMB and Enterprise
 

At iContact, we built two different product offerings targeted at different market segments: iContact and iContact Enterprise. Each of these products had their own unique unit economics.
 

iContact was targeted at small businesses who paid on average $36/mo (range of $10/mo to $1000/mo) and iContact Enterprise was targeted at mid-sized businesses and larger senders who paid an average of $1190 per month (range of $800/mo to $50k/mo). It was essentially the same product with a couple added features and access to a shared account manager.
 

We marketed iContact via Google search ads, resellers, affiliates, online review sites, SEO, postcards, and radio ads. We offered a 15 day free trial and converted about 16% of our free trials into paying customers via an automated email follow-up sequence.
 

At the peak we were adding 18,000 new free trials per month. Later on, we switched to a freemium model (free for small accounts under 1000 subscribers), which initially performed worse, but after the network effect took place it ended up performing better for us than a free trial.
 

iContact Enterprise was marketed via similar channels – with the only difference being that prospects had to already have 50,000 subscribers on their email list (we asked at the time of trial signup) before we’d invest the time/money to approach them with the Enterprise offering. If the prospect indicated they had that scale already, we’d have a sales development rep (SDR) call them to set up a demo. We also had SDRs reach out to prospects via outbound email campaigns.
 

Once our SDRs had validated that the client had the list size and the budget, they’d pass the opportunity to a Sales Executive to close the deal. Once the account was closed, they’d be passed over to an Account Manager to manage and grow the client revenue. Land and expand.
 

Because we knew our unit economics cold, we were able to get solid investment term sheets from Bessemer, Updata, JMI Equity — and our eventual buyer.

The Actual Unit Economics at iContact

Let’s start with a recap of our numbers at iContact. At iContact, we had two parts of our business with two different unit economics and sales approaches. At the time we sold the company, these were our approximate unit economics.

Ideal Ranges for SaaS Unit Economics
 

Here are some target unit economic ranges you should aim for in your recurring revenue SaaS company, noting that if your account churn is exceptionally low (<2% per month) you may be able to afford more than 12 months of revenue in upfront Sales & Marketing Costs and still build a strong firm. Some venture-backed firms will even accept 15-18 month payback windows if their account churn is <1.5% per month.

Generally speaking, SMB focused companies have higher churn rates than Enterprise focused companies (less upfront sales friction leads to less long term commitment). 

An SMB focused business with 3% monthly account churn (and 33 months of average customer lifespan) may only be able to invest 6-12 months upfront in S&M, while an Enterprise focused business with 1% monthly account churn (and 100 months of average customer lifespan) may be able to invest 18 months upfront in S&M.
 

We’ll be back in touch in a few days with another article on rapid SaaS scaling for SaaS CEOs. In the mean time, check out our SaaS CEO & Founder Mastermind community, SaasRise and our B2B Marketer community GrowthRise.

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