If there is one thing I have learned in my decades of building businesses, it is that KPIs are most useful if you are clear about the goal of the metric. You have to know what the KPI should be telling you in order to understand how to calculate it. If you don’t, you may end up with distorted or incorrect results.
Now is the time to identify what KPIs are not calculated quickly and easily at your company. If you don’t have time to do anything about it with year-end planning, make a note of each issue, and plan to resolve in the calm after the storm, at the beginning of the new year.
Customer Acquisition Cost (CAC)
Take CAC, for example. This KPI should tell you how much it costs (usually in sales and marketing expenses) to acquire a new customer account. Each of the components of the CAC calculation—expenses to acquire new customers divided by new customers—must align with the goal.
As a SaaS company scales, your CAC components will change. If you are an early-stage or growth SaaS company, most likely all your sales and marketing expenses are invested in acquiring new customers. Everything in sales and marketing expense can be divided by the number of new customers acquired as a result of that expense.
If you are a $100M SaaS company, you have $100M of existing customers, and some of your sales and marketing dollars are spent on retaining your existing customers, user meetings, your brand, corporate communications, etc. Especially now, since the onset of the pandemic, most companies have shifted some acquisition resources to customer retention—especially in 2020, look at what was spent on acquiring new customers and back-out anything that doesn’t apply.
If you work backwards from the purpose of CAC to review the inputs, it should be clear what expenses are associated with acquiring versus more broad-based sales and marketing and customer retention. Customer success, even if it sits in sales, is not associated with acquiring new customers, and its expenses should not be included in CAC. Any new marketing programs undertaken to build customer loyalty and commitment to your products are not part of CAC.
A Few Nuances
For companies with a Land and Expand sales model, where the model is to sell a small contract, followed by much larger contracts over time, the question becomes: At what point is an account no longer a “new” customer? It may take as much sales effort to get the much larger contract as it took to get the small beachhead into the customer. In this case, the customer isn’t really a customer until they buy the big contract.
Some companies determine the change from “new” to “existing” customer by time period, e.g., anything sold in the first year, in the first six months, etc., is defined as falling into the definition of new revenue. Other companies define the switch from new to existing customers by absolute contract value, meaning that at the point the contract reaches a certain amount, they are no longer a “new” customer, even if they are on small contracts for two years before they are “hooked” and defined as an existing customer and up for renewal.
Another issue that confuses both the tracking of expenses associated with acquiring new customers and the number of new customers acquired is “lapsed” customers. Subscription companies have to have a policy about when customers who have not renewed their subscription contract are no longer existing customers, and if they do resubscribe, they are now new customers. For monthly subscriptions, it may be the day after the subscription expiration. For annual contracts, many companies have some grace period of three to six months, during which a company can renew and remain a “renewal.” After that point, the company becomes a new subscription, a new customer (and the previous contract was churn).
A variation on this is if a customer is acquired or merged with another company; does the customer become “new” if they are essentially the same under a new name, or not? Companies vary on this point, and it is really only material for customer bases where there is a great deal of M&A activity, like technology. At OPEXEngine, we have the issue where every year, a significant portion of our customer base is acquired, so our churn is higher than it would be without M&A, but so is our acquisition of new customers, because the acquirer frequently becomes the new customer.
I was speaking recently with a new FP&A director at a SaaS company, and we reviewed the company’s KPIs compared to benchmarks. The comparison was wrong, though, because the company’s customer number was way off. The company was counting “users” and not “customers”—the accounts buying one contract. As a result, the company was comparing itself to companies selling millions of low-priced subscriptions in a high-volume, transactional SMB model. But this company had more of an enterprise sales model. Its customer number was based on the number of users, but a customer account could have hundreds of users. Its CAC was misleadingly low, because it was divided by a higher number of users than by the correct number of accounts that had been sold.
Getting the Whole Team to Understand the Metrics
In addition to getting the calculation right, every department needs to understand and agree on the meaning of the metric. We forget sometimes how important this is. You don’t need to get agreement on accounting metrics; you follow GAAP or IFRS rules. But in order for the head of Sales to contribute to the management of CAC, they have to buy into the definition and track it the same way. Unfortunately, too many companies don’t communicate enough about the purpose of the metric to everyone affected by the KPI.
Don’t Let the Systems Define the Metric by Default
Most SaaS companies have a CRM, a financial system, maybe a separate billing and invoicing system, and several other systems that track customers. Not enough companies have fully integrated systems for everything touching the customer lifecycle, from prospect to quote to cash to customer success and renewal, where the various units in each are the same, i.e., the number of customers in the CRM and all other systems are the same for the same time period. Many times, we’ve been reviewing a company’s KPIs, and something is off, and our client says, well, that’s the way the system calculates the number. Again, define your key metrics, like Customers, CAC, Retention, etc. from the top, meaning by the goal of what the metric tells you about your performance, and then make the systems reflect that definition.
- Define the purpose of a KPI for your company and what you expect to learn from it, before you calculate it. Validate that the components are all defined in a way that achieves the goal. A common mistake is to mix up Customer Account with Subscribers/Users. For CAC, since you are trying to understand the cost of acquiring new customers, customers should be the buying entity, not subscribers. Define in exact terms when a “new” customer becomes an “existing” customer.
- Make sure that all your business systems have the same definition for KPIs and their components. An easy test is to look at the number of active customers in your CRM, your financial systems, and any other customer tracking system. The number of active customers should be the same in each system, but often it is not.
- Review KPI and metric definitions with all parties involved, usually including at least Sales, Marketing, Customer Success, and Consulting. Make sure that you agree on time period, lapses and renewals, and differences between new and existing customers, or differences will creep into different systems and departmental definitions of the same items.
KPIs provide information to be used in predicting the future and informing decisions that affect the future. KPIs are strategic business information that guide how a company grows, how to be more efficient, and how to be more competitive. However, KPIs are only valuable if they are defined and calculated correctly, and that depends on your stage of growth and business model.
It is a good management process to regularly review the definitions of each key metric your company tracks and iterate on it each year as your company grows. 2020 has changed how many SaaS companies are doing business—so make sure your KPI calculations reflect how you are doing business now and expect to continue in 2021.