The importance of unit economics and the associated metrics (CAC, LTV, LTV/CAC ratio) is well established in the SaaS world. But how you calculate your operating numbers isn't as well understood - these critical non-GAAP metrics aren't consistently defined. And changes in calculations - not the business - can have a real impact on your decision-making.
Accurately calculating the underlying components of SaaS metrics is more complex than many companies expect and it can affect your business operations, for example, in Sales and Marketing, and drive greater growth - or limit growth.
We have seen companies that are held back from growing as much as they can because they don't have the data and analysis to make good decisions about where to place operational bets. We have also seen companies that are less confident of the outcome and don't have much margin for error. So, what can you do to get the SaaS metrics right when you can't afford to get them wrong?
The Methodology of SaaS Metrics
Watch out when changing the methodology you use for these SaaS metrics – it can result in unpleasant surprises, as well as losing valuable trends data. Try explaining to senior management and the board why key metrics like Gross Margin (driven by Cost of Revenues) and Customer Acquisition Cost (CAC) have improved or worsened when nothing obvious has changed in the business, other than the method of accounting for these metrics. The better a process you put in place for calculating SaaS metrics early on, the more value you will get from them over time.
Questions We Get Asked for You to Consider
Here we'll discuss two questions we are often asked by SaaS Finance teams when calculating Cost of Revenue versus Customer Acquisition Cost (CAC):
- Accounting for Customer Success expense, and
- Where to put Onboarding and Customer Implementation expense
Should Customer Success be a COGS or a Sales expense? It depends.
Situation One - Customer Success is helping with both Sales and Support. Companies initially often just arbitrarily pick COGS or Sales for simplicity, but we advise them to split it 50/50 so the numbers don't get skewed incorrectly. Let’s call this the blended model. It is important to look at Customer Success compensation plans and see if they are compensated on revenue (Sales) and/or customer satisfaction or usage (COGs). If it is both, then this is a good example of the blended model and it makes sense to allocate expenses.
Situation Two - there is a dedicated support team focused on supporting customers (COGS), and Customer Success is focused and compensated based on upsells/renewals like a salesperson. In this case, Customer Success should be a Sales expense.
Situation Three - Customer Success is involved in the upsell/renewal process, but they are not compensated on revenue but on things like customer satisfaction, overall churn rate, etc. In this case, they should be COGS.
If you move from Situation One to Situation Two where you now have dedicated resources for both customer support (COGs) and dedicated upsell/renewal salespeople, you may skew either COGs (GM) or Sales expense (affecting CAC) if you didn’t initially allocate those expenses across both COGS and Sales expense buckets, at least in the initial phase of transitioning to a dedicated model. Make sure to clarify this clearly to senior management.
Should onboarding and implementation costs be COGS or Sales expenses? This is one of the trickiest questions, as implementation often spans the pre-sales and post-sales processes.In general, we recommend implementation work that is done as part of the pre-sales and demo process be a sales expense. Implementation work that is done after a customer has been signed should be COGS.Think of the implementation of a customer site as professional services, even if you do not bill separately for it.
- Demos, proof of concepts, and free trials - implementation costs for these are generally selling expenses.
- Getting customers onboarded successfully and up and running on the platform - implementation costs for that are generally COGS.
Key Take-Aways
Here are a few general tips we suggest for companies managing their SaaS metrics for the most insights and consistency:
- Look at the metrics on a rolling window basis to avoid seasonality and spikes, rather than calculating the metrics only for a single month at a time.
- Make sure that you are looking at costs and expenses over the same time frame as revenues, and that you’re properly allocating expenses like annual subscriptions over the entire period.
- Think about the impact that changing how you calculate or define an expense will have on your analysis. The direction various metrics are trending provides valuable insights into your business, but that requires consistency in calculation over time. You lose a lot of value in these metrics if you change the definitions or do things that skew them during your growth.
- Comparing your company metrics to peer benchmarks can help you identify where you might be calculating your numbers differently than your peers.
