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Unit Economics & how to impress your investors

SAAS companies which track their data and metrics are consistently more successful in the long term.  Investors know this, but are frustrated by investee data awareness and reporting.

To quote Smedvig Capital, An important part of our evaluation of a company is digging into their financials and economics. However, we often find there is very little consistency in how financial data, cohorts and metrics are recorded and tracked, and in how companies use these to forecast growth.”

A critical component that brings order and understanding to data analysis is “unit economics”. Unit economics refers to direct revenue and cost, measured per unit.   For SAAS companies, the most common unit is per customer.

Unit economics are critical to understanding and forecasting future growth and profitability.  While there are many measures of unit economics, three dominate:

  • LTV: Lifetime Value
  • CAC: Cost Customer Acquisition
  • Revenue per Customer

 

CUSTOMER LIFETIME VALUE (commonly abbreviated CLTV, LTV or CLV) is a measure of how much money you will make from a customer over their life, or the time that they are your customer.

For early-stage companies, particularly pre-seed or seed stage companies, measuring margin over the actual life of a customer can be tricky as they may buy from you for years into the future, making it hard to assess their ‘lifetime’, today.

To address this issue, our preferred formula for Lifetime value is based on the average margin per customer divided by average churn.

 

This formula is particularly useful for venture funded companies because it:

  • Extrapolates lifetime value, using the average churn rate, eliminating the need to determine if a particular customer will remain active for a designated time period.
  • Considers the most recent 3 months of data, making it easy to spot changes, either improvements or deteriorations.

Seeing this data regularly using automation helps ensure an ongoing focus on improvement.

CUSTOMER ACQUISITION COST (commonly abbreviated CAC or CCA) is a measure of how much it costs to acquire a new customer.  It should include all marketing and sales costs, including salaries.

 

As companies grow, CAC falls usually because more customers are acquired over time as businesses gain traction.

The most common question that we are asked is,

“What is best practice for my CAC?  Is it too high?”

CAC varies widely by company.  For some SAAS companies, it can be as low as a few pounds.  For others, it can be £500,000+.  The amount does not matter.  The relationship to LTV is critical.

The best rule of thumb is that LTV should be at least three times CAC.  If a company spends £1000 to acquire each new customers, LTV should be £3000, ideally more.

And, in case you want to see just how wide the gap between LTV and CAC can grow, here is a great snapshot from one of our current customers. An LTV:CAC ratio of 50 is truly impressive!

 

The ratio of LTV: CAC can shift quickly as a company finds product market fit and starts to gain traction.  LTV will increase as customers spend more and churn less.  CAC can simultaneously fall through more efficient marketing.  As the gap between LTV and CAC widens, it is a greater indicator and perhaps the best indicator that the company is ready to accelerate.

While Lifetime Value and Customer Acquisition Costs are the most important metrics for unit economics, we like to balance this with a third, which is a simple measure of revenue per customer.

Revenue per Active Customer is frequently the first indicator of a business in growth mode.   Spend per customer is increasing, and ideally the number of customers at the same time.

All B2B companies, no matter their stage of growth, can benefit by measuring unit economics regularly.  Collating data across teams, however, can be tricky and time consuming.  The good news is that ScaleXP can make your life just a lot easier.

Our objective at ScaleXP is to ensure our clients have an environment where every company has actional data insights in real time.  Our system will provide CAC, LTV, revenue per customer each month using data in your underlying systems (Xero, Hubspot, Salesforce, etc), allowing you to access the data each month without even building a spreadsheet.   And CAC and LTV are just the tip of the iceberg.

Let us know if you would like a quick 15 min product demo.

 

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