The successful recipe of a SaaS business is to acquire customers at relatively low costs and keep them happy for an extended period.
Thus, Customer Acquisition Cost (CAC) and Lifetime Value (LTV) are key metrics for a SaaS business.
CAC is calculated as the total cost of acquiring customers (Sales & Marketing), divided by the total number of customers acquired over a given period.
LTV is the average gross revenue customers will generate throughout their lifetime as customers of the business. The LTV metric is then calculated as the Average Revenue Per User (ARPU) * Gross Margins / Churn Rate.
So, what is the beauty of the LTV-CAC Ratio for a tech SaaS business?
An LTV-CAC Ratio exceeding 3 generally indicates that a tech SaaS business is sound.
a) Tech SaaS businesses typically enjoy very high gross margins, ranging between 70%-80%, in contrast to the 10%-20% gross margins of tech-enabled businesses, where technology is not the core offering
b) Customers usually stick to SaaS solutions, which ditches churn rates
c) Because of the usually high numerator coming from a) high gross margins and b) low churn rates, tech SaaS businesses can more easily calibrate their sales impetus
However, there are caveats associated with the LTV-CAC Ratio:
* It lacks significance for early-stage companies, since they still do not enjoy scale and audience diversity
* CAC increases when targeting new audiences since they are harder to acquire and convert
* CAC tends to grow faster than what the brand can compensate for
* On order to keep the product competitiveness and, thus, low churn rates, R&D for new bells & thrills becomes a never-ending process
VC and PE money has been pouring into high LTV-CAC Ratio tech SaaS businesses with reason. Once reaching a certain scale they become money-making machines.