Plenty has been said about nonsense SaaS metrics. Thanks to those warnings, founders rarely hold up revenue projections, proofs of concept, and social media stats as demonstrations of success and beacons of strategy. It’s the SaaS industry’s legitimate metrics that are more likely to delude founders.
Metrics quantify what someone cares about. When we use common SaaS metrics to run a business, we adopt commonly held assumptions about what a SaaS startup is and what it should aspire to be. Those metrics tend to be biased toward the VC business model, which favors quick growth, high valuations, and predictable exits.
For founders, the challenge is putting SaaS metrics into context. That requires awareness of how they can delude us, a basket of metrics that provide checks and balances, and a management strategy that prevents favoritism.
THE METRICS THAT MISLEAD
The SaaS metrics we check most often have the highest potential to mislead us. It’s not that the metrics are inaccurate; the issue is why they matter and how we interpret them. Three metrics are common culprits:
1. Users: Some SaaS companies define an “active user” as someone who logs into their platform once every six months. Therefore, a massive proportion of their users are people who will never log in again. While this definition might pass scrutiny in a puffy press release, it won’t help founders manage their business, and it won’t slip past serious investors and partners.
2. Net Promoter Score (NPS) and customer satisfaction (CSAT): NPS is the net percentage of surveyed users who are likely to recommend a SaaS platform to a friend or colleague. SaaS companies often hold up NPS and CSAT scores as evidence of customer loyalty and propensity to renew subscriptions. Overwhelmingly positive feedback from customers can be misleading, however. Customers only get frustrated about a SaaS platform if it matters to them. The upset customer who needs the product to get work done—and gives it three out of five stars—is more likely to renew than the ambivalent customer who gives it five stars (often a euphemism for, “nothing bad happened”).
3. Annual recurring revenue (ARR): Growth in ARR is great, but what does it really mean? I once spoke with a VC about a SaaS company with aggressive ARR growth. The VC wisely pointed out that it had no other choice. The company had extremely high churn, so it needed to continuously add customers in anticipation that 25%-30% would vanish yearly. In other words, high ARR growth can indicate that a SaaS company is merely filling the bucket faster than it’s leaking.
To be clear, active users, NPS and CSAT scores, and ARR can all be insightful metrics. Without additional context, though, they can delude SaaS founders. The best way to put those metrics into context is to cross-check them against several others:
1. Engagement: Time is our most precious commodity. If users spend little time on your platform, what does that say about its necessity? While there are exceptions to this rule (e.g., SaaS that operates autonomously in the background), low usage tends to correlate with high churn.
2. Net dollar retention (NDR): I credit consultant and investor Dave Kellogg for making this metric front and center at my company. NDR is today’s ARR value divided by ARR value from the previous quarter (or whichever period you want to compare). It’s a powerful indicator of whether customers value a product. NDR below 110% means a SaaS company is barely treading water, even if it posts strong ARR at a given moment.
3. Best customers: The best customers are the ones who use a SaaS platform more than average, give high NPS and CSAT scores, and pay their bills. A SaaS company wants to increase the proportion of best customers to “meh” customers (technical term). An influx of “meh” customers means that other metrics will, sooner or later, take a dive. It can also mean that sales and marketing are optimizing lead generation and conversion metrics that inflate volume at the expense of quality.
Altogether, engagement metrics, NDR, and a quantified profile of your best customers can prevent more conventional SaaS metrics from deluding you. The right basket of metrics provides checks and balances.
NEVER FAVOR ONE METRIC
The most successful SaaS companies seem to manage performance around seven to eight core metrics, often including the six described above. That mix of metrics depends on the company. To choose them well, study the S-1 disclosures from publicly traded SaaS companies that resemble yours. At my company, for example, we pattern our metrics on other systems of record like ServiceNow, Workday, and Salesforce.
Once you have that basket, defend it against metric hobbyists. An advisor or investor may tell you to pay special attention to one metric this quarter then choose a new hobby metric the following quarter. When you optimize for metrics one at time, in isolation, there are unintended consequences. For instance, a sales team told to maximize ARR might give steep discounts on implementation to get there, leaving the company exposed to opportunist customers with a high propensity to churn.
Eventually, SaaS companies need a revenue team that holds the entire company accountable to the basket of metrics. Otherwise, individual metrics invite favoritism and manipulation.
RENEWAL IS THE GAME
Throughout this discussion, I’ve highlighted the relationship between metrics and subscription renewals because that is the engine of a SaaS business. No renewals, no revenue.
In pursuing renewals, the challenge is to cultivate a clear picture of reality. Metrics can help, or hurt, in that endeavor. The metrics that matter also mislead. When we build checks and balances into our basket of metrics, we gain the context to know when we are deluding ourselves or others.
Metrics aren’t the end of that struggle. There are countless ways to trick ourselves into thinking that a business is healthy and thriving. Reality checks are invaluable.
Ryan Anderson is the founder & CEO of Filevine, a project management, collaboration and legal case management tool for lawyers.