When it comes to your software company, you should be aware that cancellations can kill your business. Often business owners focus on gaining new customers without servicing their existing user base. The larger and faster your company grows, the more difficult it is to oversee various metrics such as customer churn.
There are better ways to think of this effect on your finances than the traditional models you’ve been using. First, you must figure out what it costs your company to add a single dollar to your monthly recurring revenue.
Cost of MMR
The first step in your new process is to determine what it costs you to add $1 to your MRR.
You will use CAC, or Cost to Acquire a Customer and MRR, or Monthly Recurring Revenue. In traditional calculations, you can see that it costs CAC to make MRR. If you label the cost to earn a dollar of MRR as “p”, you come up with the formula p (pay-back period) = CAC / MRR.
Cost of Cancellations
Let’s imagine for a moment that your cancellation rate on a monthly basis is “c”. If 5% of your revenue cancels in one month, that would be c = 0.05.
Because we want to stay even (we’ll worry about growing later), c dollars of your MRR have to be replaced. Each $1 of MRR requires you to spend p dollars.
So you now have your COC (Cost of Cancellations), formula: COC = pc.
Using the above example for c, we’ll stick with your revenue loss due to cancellations per month is 5%. Plug your numbers in and you have 0.05 multiplied by 6 months. This gives you a number of 0.3 as your COC. In other words, 30% of your revenue on a monthly basis is spent to keep your revenue even.
If you consider this percentage, it’s a tremendous amount. Imagine that your MRR is $1,000. You are spending $300 of that money just to keep revenues even. It’s an especially large number when you stop to think that it doesn’t include the money that you are spending on overhead, service and growth.
If there is anything to take away from your calculations, it is this: If your COC amount is high, you must continuously work to get it under control. Quite simply, you’ve got to work to reduces cancellations and CAC while increasing your MRR.
If you’ve been following a traditional metrics model, you may have been led to believe that you only needed to focus on reducing your rate of cancellation. Unfortunately, this isn’t enough. As you will learn, reducing the rate of cancellation is difficult when compared to reducing CAC and increasing MRR.
Upselling customers is important. If you are losing 3% of your revenue to cancellations, but you upsell 2% of your customers with add-ons, premium support, etc., then you are only losing 1% of your MRR each month.
So “c” is not necessarily an accurate rate of cancellation but, instead, your net churn. In other words, it’s the rate of up-sell taken away from the cancellation rate. Negative net churn is what you’re aiming for.
When you begin to approach a net churn of zero in your COC, your maintenance of an even revenue costs you nothing. In considering COC, the best thing that you can do for your company is to achieve zero net churn.
There’s little doubt that you started your SaaS with anything other than turning a profit in mind. Unfortunately, if you don’t know which metrics to use, you will never know what steps to take to earn revenue.
When you stick to the traditional SaaS metrics, you may be doing yourself a disservice. As the world of SaaS grows and becomes more competitive, people begin to learn which metrics are the most important and even create calculations of their own to better keep track of their businesses.
As an SaaS owner who wants to make money, you’ve got to be sure you aren’t bleeding it. When you are losing money due to the cost of cancellations, you better figure out ways to make it up. By upselling to your current customers and making extra features and add-ons more attractive, you end up with a happy balance between profit and loss. You may even surpass your loss and end up with a healthy amount of money to put in the bank.