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The SaaS Customer Acquisition Conundrum

Building a successful SaaS startup and putting it on a growth trajectory involves a great amount of effort and a thorough understanding of the market dynamics. To begin with one would need to build a product and achieve product market fit. Once you have a product market fit, you know there is a target segment that you can sell into. The question then becomes – How do I reach out to my target audience and start converting them as paying users?

An easy answer some would say with the amount of options a SaaS company has to interact with its customers in today’s digital world. But is it so? To understand SaaS customer acquisition and business viability one would first need to understand a few basic metrics that become extremely crucial to understand the health of a SaaS business:

  • LTV – Lifetime Value of a Customer
  • CAC – Cost to Acquire a Customer
  • Sales Velocity – Number of days required to acquire a customer from the first point of interaction
  • Payback – Time taken to recover the CAC
  • Churn(monthly) – % of customers you lose in a month

A well balanced business model will always have a LTV value greater than the CAC. If it’s not so for your SaaS business, then it might be a good option to reconsider the business model you are building.

One in a million SaaS startup would be able to depend upon the inherent virality of the product to scale up. But even in case of these startups there is an initial threshold value for the customer count that they need to hit for the virality to kick in. Rest of them, well they have to use of mix of SEO, SEM, Social Media, Direct Sales, Channel Sales, PR etc to hit their audience. Let me tell you, the CAC for majority of the SaaS companies have shot up so much that it becomes really difficult during the initial days of its incubation to rely on the Paid channels to acquire customers.

So, when does Paid Channels Work for a SaaS Startup?

Paid Acqusition works only when LTV > CAC

To elaborate, let’s assume a startup which relies on Google Adwords for eg to generate leads and works with the following numbers:

Scenario-1Scenario – 2
Total Traffic80008000
Cost Per Click$1$4
Conversion to Trials10%10%
Conversion to Paid Customer5%5%
Number of Trials800800
Number of Paid Customers4040
Cost of Converted Trial$10$40
CAC$200$800
No. of Sales & Marketing Resource710
Cost per Employee per Month1000010000
Total Cost Incurred Per Month( Without salary)800032000
Total Cost Incurred Per Month( With salary)78000132000

 

As you can see the CAC is a function of CPC, Conversion % at each stage, Sales & Marketing Overheads, Churn and the Sales velocity. You would want to have a high velocity and a churn percentage close to zero to reduce the CAC. Similarly, with more human touchpoints, your CAC value goes higher. Touchpoints could be any of email followups, sales calls or demos the inside sales team does. The CAC value goes even higher with direct Sales team involved, however in such cases your Average Contract value will also be much higher. In short it’s important for any company to keep their CAC < LTV to sustain.

While you do your math and try and figure out the CAC number during the early stages of your business, another important metric to track is the payback period. Let’s assume in the above example your avg. revenue per customer is $400/ year.

Scenario 1: Payback Period = 200/400 = 0.5 years

Scenario 2: Payback Period = 800/400 = 2 Years

 

Implies, in Scenario 1, you would take 6 months to recover the amount of money you had invested in acquiring the customer, while in Scenario 2, you will take almost 2 years to recover the money you spend on getting your customers. For a Startup at an early stage having limited access to capital the second Scenario is a sureshot bankruptcy contender, so while you analyse your business keep in mind the payback period and the amount of capital you would need to sustain your business. A simple workaround in Scenario 2 would be to collect the payment upfront – For more, refer Pricing Strategy makes or breaks a SaaS startup.

Always be asking yourself the following questions before you decide to spend on acquiring customers through Paid Channels:

  • Has my product already achieved Product/ market fit?
  • What’s my CAC for a paid channel?
  • How much Capital do I have?
  • What’s my runway with the Capital I have?
  • What Pricing Strategy can enable me to sustain the business if I am relying upon my cash reserve to acquire customer.
  • Do I plan to raise more money or am I planning to run the business through the revenue generated? If you are planning to raise funds, burning money to show momentum might be a good idea. You may want to read this article The Incremental Customer

Find answers to these questions to have a clear understanding on why and when to use paid channels for customer acquisition. Remember you will have a sustainable business only when:

  • CAC < LTV (general rule of thumb is that LTV should be 3 times your CAC)
  • Payback period < 1 year
SaaS Pricing Strategy - Payment Collection

How Pricing Strategy Can Make or Break a SaaS Startup?

I’m sure if you have ever been part of a startup, you would understand the importance of managing cash flow at an early stage and how it can make or break your startup. It becomes even more important for a SaaS company which depends on the recurring revenue to sustain itself.

Cash is the lifeblood of any startup. It let’s the management invest in the business not just in terms of growth but also with regards to beefing up the intellectual capacity of the team. It helps the startup take a faster trajectory to achieving its milestones – It’s virtually a no brainer that any startup should focus on improving its cash flow at an early stage.

Let’s analyse the pricing & payment collection strategies a SaaS startup could adopt to improve its cash reserves. Assume a hypothetical startup generating a MRR of $60k in the first month, growing 10% YoY and with a burn rate of $250k per month. Startup has an existing cash reserve of $3 Million from series A.

SaaS Pricing Strategy - Payment Collection

I have put down 5 pricing strategies ( payment collection) options :

1) Monthly – Customers pay at the end of each month

2) Quarterly – Customers pay at the end of each quarter

3) Bi Annual – Customers pay at the end of each 6 month period

4) Annual Pre Payment – Customers pay for one full year at the beginning of the year

5) Annual Post Payment – Customers pay at the end of one year

See how in the case of Bi Annual and Annual Post Payment systems, the startup runs out of cash and is on the verge of bankruptcy. It’s a a situation you wouldn’t want to address as a startup founder. While the Annual Pre Payment system infuses a ton of cash into your reserves which will help you pump in more money into your business to grow. Remember, this is an effectively zero interest capital that your consumers have provided you access to that you can leverage for rapid business expansion.

So how are you collecting payments from your customers? It might make complete sense for a startup to shift their pricing strategy to a annual pre-payment option provided you don’t see an increased reduction in conversion because of a change in the pricing strategy. Certain segments and markets do react differently to annual pre-payment pricing strategy especially the SMB segment where the owners of these business themselves would in all probability be in a cash crunch situation to run their businesses.

Do your math and run the experiment!