Tag Archives: KPI

Product success

How do you know if your product is going to be successful?

How do you know if your product IS successful?

When I ask product managers this question, I get answers like these:

“We regularly ask our customers for feedback on our product.”

“We have a customer satisfaction metric that we measure.”

“We look at usage — customers who are logging in and using the system.”

“We measure conversions from free/trial to paid users.”

Those are very valuable data points. Good things to measure and track.

But none of those things tell you if your product is actually going to be successful.

Because they don’t answer the most fundamental question about the success of your product:

Is your product PROFITABLE? 

Said differently:

Can you make more profit from your customers than it costs to acquire them?

And that’s what unit economics is about.

Unit economics makes it possible to project whether your product will be profitable.

Because, quite simply, you could have great customer satisfaction, high usage, lots of positive feedback…

But if your product isn’t profitable, you won’t have a business.

So as a product manager, in order to truly measure the success of your product, you need to understand the underlying unit economics of your product.

What are unit economics?

Unit economics are the direct revenues and costs associated with a particular business model expressed on a per unit basis.

What’s the basic unit for your product?

For a SaaS product, it’s usually users, customers or accounts. And the unit economics are:

  • Lifetime Value (LTV): The average revenue a customer will bring in during the entire duration of using your product. Sometimes also called Customer Lifetime Value (CLTV or CLV).
  • Customer Acquisition Cost (CAC): How much it costs to acquire a customer. Sometimes also called Cost per Acquisition (CPA).

LTV and CAC are critical drivers of a SaaS product’s growth and success.

To the extent that LTV exceeds CAC, your product will be successful and you will have a business.

So LTV is a measure of your product’s sustainability: will it make a profit and continue making a profit.

In other words:

LTV is a prediction of all the value a business will derive from its entire future relationship with a customer expressed as net profit.

As a very simplistic example, let’s say on average your customers stay with your product for 24 months and pay $50/month. Then your average LTV is 24 * $50/month = $1,200.

If customer lifetime increases to 28 months, LTV at the same monthly recurring revenue is 28 * $50/month = $1,400. Nice.

If average monthly recurring revenue increases to $75/month, LTV at the same customer lifetime is 24 * $75/month = $1,800. Even better.

But in any of those cases, if it costs $100 to acquire a customer, your product will die.

(Note: This overly simplistic example doesn’t consider churn, which is a critical factor in the sustainability of your product’s profitability. We’ll get to that in another post.)

So ideally, LTV is way more than CAC.

This balance is INCREDIBLY important for a SaaS product, and good product management involves being mindful of the competing forces that affect this balance.

So how can you, as a product manager, affect this balance?

Let’s first talk about how to calculate LTV. There are several formulas, each of which is just a different approach to do the same calculation:

LTV = ARPU * Gross Margin * (1 / Monthly Churn)

LTV = ARPU * Average Customer Lifetime – Cost to Serve

Where:

  • ARPU = Average recurring revenue per user (or customer or account) = Total Net MRR ÷ number of customers
  • Gross Margin = (Revenue − COGS) / Revenue
  • Customer Lifetime = average number of months we expect a customer to use the product (i.e., before they churn)
  • Cost to Serve is basically COGS (i.e., cost of goods sold), and typically can include hosting and monitoring costs, infrastructure costs, licenses and royalties for 3rd party embedded apps, credit card fees, commissions to affiliates and partners, support, etc.

Driving up LTV can have a significant impact on your product’s success.

Let’s say Customer A is on a $100 monthly plan. We expect them to churn after 1 year.

LTV = $1,200.

Customer B is also on a $100 monthly plan and expected to churn after a year, but upgrades to a $150 monthly plan in month 4 and then again to a $200 plan in month 8.

LTV = $100 * 3 + $150 * 4 + $200 * 5 = $1,900 — a significant difference!

BTW, customer B upgrading is called expansion revenue, and it’s pretty sweet!

And understanding the LTV formulas makes it really easy to pinpoint which areas need improvement. (Because math.)

As a product manager, you may have little control or influence over CAC (because you don’t control sales or marketing).

But there ARE a number of ways you can impact LTV:

  • Increase average revenue per user (ARPU).
  • Increase customer lifetime — i.e, get customers to “stick” with your product longer.
  • Drive expansion revenue from existing customers.

You have a number of levers to impact these numbers.

The obvious one is to identify new features, experiences, and improvements to your product that will help increase these numbers.

You can look at offering different feature mixes in various pricing packages, or build “upgrade incentives” into the product itself, etc.

You can also segment your customers by LTV and double down on the more profitable ones or the faster growing segments by targeting them with specific features, pricing options, or other valuable services.

Let’s look at a couple of examples that bring these concepts together.

Let’s say you manage a project management SaaS product that caters to two customer segments:

Customer Segment MRR Customer Lifetime LTV
Smaller teams $50/month 24 months $1,200
Larger, enterprise teams $500/month 36 months $18,000

To keep things a bit simple, we’ll assume churn and the cost to serve each segment is the same.

Now, on the surface, looks like enterprise customers are the more valuable ones. They pay more and stay longer.

But on further analysis, you find the cost to acquire an enterprise customer is $6,000, while the cost to acquire a small team is just $240.

CAC for enterprise customers is a third of their LTV, whereas CAC for smaller customers is just 1/5th of their LTV.

This means it costs 25 times more to acquire an enterprise customer but they’re only 15 times more profitable.

So turns out smaller customers are actually the more profitable segment!

LTV for enterprise customers would need to increase to at least $30,000 to be just as profitable as smaller customers (assuming no change to CAC or churn).

It would seem to make sense to direct your product strategy toward pursuing features and experiences for smaller teams that could minimally protect their lifetime value and ideally increase it and/or their MRR.

Alternatively, you may believe it’s better to focus on increasing LTV for enterprise customers. You could define a product strategy that targets increasing LTV to at least $30,000 by increasing either their customer lifetime to 60 months (maybe they’ll sign 5-year contracts?) or your price to $833/month (will they pay that much?). You can then craft a product roadmap that identifies features and services that will justify the longer contract commitment or higher price point.

Let’s take another example.

Again, you manage a SaaS project management product. Customer lifetime is 24 months, and LTV is $1,200 on an MRR of $50/month.

Because you’re a smart, intrepid product manager, you do some digging and discover the following:

% of customers Lifetime LTV
20% 30 months $1,500
30% 24 months $1,200
50% 18 months $900

Wow — half your customers are actually churning in just a year and a half! Your product’s profitability is actually being propped up by just 20% of your customers.

So maybe you should double down on the 20% segment, encouraging sales and marketing to focus their efforts on acquiring more of the same kinds of customers, and define a product roadmap that delivers features and capabilities that could help acquire more of them.

Alternatively, or in addition, you could try to identify any gaps in your product portfolio that are causing customers in the 50% segment to churn so quickly, and get the relevant solutions prioritized on your product roadmap.

Remember that our primary job as product managers is to drive sustainable business growth.

I’ve talked about how MRR and ACV bookings are key metrics for a product manager to measure the demand and growth of their SaaS product.

LTV helps you measure the sustainability of your product.

In other words, the key question of will it be successful?

So if all you’re doing is gathering qualitative feedback or measuring usage, customer satisfaction, or things like that, you’re NOT getting the true measure of whether your product is successful.

Those ARE important to measure. But they are NOT the ultimate measure of your product’s success, which is simply:

Is your product PROFITABLE? 

Unit economics help you understand this.

By analyzing the unit economics of your product, you can highlight opportunities, expose gaps, and identify optimal strategies for maximizing the profitability (= success) of your product.

BTW, I’ve created this helpful 2-page SaaS Metrics Quick Reference Guide for Product Managers that you can download totally for free. Print it out, post it on the wall of your cube or office so that way you have it conveniently available as a reference at all times.


Get the SaaS Metrics Quick Reference Guide for Product Managers >>


Your #1 KPI as a product manager

What’s the #1 metric you need to track as a product manager?

What’s the #1 KPI you should sign up for as a product manager?

It’s not on-time delivery, the number of bugs or features per release, innovation success, speed-to-market, sprint velocity, uptime, or even customer satisfaction.

Those are interesting to track, but none of them are #1.

It’s important to remember that our primary job as product managers is to drive sustainable business growth.

To do this, it’s not just important for us to deliver customer value, but monetizable customer value — products, features, capabilities, services that customers will pay for and continue to pay for.

Product management as a function is about sustainably managing and growing the customer value monetization process.

Meaning the process by which we create and deliver monetizable customer value.

And so as product managers we need to deliver monetizable customer value in a way that drives sustainable business growth.

On-time delivery, features or bug per release, sprint velocity, uptime, etc. — none of these metrics help us measure how successful we are in doing this.

So if our job is to drive business growth through the delivery of monetizable customer value, then the #1 KPI a product manager needs to track is sustainable growth.

That means product management and product managers should sign up for the business metrics that best measure customer demand and market growth for our products.

For a SaaS product, that boils down to two key metrics:

  1. Monthly/Annual Recurring Revenue (MRR/ARR) or its cousin Annual Contract Value (ACV) Bookings
  2. Customer Lifetime Value (LTV or CLTV)

The first is a measure of the demand and growth of your product.

The second is a measure of its sustainability.

I introduced these in an earlier post. In this post, let’s take a deeper look at MRR and Bookings. I’ll discuss LTV in another post.

Let’s start with MRR.

Monthly Recurring Revenue (MRR)

Monthly recurring revenue is the total amount of predictable revenue a company expects on a monthly basis.

Annual recurring revenue or ARR is simply MRR multipled by 12.

MRR is typical for a monthly subscription business, and many SaaS companies follow this model: MailChimp, Hubspot, Basecamp, Jira, ConvertKit, Aha.io to name just a few.

MRR is the purest measure of revenue and a key indicator of growth for a SaaS product. The month-over-month percentages give a good status check of whether momentum for your product is building or waning over time.

When MRR is relatively consistent and predictable, it’s a crucial financial metric to use in financial forecasting and planning. For example, to use as part of your ROI analysis when putting together the business case for a product idea.

How To Properly Calculate MRR

At first, calculating MRR may seem as simple as multiplying the total number of customers by the average amount they’re paying per month.

But if that’s all you do, you’ll be making a BIG mistake.

Not calculating your MRR/ARR correctly can cause you to misjudge the true health and trajectory of your product.

The calculation is as follows:

MRR at the beginning of the month
+
MRR gained from new customers during that month
+
Additional MRR gained from existing customers who upgraded that month

MRR lost from customers who downgraded that month

MRR lost from customers who churned that month
=
MRR

ARR = MRR * 12

Things to include in your MRR calculation:

  • All recurring revenue, including monthly subscription fees and any additional recurring charges for extra users, seats, etc. (based on your pricing model).
  • Upgrades — i.e., customers who upgrade to a higher paying plan.
  • Downgrades — i.e., customers who downgrade to a lower paying plan.
  • All lost recurring revenue — i.e., customers you’ve lost, including any additional recurring fees they were paying for extra users, seats, etc. (based on your pricing model).
  • Discounts — for example, if your customer is on a $100/month plan, but pays a discounted rate of $75/month, that customer’s MRR contribution is $75, not $100.

Things NOT to include in your MRR calculation:

  • One-time charges — like setup fees, implementation charges, one-time upgrade fees, etc. They’re not recurring. You don’t expect to receive them on a regular basis.
  • Non-recurring add-ons — again, not recurring.
  • Subtracting transaction fees and delinquent charges. This may be tempting in order to be more conservative and “accurate”. But while well intentioned, it will result in misleading results. Transaction fees are an expense, not a loss in revenue. A delinquent charge technically means you didn’t collect the subscription from the customer. Both should be separated out and represent optimization opportunities.
  • Recurring costs, COGS and other expenses — MRR is a revenue growth metric, not a profitability metric, so don’t include costs.
  • Trialers — these are folks who have signed up to trial your product. They haven’t paid you yet, have they? So they don’t count toward MRR. Once they pay you, they count.
  • Bookings — This a common mistake. We’ll discuss bookings in a bit.

It’s important to understand that MRR is a metric that allows you to measure momentum and growth, and so should be kept as pure as possible. That means non-recurring fees and expenses should be kept out of it.

Product Teams Need to Focus on Net MRR/ARR Growth

Sales and marketing teams will typically be incentivized to focus on new MRR/ARR — meaning adding new customers every month (or year).

Customer Success teams will typically be incentivized to defend against MRR churn by focusing on retention and/or expansion MRR/ARR (i.e., getting existing customers to pay more).

Product teams need to be incentivized to develop features and experiences that drive both new MRR and defend against MRR churn — i.e., net MRR growth.

Product teams need to focus on net MRR growth – from SaaS Metrics for Product Managers

This is where we get to the heart of the matter.

By focusing solely on new MRR, it could lead the product team to believe MRR is growing at 30%. But that would be misleading!

The more accurate growth rate is 15%. So the product team needs to focus on downgrades and churn as well.

What’s the point of building new features if new customers aren’t subscribing or existing subscribers don’t keep paying every month?

How do you know if those features are attracting new customers or keeping the existing ones happy?

And BTW, by “happy” I mean “continuing to pay you money for your product”!

Bottom line: For a subscription based SaaS product, your #1 KPI as a product manager should be net MRR growth.

Next, let’s talk about Bookings and ACV Bookings.

Bookings and Annual Contract Value

Simply put, a booking happens when a customer agrees to spend money with you.

In B2B enterprise SaaS businesses, it’s typical for a customer to sign a contract. The booking exists when the customer signs the contract.

So bookings are the total dollar value of all new signed contracts — it’s the sum of all revenue promised to your business through any contracts signed.

It’s typically expressed as an annualized number even if the agreement period is longer than a year. Hence, Annual Contract Value or ACV.

A contract doesn’t have to exist, though, to have a booking. In a month-to-month subscription model, a booking exists when the subscriber signs up for a month of your SaaS offering — the subscriber has committed to that month of service without having signed anything.

In this case, bookings are typically an annualized recognition of expected recurring revenue, i.e., MRR/ARR. (And so ACV is pretty much the same as ARR.)

Why ACV Bookings is a Critical Metric

ACV bookings are a measure of the market demand for your product.

In other words, bookings tell you how the market is responding and committing to your product. As such it’s an important metric for measuring the growth and success of your product.

In other words, how do you know the features and user experience you’re delivering are actually resonating with customers? That’s what ACV bookings tell you. Because if those features and experience don’t resonate with customers, they won’t commit to spending money on your product.

Bookings also allows you to understand your expected revenue and cash flow. For example:

  • Let’s say in a given month 20 customers sign 1-year agreements committing to pay $20K each.
  • This means you know you can expect $400,000 in revenue over the course of the next 12 months.
  • You add some cool new features to the product, and the following month 30 customers sign $20K one-year agreements
  • This means you can expect $600,000 in additional revenue over 12 months from these customers.
  • So ACV bookings went up 50%, expected revenue went up 50%, which means the business is growing!
  • This is a great indication of the value your product (and your efforts) are delivering to the business.

In addition, for a SaaS product requiring customer contracts, tracking ACV bookings allows you to track growth without having to worry about when the customer actually pays (i.e., the precise payment terms, which can vary contact-to-contract). Let your accounting department worry about that.

The things to include and exclude in calculating bookings are the same as those for MRR.

Difference Between Bookings, MRR, and Billings (or Cash)

It’s important to understand the difference between these metrics so you don’t get tripped up with how your finance department looks at revenue.

Let’s take the following example:

In the table above:

  • Customer A signed up for the $50/month Basic plan and decided to pay monthly.
  • Customers B and C signed up for the $100/month Premium plan and decided to pay annually.
  • Customers D and F signed up for the $100/month Premium plan and decided to pay monthly.
  • Customer E signed up for the $50/month Basic plan and decided to pay annually.

Here are what the metrics look like:

Can you see the difference? Customers A and B were acquired in January. Their accounts represent ACVs of $600 and $1,200 respectively. So that’s a bookings of $1,800 in January. Customers C and D were acquired in February. So

Customers A and B were acquired in January. Their accounts represent ACVs of $600 and $1,200 respectively. So that’s a bookings of $1,800 in January.Customers C and D were acquired in February. So

Customers C and D were acquired in February. So that’s a total ACV bookings of $2,400 in February.

In February, there was no churn and two customers were acquired. So MRR went up to $350.

Unlike Bookings or MRR, Billings is when you actually collect money from your customers. Customer A paid $50 for January, but customer B paid $1,200 for the entire year. That’s a cash inflow of $1,250.In February, customer A paid $50, because that customer is making monthly payments. Customer B

In February, customer A paid $50, because that customer is making monthly payments. Customer B paid nothing because that customer already paid for the entire year in January. Customer C signed up and paid $1,200 for the entire year. Customer D signed up, but only paid for that month. So Billings for February $1,350.

Product Teams Need to Focus on ACV Bookings

The nice thing about ACV Bookings is it aligns the interests of both sales and product teams. Because bookings is a measure of market demand and acceptance, it’s a relevant business metric to use to motivate the product team to continuously develop amazing features and user experiences to increase committed contracts.

Bottom line: While applicable for any SaaS product, particularly for contract-based SaaS products, your #1 KPI as a product manager should be ACV Bookings growth.

Key Takeaway

Remember: Your primary job as a product manager is to drive business growth through the delivery of monetizable customer value.

So the #1 KPI a product manager needs to track is sustainable growth.

For a SaaS product, that boils down to two key metrics:

  1. Monthly/Annual Recurring Revenue (MRR/ARR) or its cousin Annual Contract Value (ACV) Bookings
  2. Customer Lifetime Value (LTV or CLTV)

So for a subscription based SaaS product, your #1 KPI as a product manager should be net MRR growth.

And for a contract-based SaaS products, your #1 KPI as a product manager should be ACV Bookings growth.

BTW, I’ve created this helpful 2-page SaaS Metrics Quick Reference Guide for Product Managers that you can download totally for free. Print it out, post it on the wall of your cube or office so that way you’ll have it conveniently available as a reference at all times.


Get the SaaS Metrics Quick Reference Guide for Product Managers >>