Tag Archives: SaaS

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 >>


SaaS product management

It’s amazing how often product managers forget a simple, yet fundamental truth:

Our job as product managers is not just to build features users want…

Not just to prioritize the roadmap…

Not just to spend time talking with customers…

Not just to ensure a successful release…

Those activities are important, of course.

But they don’t represent our primary job.

They don’t speak to the thing that enables us as product managers to deliver value to the organization.

So here’s the thing many product managers forget:

Your primary job as a product manager is to help drive the business.

Our job as product managers is to find ways to drive the growth and profitability of the business.

Period.

Now, we’re not sales people. We’re not in marketing. We’re not in customer success or support.So you’re not directly held to meeting a sales quota, or a lead gen goal, or a customer satisfaction score.

So we’re not directly held to meeting a sales quota, or a lead gen goal, or a customer satisfaction score.

So the way we drive business growth is by being strategic in how we decide to add new features and enhance existing ones, build new products and expand existing ones.

This goes beyond just validating feature requests and prioritizing and building them. This is much more fundamental than that.

In order to be strategic about your product, you must understand your product’s business model.

In other words, you need to understand:

  • How your business acquires, retains and expands customers; and
  • The key goals for your product’s business model.

Furthermore, you need to know the right set of metrics to focus on to drive the success of your product — not just metrics for the sake of metrics, but the metrics that are actionable.

Actionable metrics, combined with an understand of your product’s business goals and business model, provide you with the core foundation you can use to make strategic decisions about how to grow your product and measure its performance.

Let’s get specific. Let’s take a SaaS product as an example. Lots of product managers manage SaaS products. And there’s plenty of range here, from SaaS products targeted to individuals and small teams to those targeted to B2B enterprises.

Let’s look the high-level goals of a SaaS product and drill down from there to discuss the kinds of business metrics we all need to be focused on to measure the performance of our SaaS products, and use them to be strategic in how not only we manage and grow our products, but deliver monetizable customer value.

Primary SaaS Business Goals

At the most fundamental level, there are three primary business goals for any SaaS product:

  • Profitability. Duh.
  • Growth. Meaning sustainable revenue growth through the acquisition of new customers, and retention and expansion of existing customers.
  • Cash. This is a top concern for your CEO. Ultimately, cash inflows must be > cash outflows. No cash = no business (regardless of how good other metrics may be). Cash is heavily impacted by months to recover the cost of acquiring a customer.

For the purposes of this post, we’ll focus on the first two: profitability and growth. The good news is that by impacting these two goals, as a product manager you’ll be helping the third one too.

There are three ways to look at profitability and growth:

  • Revenue
  • COGS and Gross Margins
  • Unit economics

Let’s talk about each in turn.

Revenue Growth and Profitability

For a SaaS product, the key revenue metric is Monthly Recurring Revenue (MRR) or Annual Contract Value (ACV).

Monthly Recurring Revenue (MRR)

Many SaaS products are sold requiring no long-term contractual commitment from the customer. The customer signs up for a monthly payment plan and has the convenience of unsubscribing any time.

The recurring amount the customer pays every month is called Monthly Recurring Revenue or MRR is the key revenue metric for this type of SaaS product.

Quite simply, MRR is the revenue you’re earning every month from your customers. It can be calculated by multiplying the total number of paying customers by the average amount they pay you every month, called Average Revenue Per User (or Customer) or ARPU.

  • Total Number of Customers increases with new customers acquired every month and decreases with customers lost during the same month.
  • ARPU increases with customers who upgrade to a higher paying plan and decreases with customers who downgrade to a lower paying plan and customers who churn. It can get a bit complicated when you have customers paying different price points, different customer segments, and your product mix.

The key point to remember when calculating MRR is to focus on net MRR because every month you’re both gaining and losing customers. And hopefully, you’re gaining a lot more customers than you’re losing!

Focus on net MRR! – From SaaS Metrics for Product Managers

Focusing on net MRR will provide a more accurate view of growth. Here’s an example:

If you focus solely on new customers and upgrades, you could be led to believe MRR is growing at 30%. But that would be misleading!

You need to factor in downgrades and churn (i.e., lost customers), resulting in a more accurate 15% growth rate.

Annual Contract Value (ACV) and Bookings

If you manage a B2B enterprise SaaS product, it’s likely your customers are signing long-term contracts for a guaranteed period of time, like 12, 24, 36 or 60 months. (The business, in turn, commits to certain SLAs.)

This means unlike month-to-month SaaS products, the business can usually rely on a certain amount of guaranteed income over two or more years based on the length of the contract.

The annual amount owed by the customer is called the Annual Contract Value or ACV and is the key revenue metric for this type of SaaS product.

A related metric is Total Contract Value or TCV, which is the total value of the customer contract over the life of the contract.

So if a customer signed up for a 3-year contract worth a TCV of $300,000, the ACV would be $100,000.

In particular, you want to track ACV bookings. ACV bookings are the total value of all new signed customer contracts. Simply put, a booking exists when a customer agrees to spend money with you. So bookings are the amount of money customers have committed to spend with the business.

For example, a customer signs a 3-year contract worth a total of $36,000. Whether the customer pays you annually, monthly, quarterly or the entire amount up front, the ACV bookings value is $12,000.

Why are ACV bookings important? Because it allows you to accurately track money customers have committed to spending on your product (regardless of how they are actually billed and pay for it).

More to the point, ACV bookings are a demonstrator of the demand for your product. It tells you how the market is responding and committing to your product — its features, its user experience, it’s capabilities — and 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 you’re building and the user experience you’re delivering are actually resonating with customers from a business perspective? That’s what ACV bookings tell you.

Using MRR or ACV to Drive Growth

So how can you as a product manager impact these critical metrics of MRR and ACV, and thus drive growth?

  1. Identify and deliver features new customers want.
  2. Identify and deliver features that encourage existing customers to upgrade to higher price points.
  3. Up-sell and cross-sell add-ons and product extensions that increase recurring revenue or boost ACV — some customers may be willing to pay extra for value-added features and services.
  4. Look at how you segment customers. It may be worthwhile to look at different ways to segment your customers and package your product’s features into pricing plans that are more specifically targeted to these customer segments, and thus deliver more growth and profitability.
  5. Offer scalable or metered pricing. Does it make sense to offer pricing that scales by a unit metric, like number of users, events, transactions, campaigns, etc.? Some customers may be willing to pay more for your product than others to get more of the same feature or capability.
  6. Reduce churn. This is the #1 growth killer. Are you losing customers because you’re missing critical features? Because they abandon after onboarding? Because valuable features are not easily accessible to the user? Because you’re targeting the wrong set of customers?.

By analyzing the above, you can identify what are the things you can do from a product perspective to drive growth, and then craft your product strategy and roadmap to accomplish those goals.

COGS and Gross Margins

When a customer pays for your product, you generate revenue. Gross margin is the revenue left over after the costs associated directly with the delivery of the product or service are paid for.

The costs directly associated with the delivery of the product or service are called COGS or cost of goods sold.

Unlike a manufactured product, where COGS include materials and direct labor, COGS for a SaaS product can be a bit tricky to figure out. Generally, they include items that contribute directly to the delivery of the service. (Remember: SaaS = “software as a service”).

COGS for a SaaS product typically including things like:

  • Infrastructure, hosting, monitoring costs
  • Licenses and fees for 3rd party embedded apps, integrations or other back-end services
  • Payment processing fees
  • Commissions and royalties to affiliates and partners

There could be others. (Check with your Finance department.)

Gross margin is the cost of goods sold subtracted from revenue. It’s typically represented as a percentage of revenue.

Gross margin is critical because it’s used by your executive team and the company’s Board and investors to determine how much the company has left to cover operating expenses and reinvest in the business after delivering the service to the customer.

Gross margin is also an indicator of customer lifetime value, which in turn is a prediction of all the value a business will derive from its entire future relationship with a customer. (More on LTV in a bit…)

Gross margin is why a $10M SaaS company can be more valuable than a $100M brick and mortar company.

As a product manager, you can look at ways to reduce COGS by finding more cost-effective vendors, reducing fees or finding more efficient ways to deliver your product.

Unit Economics

Unit economics look at the most basic elements of a product’s business model and provides insight into whether the business will be profitable.

And profitability is a pretty important measure of success.

Unit economics express revenues and costs on a per unit basis. For a SaaS business, that unit is typically the user or a customer account.

One of the most fundamental unit economics is LTV or customer lifetime value (or CLV or CLTV).

LTV is a great measure of how “sticky” your customers are — whether they’ll keep paying you and for how long. LTV is also a key data point in determining company profitability.

For a product manager, LTV allows you to calculate the profitability of a single customer or segment of customers. You can then use this analysis to identify your most profitable customers and double-down your product related efforts for those customers or perhaps identify upsell/cross-sell opportunities.

Key Takeaways

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

To do this, you need to:

  • Learn the business of your product and the key levers of growth.
  • Understand the underlying economics of your product’s growth.
  • Focus on the right set of actionable metrics.
  • Marry these with your VOC insights to build robust business cases for your product ideas.
  • Craft product strategy and your product roadmap such that they show how you will drive growth via these business metrics.

This is how you can actually QUANTIFY the value you as a product manager bring to your company!

To help you, 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 >>


P.S. If you’re not managing a SaaS product, so these metrics may not apply, of course. You just need to identify they key business metrics for your product that will help you shape your product strategy and drive its business performance.