Sep 29

Unit Economics – Do you have a viable business model ?

By Eckhard Ortwein | Investor , Lean-Case

lean case unit economics

Unit Economics: Is Customer Lifetime Value > Cost of Customer Acquisition?

This post provides Entrepreneurs, Business Managers and Investors provides a simplified model and an introduction to Unit Economics enabling you to validate if the business model for any SaaS or subscription/recurring revenue business is viable.Unit Economics answer a key business question:  Is the Lifetime Value of a customer significantly higher than the cost to acquire a customer? We also have a look at various factors, how they can impact unit economics and how you can check your unit economics in 7 steps. Why is this so relevant? Only if you get your unit economics right, you can invest funds into scaling your business. 

Continue reading
Sep 16

What is a Business Model ?

By Eckhard Ortwein | Business Model , Investor , Lean-Case

What is a business model

What is a Business Model and what turns a Business Model into a Business Case?

A great business model describes your business logic and supports it with meaningful numbers and metrics. However, most business model approaches are very thin (not even lean) when it comes to numbers and metrics. They don't lay out activities to quantify assumptions or even suggest meaningful benchmarks. So, what is a business model? This post proposes a business model framework taking the best elements of a few approaches and allowing you to capture your assumptions in a structured manner. We describe what turns a Business Model into a Business Case and how you can easily quantify your assumptions. Discover a completely new way of how to create a business case.

Continue reading
Jul 20

On Target Earnings per Inside Sales Rep – Are Your Inside Sales Reps “Pay-As-You-Go” or Overhead?

By Satyen | Uncategorized

On-target-sales

Get a clear vision of your business

On target earnings or OTE for inside sales reps in your company clearly have an effect on your bottom line. You need to pay well enough to attract sales talent of the level required to meet your revenue goals. Yet you also have to maximize profit on each sale. And just to spice things up, your choice of the base-salary-to-variable ratio of such on-target earnings will also have an impact on your finances, particularly in the first few months of existence of your SaaS or software company.

Continue reading
Nov 20

testing new post

By Fasih Rehman | Uncategorized

lean case unit economics

Unit Economics: Is Customer Lifetime Value > Cost of Customer Acquisition?

This post provides Entrepreneurs, Business Managers and Investors provides a simplified model and an introduction to Unit Economics enabling you to validate if the business model for any SaaS or subscription/recurring revenue business is viable.Unit Economics answer a key business question:  Is the Lifetime Value of a customer significantly higher than the cost to acquire a customer? We also have a look at various factors, how they can impact unit economics and how you can check your unit economics in 7 steps. Why is this so relevant? Only if you get your unit economics right, you can invest funds into scaling your business. 

Inbound Marketing Strategy: Introduction

n your opinion, what’s the best technology to use for presenting a pitch to a new potential investor?

ongratulations! You’ve landed a pitch meeting with a potential investor. They may be interested in your idea, but it’s the presentation you give that will make or break the deal.

From PowerPoint to Prezi, there are numerous technologies that can help you organize and augment your presentation. Ten members shared their favorite tool to use when giving an investor pitch.

Why understanding unit economics is so important

Customer acquisition cost is a direct reflection of the future success of your SaaS business. If you’re too cautious about your CAC, you will likely be missing out on customers and future revenue. Yet, if you spend too freely, you won’t be profitable and will likely end up in the Deadpool.

The challenge is that you want to spend the right amount of CAC to drive new customers to your service without jeopardizing the Lifetime Value (LTV) and revenue from that customer. A great measure to gauge this balancing act is the LTV/CAC ratio, which is sometimes even referred to as the “god metric” of many successful SaaS companies.

Experiencing Unit Economics

Inputs

To experience Unit Economics hands-on, we created a simplified, interactive model for you below. You can play with the model to understand how Cost-of-Customer-Acquisition, Customer Lifetime in Months, Monthly Recurring Revenues per Customer and Gross Margin relate and how they impact the CAC Payback Period and the LTV/CAC Ratio. You can enter

  • the estimated Customer Lifetime in Months
  • < check
    the Average Monthly Recurring Revenues (MRR)
  • check
    the Gross Margin of your Service in % (reduces revenues with direct costs associated with producing the goods and services sold by your company)
  • check
    the Cost of Customer Acquisition (CAC)
Output Input
Lifetime in Months MRR in $ Growth Margin in % CAC in $ Payback in Months LTV/CAC Ratio
10.00
3.60
 
Created with Highstock 6.2.0End of Customer LifetimeCustomer Lifetime in MonthsDollars ($)Chart context menuSaaS Key Viability MetricsLifetime valueCustomer Acquisition Cost1357911131517192123252729313335373941434547050010001500200022 Lifetime value: 880

Impact

The model shows you two lines

  • the blue line which represents Cumulated Customer Lifetime Value (= Customer Life Time in Months * MRR * Gross Margin) at a given point in time (reaching its final value at the end of customer lifetime)
  • check
    the red line representing the Cost of Customer Acquisition (which actually occurs at or even before the customer sign up)

The customer starts to pay monthly for your subscription service and you eventually break even (where the two lines intersect) and make your money back on the initial CAC investment. This is the Payback Period in Months. From then on is a magical period where you’re rolling in the dough and netting a profit from that customer to optimize your LTV/CAC ratio. Lifetime Value increases until the customer decides to churn and its lifetime ends.

When you change any of the input factors, the model re-calculates the two lines and the viability metrics

  • check
    Payback Period = MRR * 12 * Gross Margin / CAC
  • check
    LTV/CAC Ratio  = Lifetime Value / CAC

Based on the calculated values for Payback Period and the LTV/CAC Ratio,  the model give you a red/green-traffic-light-indication of the viability metrics.

Traffic Light Guidelines of Viability Metrics

David Skok in his blog post SaaS Metrics explained set up a few traffic light guidelines for B2B companies: 

  • the Payback Period should ideally be less than 12 months and
  • check
    the LTV/CAC ratio should ideally be higher than 3 meaning that for every dollar you put in your SaaS machine you’re getting three dollars out (in this case, both output parameters will turn green). 

This exercise should help you to understand and tune your subscription business input thresholds to enable a viable business. The thresholds do not apply to all SaaS businesses in the same way. For example, a business without a salesforce that has a touchless conversion usually has a far lower investment in sales and marketing expenses, and becomes cash flow positive far earlier. On the other hand, a business with a lower gross margin might require a longer time to break even. You should be able to adjust these thresholds to your specific expected business.


Understanding sensitivies

Playing with the model, you can now draw a few conclusions and ask how sensible the Payback Period and LTV/CAC Ratio react upon a change of any of the input variables. Specifically, you can test how the viability metrics change upon a change of an input variable. Check it out:

  • If you increase the Lifetime value, short-term Payback Period remains unchanged, but the long-term LTV/CAC ratio increases.
  • check
    If you increase MRR per customer, the Payback Period decreases (that's a positive result and the LTV/CAC ratio increases.
  • check
    If you increase the Gross Margin, the Payback Period decreases and the LTV/CAC ratio increases.
  • check
    If you increase the CAC, the Payback Period increases and the LTV/CAC ratio decreases

The table below summarizes the positive or negative impact of an increase of any of the input variables.

Increase of ...
Impact on CAC Payback
Impact on LTV/CAC Ratio
Customer Lifetime in Months
-
Monthly Recurring Revenue
Gross Margin
Cost of Customer Acquisition

Is it all that easy?

As simple as the above model, is the answer this question: "NO!"  There are many more variables which impact the Viability Metrics such as

  • Churn
  • check
    Revenue Expansion
  • check
    Sales Team Compensation
  • check
    Sales Team Quotas
  • check
    Cost per Lead
  • check
    Lead-to-Deal Conversion Rates

The impact of a change of one of any of the input parameters on any of the Viability Metrics can differ dramatically. This is what is called a Sensitivity Analysis. The image below shows results of a Sensitivity Analysis from one our Lean-Case projects.  For example, check out the green line which shows the impact of a change of churn on the LTV/CAC Ratio

  • A 20% reduction of Churn increases the LTV/CAC Ratio from 5.8 to 7.3 (that is an increase of almost 30%) whereas
  • check
    a 20% increase of Churn decreases the LTV/CAC Ratio from 5.8 to 4.8 (that is an decrease of almost 20%)  
sensititvity analysis pabaxk

Your Unit Economics in 7 steps

If you want to get more hands-on, check out the 1-min video below. By selecting your revenue model, defining your average customer contract, defining a forecast, adding Cost-of-Goods-Sold, Cost-of-Selling and Cost of Marketing, you can check your unit Economics in 7 steps.


If you want to get more background on the key metrics of a SaaS business are and how to calculate them, we would like to refer you Lean SaaS Metrics – The Definitive Guide to create business impact and the associated InfoGraphic.
Check out this post from ProfitWell to calculate and optimize CAC and this post from HubSpot on how their product team thinks about the payback period. Tomasz Tunguz explains the Importance Of Payback Period For SaaS Startups and Dave Kellog sheds light on The Ultimate SaaS Metric: The Customer Lifetime Value to Customer Acquisition Cost Ratio (LTV/CAC)

Interested in using Lean-Case

Don't hesitate to get in touch with us 

Lean SaaS Metrics Expalined