It’s almost comical how little we knew about SaaS companies when starting out with LayerVault. To add to that, we thought we knew how things worked or that tried-and-true methods didn’t apply to us. It turns out, we simply weren’t spending enough time on understanding the things we should have been tracking.

Our ignorance hurt us, and merely understanding the fundamentals of SaaS businesses could have saved us lots of pain down the road. This post covers some of the fundamentals of running a SaaS business, and how metrics can be much more than just indicators of past results.

Churn tells you everything

It was a long time before we started accurately tracking churn.

We had not tracked churn accurately for a few reasons. Early on, you couldn’t sign up for LayerVault without also giving us your credit card. Because we already had your credit card, we counted all trialers as activations.1 Our churn numbers, when computed like this, were so high they didn’t make sense. This is one of the things where we should have gone earlier to our investors to ask them, “How do other companies in your portfolio handle this?”

If you are running a SaaS business, churn is one of the most powerful numbers I have found.

As an engineer, you’re always looking for what I call the Tetris moment. Blocks clicked together perfectly and magic happens. An accurate measurement of churn for your business is exactly that. Churn should usually be measured as the existing business that was lost each month. You should track both logo churn and a revenue churn.

We also had no idea what were considered acceptable churn rates. The best I’ve found on the subject is a post on the Sixteen Ventures blog, SaaS Churn Rate: What’s Acceptable? Had we realized this earlier, the history of the company might have been much different. Generally, below 3% monthly churn indicates a product-market fit. The goal is 0.5% per month churn. If you’re above 3%, you have a lot of work to do and likely need to talk to your customers more.

Churn is fascinating because it tells you the past and can tell you a bit about the future.

First, churn is a great indicator of how you are doing on the whole. Low churn represents a product that customers are willing to pay for, and have no problem doing so. The price your company charges for its product is less than the value derived from your customers. Churn as an indicator of past performance when things are bad is a bit dicier. Almost everything you do is rolled up into your churn metric: pricing, reliability, value, customer service, and so on. Worse yet, churn can also take swings based on seasonality. If your churn is close to the acceptable range, it becomes an accurate measurement if recent efforts.

Second, churn is one of the metrics that give you the ability to see into the future. 1 divided by your churn percentage gives you your average customer lifetime. This is the number that shows—were you to take your hands off the wheel and close off signups—how long it would take for all customers to churn out of your service. If my company’s monthly churn rate is 3.33%, my customer lifetime is 36 months. This is important when you plug values into some powerful worksheets.2 Even bringing a (catastrophically high) 10% monthly churn rate down to 5% has huge, lasting effects on the health of the business.

Monitoring churn as soon as possible is immensely important to you SaaS startup. It is the best metric I’ve seen to answer the important question, “How are we doing?”

Most importantly, because a low churn indicates happy customers, it can also be a predictor of top-level growth. If people are happy with a service, their likelihood of telling others about it goes up. Now not only have you made your current customer base happy, but you are turning them into evangelists.

Get things set up today

In the very early stages, these metrics will suffer from the Law of Small Numbers. (It doesn’t take a few people to greatly swing them in one direction or another.) Nonetheless, it’s important to establish baselines early, however small the numbers may be.

After the numbers start to grow, you’ll be able to start deducing many things about your business. If we were to begin paid acquisition, how much should we spend? With metrics, you’re able to make educated guesses and spend less time spinning your wheels. At LayerVault, we did not understand this and spent lots of time throwing things at the wall and emulating other companies.

We should have started building dashboards as soon as our product was in the beta testers hands. We would be able to measure our progress and new feature releases.

There’s no shortage of tools to do this, but I recommend long-time LayerVault customer Geckboard. Use the spreadsheets I have linked below. Take a Friday afternoon or two and get this stuff set up today. As you start generating real data, you can start to see how changing one metric has cascading effects on the rest of them. Pricing, one of the most difficult problems for a young company to get right, can be approached scientifically.

Why incubators exist

Depending on who you ask, incubators and very early stage funds can leave a bad taste in your mouth.

Never stop learning

The number of fundamental metrics and things to understand doesn’t stop here. Churn is probably the most important, since it aggregates the performance of the business, and can be a leading indicator for other parts. Low churn is necessary for high-growth startups.

There are many great resources for this stuff. Do yourself a favor and make the investment to learn this stuff now. Unfortunately, I learned much of this too-little-too-late:

Above all, make sure you never stop learning. Eventually, you need to develop a muscle to know exactly how changes in your key metrics affect your business. It will allow you to make much more calculated decisions about prioritizing features, handling customer support, and much more.

Learning the fundamentals of SaaS businesses could have completely changed how LayerVault turned out. I hope that you, dear reader, do not make the same mistakes that I did.

  1. For the record, acquisitions for most self-serve SaaS products should be considered the trial sign-ups. A customer becomes activated once their first payment is made (and not refunded). If you have questions about getting your company’s metrics set up for success, please drop me an email. More than happy to help. ↩

  2. My two favorite worksheets are ones those provided by Ryan Carson, founder of Treehouse, and the model provided by Christoph Janz, a partner at Point Nine Capital. ↩