SaaS Profit Formula For Successful Business
The best SaaS founders won’t have broken a sweat over what happened to Homejoy. They know that the beauty of SaaS is that it’s just math.
To build a company with long-term growth that lasts, you need to nail down two variables in your SaaS math equation: customer lifetime value (LTV) and cost of customer acquisition (CAC). Based on the current state of the market, these variables should help most SaaS companies, as their customers and companies mature and scale, achieve gross margins in the 75%–80% range.
There is a basic ratio for your business that’s absolutely critical that you understand: LTV/CAC.
If this ratio is greater than 1, you’re making money—if it’s not, you’re losing money on each new customer and your churn rate is too high. It is really that simple, but if you don’t nail this down, your business will be unsustainable at its very core and its days will be numbered from the get-go.
We think the optimal LTV/CAC ratio is 3 or higher. Every customer should be paying you $3 for every $1 spent acquiring them. That’s a rule of thumb that has come out of the experience of many a successful and failed SaaS company.
The reason why it needs to be greater than 3 is because CAC is paid up front, while LTV accrues over time. Cash flow will become a serious issue with a lower LTV/CAC ratio.
In addition, you need to build in margin for the other expenses in your business—like payroll, rent, operations, and more—so that your company on the whole is profitable. Otherwise, your customer profit won’t be enough to cover your overhead.