- If you're building and scaling a SaaS business
there's a myriad of SaaS metrics to look at.
Honestly, it can be a little dizzying.
In this video, though, I'm going to be looking into
one of my most favorite metrics, it's the LTV to CAC ratio.
We're going to go into exactly what it is,
how do you parse it,
and the one thing you can do to optimize it.
Intro.
(drumming jingle)
What's up everybody?
Welcome to Unstoppable, I'm TK.
On this channel I bring an episode every single Sunday
and every single Wednesday
to help SaaS founders like you
build, scale and exit a SaaS business.
So, if you're new to our community, welcome.
Be sure you to hit that subscribe button and that bell icon
because I bring an episode like this
every single Sunday and Wednesday with the TK energy.
Also, by the way, if you are at that stage
of your SaaS business where
you're building a go-to-market machine,
I run a weekly training on how to build an
unstoppable go-to-market machine.
So, be sure to follow the link below this video.
And I'll share more details about that training
at the end of this video as well.
But, first, let's dig into the LTV to CAC ratio.
Here's the thing, there's no shortage
of actual SaaS metrics to look at.
And it can be fairly dizzying.
But, ultimately, when you get to the core of a SaaS business
there's two things to know.
One, the reason SaaS businesses are so coveted,
they command such high multiples,
is because of their highly predictable nature
in terms of revenues.
Investors love that.
Which means, two, if you have a SaaS business
there's really two things that matter the most.
It's at what low of a cost you can acquire new customers,
and it's how low you can actually keep your churn
and actually increase that lifetime value.
LTV and CAC ends up being two of the most important metrics
when it comes to that health of a SaaS business.
This is why the LTV, the lifetime value of a customer,
to the customer acquisition cost, CAC, ratio
is super, super powerful.
Very quickly you can start to understand
the health of a SaaS business,
and you can start to diagnose what might be going wrong
with a stalled SaaS business, if you're diagnosing it.
Knowing everything that I know in my ToutApp journey
and my Marketo journey,
both very different scale SaaS businesses,
we're gonna be digging into the LTV to CAC ratio.
So if you're excited to dig in
smash that like button and let's get right into it.
Okay, so step number one,
and this is what is the LTV to CAC ratio.
So the LTV is essentially your lifetime value
of the customer.
And the CAC is your customer acquisition cost.
And the ratio of that can give some insights
into how efficient you are in your SaaS business.
So, to calculate your LTV, what you want to look at
is the average value of a customer,
the average amount of money that your customer pays.
You want to times that by your gross margin,
so that's essentially netting out the cost
of servicing that customer,
not acquiring that customer.
And then you divide that by your revenue churn rate.
A simple way to think about this is
if a customer actually comes in and pays you a $1,000,
and it turns out for that $1,000
that they're paying you for the year
it costs you $300 in server costs and whatever
to actually service them,
then you're actually getting $700 through that customer.
Now, on average, if that customer stays for three years,
then it's $700 times three.
That's $2,100 of LTV that you have for your customer.
So that's your LTV.
Your CAC is essentially how much you spent
in your go-to-market divided by the number of
net new customers you brought on in that period.
Typically, for your CAC, you're looking at
the trailing three months.
How much you spent on it.
And you compare that to the number of new customers you got.
That's your customer acquisition cost.
All right?
So, when you have your LTV divided by CAC
you get this ratio.
That's your LTV to CAC ratio.
LTV and CAC are two of the most important metrics
that you need to start monitoring
once you have some semblance of a SaaS business.
And, more importantly, when you have a SaaS business
that you're looking to grow.
This gives you an insight into what's working and what's not
in your SaaS business.
Now, if you have a problem with the formula that I gave,
you probably do, here's the thing,
there are a million different nuances
on how LTV is calculated and how CAC is calculated.
And the nuances are on that.
And it can vary depending on the sophistication level,
and the stage, and the specific type of SaaS business
that you have.
So, with that said, what I wanted to do
was just give you the gist of what the LTV to CAC is,
so we can have the broader discussion
on what exactly to do with that ratio.
So, you can follow this formula.
And if you don't like it you can do your own.
What's more important is you get to this ratio.
Once you get to this ratio,
that's when the fun begins.
Essentially you'll get a number
that's essentially the ratio,
and it gives you a view into how efficient
your go-to-market is.
When you start to look at this,
if you have a 1X ratio you are squarely in the bad zone.
Essentially what that means is you're spending more
money to acquire customers that are not paying you much,
you're not even making back that customer acquisition cost
in the lifetime of the customer that you're gonna keep them.
So if you are a 1X, you're likely bad,
you need to actually stop the brakes
and figure out what's going on.
If you are a 3X that is what's considered good.
There are some VCs that disagree now,
but by and large it's agreed that a 3X LTV to CAC ratio
is considered good.
It means that you're actually spending a reasonable amount
of money on your customer acquisition cost,
and your lifetime value is much higher,
and therefore there is money to be made
and a profitable business to be grown.
If you are much higher than a 3X,
let's just say you're at 5X or 7X,
or you're just crushing it at 10X,
whatever it may be,
that is not necessarily good.
What that means is that you are under investing
in sales and marketing.
It means that, for some reason,
you've figured out a formula to acquire customers
and keep them for a very long time,
and have them pay for a very long time.
But, you're not taking enough of that money,
enough of those proceeds,
and putting it back into sales and marketing
so you can grow faster.
So, if you're at 1X it means that
you've got a bad, inefficient model.
If you're a 3X it means you're pretty good.
And if you are at 5X that means that
you can probably invest more in sales and marketing.
So once you actually figure out your LTV and your CAC,
and you compare the ratio on that,
you can start to understand where your SaaS business sits
in terms of the health of the business.
Now, there are a million other SaaS metrics
out there that you can look at,
but this one I like because it gives you a very quick
insight into where you are in the business.
Particularly in investment conversations,
when you start to dig into the LTV to the CAC ratio
and you get to have a discussion with the founder,
you start to understand how dialed in the founder is
into the go-to-market motion, into the churn metrics,
into the product metrics.
You can have a really insightful conversation
about the SaaS business.
So, in itself, it's actually a very
powerful metric to look at.
Now, before I go into the third piece,
which is what do you actually do with this number,
and how do you diagnose, and what do you do to improve it?
Let me just pause here for a second.
Can I just get a yes in the comments below
if you're starting to get some a-ha moments
by thinking about your LTV to CAC ratio?
Also, by the way, if you want to dig deeper into this,
I run a weekly training on how to actually run
a more efficient go-to-market strategy
for your SaaS business.
Be sure to follow the link below,
and I'll tell you more about it at the end of the video.
But, let's dig into step number three.
I believe that for any SaaS business
there's actually three core pillars.
There's your market, there's your product,
and there's your go-to-market.
You need to actually optimize for all three of these.
A lot of SaaS founders tend to over index
for the product part of their strategy.
Instead of looking at their market strategy
and their go-to-market strategy.
One of the reasons I love the LTV to CAC ratio
is because it forces you to really think about
all three of these.
Let me explain.
When you start to understand,
let's just say you're at 1X, right?
You're at 1X, you're bad,
or your growth has stalled in your SaaS business.
You want to start digging into,
"Well, what do I do about this?"
Ultimately, as a founder,
you'll have to figure out which part of the equation
you need to focus on.
You either have a churn problem
or you have a go-to-market problem.
The churn problem means people are coming in,
and maybe you have both,
but you want to first solve any churn issues first.
When you start to look at churn
you'll start to understand, well,
is the product just bad?
Meaning people come in, they love the idea of the product,
but your implementation of the product,
it's too buggy, it's too problematic,
it over promises what it does but it doesn't quite deliver.
Then you need to go double down on actually fixing churn.
Now, a lot of times what ends up happening
is you don't have a broad product problem.
But you might have a churn problem still
because of competitive dynamics.
Maybe your pricing is wrong,
maybe someone else is giving it for way cheaper,
maybe your customers just don't want to pay that much.
Or, even more importantly,
maybe you have an ideal customer problem.
Meaning, a certain subset of customers love the product,
while others hate the product,
and you're getting all of them in.
And, at the end of the day,
the broader churn number looks bad.
But if you actually were to zoom in
on a specific type of customer,
maybe the churn numbers aren't that bad.
Which means that maybe you don't have a churn problem,
but you have a go-to-market problem.
So, the first order of business
is to actually figure out if you have an LTV problem,
a churn problem, and to look at competition, product,
and maybe the ICP.
Once you've figured out if you've got,
if you're like, "You know what,
"my product's solid.
"There's a core group of users that absolutely love it.
"They don't have a pricing problem.
"We differentiate from our competitors.
"But our churn is still bad."
Then you can start to look at,
"Well, how do we get in
more of the right type of customers?"
And you maybe don't have a churn problem,
you actually just have a disguised go-to-market problem.
On the other hand, your LTV might just be fine.
By the time they come in they're great,
but you spent way too much money
on acquiring those customers.
Then you actually have a CAC problem,
you actually have a go-to-market machine problem.
In that case you need to look at messaging,
you need to look at your ideal customer profile,
you need to look at your audience,
are you building an audience you need to look at?
Are you doing inbound or are you doing outbound?
Or are you just wasting a bunch of money on ads?
What you need to start thinking about more
is your market and go-to-market strategy,
versus just your product strategy.
This is why the LTV to CAC ratio is so freaking powerful.
It forces you to really diagnose where the levers are,
where the gears are getting stuck in your SaaS business.
See, I look at every SaaS business as a machine.
And what you want to do is be able to just
visualize the machine and start to understand
where things are getting stuck.
And when you start to look at this ratio,
you can start to get some insights
into where you need to focus.
Now you know how to actually diagnose your SaaS business
using this magical metric called the LTV to CAC ratio.
You also know whether you have
a churn problem in your hand, a product problem,
or you have more of a market and go-to-market problem.
Ultimately, for any SaaS business,
the name of the game is to figure out
an efficient go-to-market machine.
That is the thing that solves a hell of a lot of problems.
Because, if we have an efficient go-to-market machine,
you'll attract the right people,
and those people will help you build the right product,
guide your roadmap, and stay forever.
And that's what makes for a really successful SaaS business.
So, now you know how to think about the LTV to CAC ratio.
But, you may not know how to actually build
an efficient go-to-market machine.
This is the big thing that I focus on.
I spend my day and night on.
I work with SaaS founders, like you,
to build an efficient and unstoppable
sales and marketing go-to-market machine.
So if you're interested in that,
I run a training every single week.
So follow the link below,
or go to TKKADER.COM/SAAS-TRAINING.
And over there you'll be able to access
a 45 minute training where I go into exactly
how to build an unstoppable sales and marketing machine
for your SaaS business.
And that way you can start to actually think about
lowering your customer acquisition cost,
and you can start to think holistically about
building your startup across
product, market and go-to-market.
If you got value from this video
please be sure to smash that like button,
it'll mean the world to me and my team.
We put a lot of effort in these videos.
Also, if you have a fellow founder
who's also trying to scale their SaaS business
and get it right,
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If you're part of a Slack group or a mailing list,
please share this video over there as well.
It would mean the world to us.
And, lastly, we bring you an episode
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So, if you haven't already,
be sure to hit the subscribe button and that bell icon
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And, lastly, remember
everyone needs a strategy in their life and their business.
But when you are with us,
yours, it's gonna be unstoppable.
I'm TK and I will see you in the next video.
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