To be fluent in the world of SaaS (ironically, an acronym itself), you need to master a dizzying array of terms, abbreviations, and ratios that underlie its unique business nature. (For a cheatsheet, here’s a helpful resource which provides a SaaS glossary.)
At the core of the subscription business model sits the concept of churn. This is the measurement of paying customers who stop using the product at some point. How a company performs on this metric drives is a fundamental driver of ultimate success (or failure).
Why is the metric of churn so magical?
Remember what the second “S” of “SaaS” stands for: Subscription. The notion that customers are willing to pay recurring fees for software is fundamental to this transformational business model. Previously, software companies sold installed solutions, often at much higher price points, for one-time sales; now, under the SaaS revenue model, customers pay recurring fees, often at lower price points, to access software via a web browser.
Done well, SaaS-delivered software is an incredibly lucrative business model: make the sale once, and collect an annuity stream of subscription revenue until time immemorial.
Done poorly, an aspiring SaaS-provider is just another struggling company: the customer signs up today only to abandon the product tomorrow.
The difference between the two outcomes is explained by the rate of churn.
The leaky bucket analogy is one that is often featured when discussing the SaaS market. As you walk from the well with a bucketful of new customers, the holes represent the churn, with revenue leaking from the bottom and sides.
At the one extreme – companies with high churn – the business starts to behave like a traditional software provider. A certain level of new sales are needed just to replace lost customers in order to maintain revenue. The level of churn can be quantified, and, even for companies which experience moderate or high churn, there is even a potential for a successful business, particularly if customer acquisition costs are carefully managed.
At the other extreme, however, the business behaves very, very differently. Without customers lost to churn, all new sales represent growth. Further, the fundamental reason for low churn – a happy, stable customer base – leads to a virtuous cycle: satisfied customers actually buy more products from vendors they like. In this case, churn becomes negative.
Some of the most successful SaaS companies are found in enterprise markets. Well-designed SaaS solutions which address real business problems for the largest companies benefit from the structural advantages of selling to this market: large budgets, stable operations, and the inertia of corporate decision-making and procurement processes.