One of the biggest mistakes that a subscription business can make is measuring their KPIs in the same way as a business that relies on one-time sales. At best, this doesn’t give you the full story, and at worst, this leads to flawed decisions.
The key difference is clear: subscription businesses are all about recurring revenue. Because of that, traditional ecommerce KPIs like average order value, cost of goods, or gross profit don’t work as well for getting insight or making decisions.
So what metrics should you be tracking?
Six of the most important KPIs for subscription businesses include:
- Customer Acquisition Cost (CAC)
- Monthly or Annual Recurring Revenue (MRR/ARR)
- Gross Margin
- Average Revenue Per User (ARPU)
- Customer Lifetime Value (LTV)
In this post, we’ll talk about each KPI and how to calculate it, along with how to avoid some of the common subscription metric mistakes.
One of the most critical metrics is customer churn, or the number of customers who are canceling at any given time. This is calculated for a specific period (whether monthly, quarterly, or annually), and is also sometimes called “subscription churn.” You can calculate your churn rate for a specific period by taking the number of cancellations and dividing it by the total number of customers, and then multiplying that by 100.
If you have 2,000 total customers in February, and 50 of them cancel that month, that means your monthly customer churn rate is 2.5%. (There’s also gross and net revenue churn, which you can read more about here.)
Churn is the most important metric to keep an eye on. As your churn increases, it becomes harder to grow and scale your business. This means that your acquisition costs will get higher, as you have to not only find new customers, but replace all of the ones that canceled. Reducing churn, whether it’s voluntary or involuntary, is the #1 factor in the sustainability of your business.
Customer Acquisition Cost (CAC) is the amount of money it costs to acquire a new customer. You can calculate this by adding all of your sales and marketing expenses in a given period and dividing it by the number of new customers in that same time.
As a general rule of thumb, if you want to grow your business over the long haul, CAC needs to be less than what the customer is paying for your product or service.
For example, if you spent $1,000 on Facebook ads and got 250 customers, your CAC would be $4. (To learn more about how to calculate CAC and how it applies to PPC ad campaigns, head here.)
When you calculate acquisition costs based on each marketing channel (i.e., Google ads, email marketing, etc), you can better understand what’s converting well and prioritize accordingly.
Depending on your business model, you’ll want to keep an eye on either MRR or ARR. You can calculate this number by multiplying your monthly (or annual) revenue per customer, by the total number of paying customers.
For example, if you have 100 customers at $50/per month, then your MRR would be $5,000. (You can also look at new MRR and other segments of MRR – learn more about that here.)
Just like with CAC, you should segment MRR based on your different pricing plans and acquisition channels to get a more holistic view. By combining CAC and MRR data, you’ll learn a lot about what is and isn’t working.
For example, it costs $20 to acquire a new customer from Google Ads (formerly Adwords). All of them join your highest monthly plan at $500/per month, and they stick around for an average of 24 months. On Facebook Ads, it only costs you $5 to acquire a new customer, but almost all of them join your lowest plan at $20/per month. They only stick around for two months.
If you are going strictly based on acquisition costs, you might be tempted to throw all of your money into Facebook, which would quickly turn into a giant money pit due to high support costs and churn. However, a smarter decision would be to sink more of our budget into Google to attract customers that will likely pay more and stick around for longer. This is why tracking where your customers are coming from and their CLTV (and tracking both of these things by lead cohorts) is so important — something a good subscription billing tool should be able to help with. (For more on how to do that and incorporate it into your marketing strategy, head here.)
Another metric to keep an eye on is gross margin, or total expenses and costs divided by net revenue. This gives you gross margin calculated as a percentage of your revenue. Gross margin is crucial for understanding how profitable your company is.
Subscription businesses that take venture capital funding, in particular, are vulnerable to “growing at all costs” where they end up growing themselves out of business. If you pour more money into growth and have a skyrocketing burn rate, then one of two things will happen:
- You wind up needing to take another round of funding to cover your operating costs.
- You’re going to have to make drastic spending cuts.
For SaaS companies in specific, it’s suggested that you should aim for a gross margin of anywhere from 50-80%, depending on your product and how old your business is.
Another metric to keep an eye on is ARPU. You can calculate this by dividing total revenue in a given time period by the number of customers.
If you made $100,000 and have 250 customers, your ARPU is $400. This metric is important for calculating customer lifetime value. ARPU is different from customer lifetime value in that it’s usually calculated for a specific period (often one month), whereas customer lifetime value includes the entire time that the user is a customer of your business.
The last metric you should track is one of the most important ones for a subscription business. Customer Lifetime Value (abbreviated as CLV, CLTV, or LTV) is the average amount of revenue that a customer generates, over their time with you as a customer.
There are several different ways to calculate CLV for a subscription business, and you can get wildly different results with each one. The simplest way is as follows:
- Take the average monthly revenue per user (let’s say $500/month)
- Divide it by your monthly churn (5% churn means we’re dividing 500 by .05)
- The result = CLV (in this case, $10,000)
This doesn’t account for customer acquisition cost or lots of other factors, including different groups of customers. For example, if you have different pricing tiers, you’ll want to calculate an average CLV for each of them. Here’s another take on calculating it for a SaaS business (which works for any subscription business), and here’s yet another calculator.
One thing to note: because it relies on knowing how long your customers stick around on average, calculating CLV can be difficult for new businesses. You might not know your actual retention and churn rates for a while. If you can’t get an accurate CLV, focus on improving the other metrics here (and collecting the data needed to get an accurate lifetime value metric in the future).
In addition to tracking the above metrics, you’ll want to avoid these common mistakes:
While benchmarks can give you a rough ballpark, it is much better to set your own metrics once you have a few quarters of data. This is so you can take into account your acquisition costs, ARPU, churn, etc.
This is pretty self-explanatory as a vanity metric is any metric that can’t be tied to a monetary number. It might look great in a presentation deck, but it doesn’t have any context to a larger business goal or objective. For example, the number of Twitter or TikTok followers.
When you understand your acquisition costs, it can be tempting to pour more money into the fire and grow super quickly. However, if you want to control your company’s destiny, you want to pay close attention to your burn rate and gross margin. Otherwise, you could find yourself scrambling for VC money at any costs, looking for a company to acquire you, or having to go through layoffs.
Want to learn more about how to boost the metrics that matter?
Our Retry Strategy guide will teach you how to use data like decline codes and card types to increase your customer lifetime value by a minimum of 43%, all in about five minutes. Get it for free below: