For any tech startup, one of the primary goals is to reach profitability and sustainability as a business. Software-as-a-Service (SaaS) companies are no exception to this goal. While early stage SaaS businesses are often more focused on top line growth and capturing market share, at some point the path to profitability becomes critical.
Ignoring profitability for too long leads to potential cash flow issues, inability to scale, excessive dilution for founders, and pressure from investors. So what are the key things that founders and executives at SaaS businesses need to focus on to set their company up for profitable growth? Here are the top 5 areas:
1. Optimizing Customer Acquisition Costs
When it comes to SaaS metrics, Customer Acquisition Cost (CAC) is one of the most important. This refers to the average cost it takes to acquire a new paying customer. The lower this number can be kept, the quicker breakeven is reached with customer contracts, and the faster gross margins improve.
Top performing SaaS companies analyze metrics like total sales and marketing expenditure over a period divided by the new annual contract value closed over that same period. The target benchmark should be around $1 or less in spending for every $1 of new annual revenue. So if total sales and marketing costs over 3 months were $300,000 and this generated $450,000 in new customer contracts, the $300k/$450k = CAC of $0.67 is very efficient.
Anything up from $1.00 or more means payback periods on sales outlays stretch longer, putting more pressure on capital requirements. So SaaS founders must continually experiment with sales motions and marketing channels to optimize CAC – whether that’s influencer programs, SEO, trial self-service signups, enterprise sales teams, or ideally all of the above with strong retention.
2. Focusing on Retention and Net Dollar Retention
While new customer acquisition is essential, retaining and expanding revenue from that existing customer base is even more important over the long run. This is why top SaaS companies track and manage metrics like churn and net dollar retention with the same level of intensity as sales growth rates.
Churn refers to the percentage of customers that cancel or elect not to renew their contracts over a period. The best SaaS startups target keeping this churn percentage as low as possible, averaging 5% monthly churn or less (equating to 15% or less annual churn).
Net dollar retention compares expansion revenue to lost revenue from cancellations and non-renewals. Leading companies benchmark for 100%+ net dollar retention consistently. This means expansion revenue at least offsets churn, creating negative revenue churn. Reaching 120%+ net dollar retention is exceptional, fueled by customers increasing contract values and seat volumes over time as they derive more value from the product.
Accomplishing high retention and expansion levels relies heavily on stellar product design and customer success teams that proactively guide customers to gain more value and adoption. These teams essentially ensure the product becomes indispensable to the customer.
3. Crafting Pricing Plans and Packages
Pricing is another fundamental driver of SaaS company profit margins. This does not necessarily mean chasing the highest price point possible, but rather finding the optimal balance across customer segments based on willingness to pay.
For B2B SaaS products especially, wide variances can exist between enterprise, mid-market, and SMB customer needs and budgets. Top companies design pricing plans and feature packages carefully mapped to each tier. Key aspects like number of user seats, level of support/service, functionality limits, and data access controls help separate various packages.
This “good, better, best” plan approach makes it easier for buyers to understand what offering aligns to their requirements and budget rather than having to negotiate one-off custom deals constantly. It also allows simpler product development mapping what features apply at which plan levels over time.
Another pricing best practice is gradually building in modest price increases over multi-year contract terms rather than waiting to renegotiate much larger increases on renewals. This minimizes sticker shock down the road.
4. Maintaining Cost Discipline
While nailing customer acquisition, retention, and pricing models provides upside opportunity, closely managing costs is equally as important to reach healthy profit margins over time. Efficient SaaS operators benchmark for roughly 70%+ gross margins at scale.
This means keeping the cost to deliver software and support customers to around 30% or less of revenue. Areas like human capital, infrastructure expenses, third party tool costs, and facilities contribute heavily here. Unit economics modeling that accurately forecasts long-term costs per customer compared to LTV helps guide smart decision making.
Dumping excessive funding into inflated headcount, expensive office spaces, overly generous perks, and low-ROI activities threaten this cost discipline quickly however. The best leadership teams take a targeted approach to company spend – hiring critical roles slowly, matching hosting capacity to usage, limiting unnecessary tools creep, and normalizing remote policies.
5. Extending Runway Through Capital Efficiency
A final but often overlooked area is capital efficiency in funding rounds. The more value that early employees can retain while minimizing outside dilution, the more incentivized they remain to build the company sustainably.
Top startups raise enough capital to fuel operations for ideally 12-18+ months in a round rather than having to constantly recycle into the next raise every 6 months. This extends runway substantially even if at somewhat higher valuations. It also shows financial planning prowess to investors.
Coupled with the cost control measures mentioned above, extending cash burn timing locks in more value for the team early on. Then in later stages, the focus can shift more heavily to scaling profit margins rather than just growth rates.
Mastering even some of these areas early creates compounding effects over time. The ultimate path to profitability relies on compelling products that customers genuinely rely on, efficient acquisition pathways, methodical expansion of accounts, disciplined spending, and non-excessive funding rounds. SaaS founders who can balance these dimensions build companies that generate profits at scale.
Image by Gerd Altmann from Pixabay