As companies grow to large scale, I’ve always been amazed by how much they keep spending on marketing/sales. The most easy examples are in consumer businesses where billions get spent on advertising but I think its true in SaaS and B2B in general.

Creating economies of scale to lower total cost of service (both CAC and ACS) is a central theme that I plan to drill down on in the next post in the series, and is essential to accelerating profitability.

WRT the model itself, I made a conscious choice to use “average” CAC/ACS values and exclude fixed costs for a number of reasons (fixed relative to increasing customers).

1) The model is meant to facilitate intuition and decision making for SaaS executives in general more than to predict the actual profitability of any single SaaS company. As such, the results should be read like this “If my current revenue/costs/growth/churn is given by ARR/CAC/ACS/g/a, what will happen if I do nothing to improve the situation? Am I OK or am I in trouble?”

2)Taking the approach above dramatically simplifies the math. I found that a more complex model made the math unbearably cryptic without increasing understanding
(See 3b below for the complicated approach)

3) There are a number of ways to include fixed costs in the model
a) Use the approach of 1 above and say, “OK, these results are bad, how can I improve them?” Make a change, recalculate the average values, and run the model again.
b) Make CAC/ACS a decreasing function of the number of customers. Sound more accurate,
but including explicit economies of scale in the math gets really indecipherable without much new knowledge.
c) Treat fixed costs as external, and then the BE₀ is not actually breakeven, but the point at which you’ve covered your variable costs…and can now start thinking about covering your fixed costs…so true break even would be longer (again variable/fixed with number of customers)…again, I chose a) to keep the model simple.

4) Lastly….but MOST importantly. There really are not that many economies of scale
for total cost of service outside the basic infrastructure TCO cost reduction,
….unless your work very very hard to make it so The bulk of the costs
in customer acquisition, onboarding, support, etc. scale directly with the number of customers when they are done by people, manual labor. Scale economies require process automation and customer self- service…which is hard work.
So, back to 1) and the approach…what happens if I don’t create economies of scale (I use of the word “create” intentionally to emphasize the point).

See
http://chaotic-flow.com/saas-tco-the-mirror-image-of-total-cost-of-service/

Stay tuned for the next post in the series…the next SaaS metrics rules of thumb basically say, “you best create economies of scale if you want to be profitable any time soon.”

Thanks for the question. Apologies for the lengthy answer.

Cheers,

Joel

I like this analysis. The formulas you presented make sense (I forgot how much I used to love math ), but I think that we have to
1. separate the company “flat” costs (R&D, Overhead, etc) from the CAC, and
2. to consider the fact that in order to be successful a SaaS company’s CAC should decrease dramatically over time. if it does – thats where the profitability should come from, the idea is that CAC should be lower then even a single year’s income from a given customer. if it does not converge to this – then its a giant challenge since you will always need X salesreps/marketing.expenses/etc per Y customers.

Yes, SaaS companies do have to deal with the fact that expenses are frontloaded while income is backloaded. but….
1. the sales cycle for many SaaS companies is getting shorter as SaaS is gaining acceptance
2. marketing is getting cheaper in the age of social media
3. individual companies’ CAC should get shorter if they can properly target their lead generation machines and more importantly – fine tune their sales cycles.

Benny Shaviv.