SaaS profitability in 3 steps

Many founders chase the dream of rapid customer growth, believing it's the key to SaaS profitability. But here's the hard truth: rapid growth means little if you're burning more cash than you're earning. The real secret? It's all about balancing revenue and cost per customer to build a truly scalable and profitable SaaS.

As a UI/UX design agency working with numerous SaaS startups, we've seen firsthand the struggles of reaching operational efficiency and profitability. Drawing from these experiences, we've distilled the journey to SaaS profitability into three critical steps. Let’s explore them together.

Step 1: Getting that unit economics right

Unit economics in a SaaS business refers to the financial metrics that describe the revenue and costs associated with a single customer or unit of the business. Think of it as the financial health of each customer relationship in your business. It's basically asking, "Are we making or losing money on each customer?" 

Key metrics include 

• Customer Acquisition Cost (CAC) 
• Customer Lifetime Value (LTV) 
• Churn rate 
• Monthly Recurring Revenue (MRR) 
• SaaS gross profit margin. 

Though all of them are important, to create a SaaS company that grows and lasts, you need to focus on two key numbers: how much money you make from each customer over time (LTV) and how much it costs to get a new customer (CAC). Getting these numbers right is like finding the secret recipe for long-term success. 

With these metrics in mind, let's zoom in on the dynamic duo.

Customer acquisition cost vs lifetime value

Customer acquision cost or CAC is the amount we burn on marketing and sales to win customers. 

You spent a ton of money to acquire new customers. FirstPageSage calculated the average customer acquisition cost for SaaS companies by industry, and it’s impressive. 

You need up to $1,450 to acquire one paying customer for B2B SaaS. Pretty dramatic. 

All that money you spend long before you see a full return on your investment. Not to mention that a full return may never occur in case if a newcomer decides to churn after the first month.

Let’s calm the intensity of emotions. Customer acquisition cost alone says nothing about your business, it’s a relative concept. Spending $1,450 for winning a customer can be too bad if that customer brings you only $1,000. Or, the same $1,450 can be a great investment if you earn $3,000 — that’s enough for a payback along with a sustainable profit. 

For measuring the amount we earn from a customer, we have another metric called LTV, or customer lifetime value.

LTV shows you how much money a customer is likely to spend with your company from start to finish, that is during their subscription period. You want to see this number staying the same or getting bigger over time. If it's shrinking, it might mean you're attracting too many customers who don't spend much. 

In tandem with CAC, it makes a litmus test for a SaaS business model and has proved to be one of the key financial KPIs for SaaS companies.

David Skok SAAS metrics golden ratio

Venture capitalist David Skok in his blog defined that for SaaS companies, lifetime value must be at least 3x greater than customer acquisition cost. His rule of thumb became an industry standard, and now any guide on SaaS unit economics you can find will tell you that a golden ratio for SaaS is 3:1.

The chart below shows a perfect picture of your CAC payback model. All starts from spending your customer acquisition money that puts you deep into a red zone of loss. As your customer starts paying for a subscription, you slowly move towards a CAC payback point where you get your money back. That’s where you reach a 1:1 ratio. After, you build up your profit until your customer decides to churn (which is hopefully never).

If everything goes as in the picture, your business model is sustainable. You spend on acquisition less than you earn, and have enough resources to drive the startup’s growth.

Doing some math: how to calculate LTV/CAC ratio

To calculate the ration between customer acquisition cost and customer lifetime value, you need first to calculate these two metrics in separate. 

The cost of acquiring a customer is the sum of all marketing and sales expenses over a given period divided by the number of new customers added during that same period. 

The customer acquisition cost formula looks like the simplest formula ever. Divide your $500 budget for search ads on your 10 new users, and that's it — $50 for an acquisition. However, there’s still plenty of room for misunderstanding. Like, what is included in customer acquisition costs? And do your freemium users belong to acquired customers? 

Patrick Campbell indicates four most common mistakes in how is customer acquisition cost calculated:

1. Counting paid advertising as your only acquisition expense;
2. Forgetting to include indirect costs, such as subscription for tools, services and software;
3. Missing the salaries of all acquisition-related personnel;
4. Considering non-paying freemium users as acquired customers — you should count only paying customers.

Any of those mistakes may dramatically affect your LTV/CAC ratio, as shown in the chart below.

 Now when we know how to calculate CAC, let’s learn how to define LTV so that we can compare the two metrics.

As we defined earlier in the article, LTV means the average amount that you expect to earn per customer over their entire lifetime. Most resources would give you the following formula to calculate it, you need to multiply the sum you’re charging per user in a given month by the average customer lifetime. 

But to truly get an accurate picture of LTV, it's crucial to factor in SaaS gross profit margin. Let's break down the formula and why it matters:

LTV = (ARPA * Gross Margin %) / Revenue Churn Rate

1. ARPA (Average Revenue Per Account): This is the typical amount of money each customer brings in.

2. Gross Margin %: It's the percentage of revenue left after subtracting the direct costs of providing your product or service.

3. Revenue Churn Rate: The percentage of revenue lost from existing customers over a specific period.

By including Gross Margin in our LTV calculation, we get a more realistic view of how much profit a customer will generate over their lifetime with the company. 

Let's say one user brings $20 per month, and you know that they stay with you for, let's say, 5 months on average. Your Gross Margin is 60%, and your monthly Revenue Churn Rate is 12%. Using the formula, we can calculate the lifetime value of one user:

LTV = (ARPA * Gross Margin %) / Revenue Churn Rate

LTV = ($100 * 70%) / 5%

LTV = $70 / 0.05

LTV = $1,400

This calculation helps us understand that while a customer might bring in $1,200 in total revenue over their lifetime ($100 * 12 months), the actual value to the company, considering costs and churn, is $1,400. This higher figure reflects the impact of our strong gross margin, despite the monthly churn rate.

Now when we can measure customer lifetime value and customer acquisition. In case our LTV is $100 and our CAC is $50, we can compare them and figure out that our LTV is 2x greater than customer acquisition cost. Good, but can be better. Can we influence CAC and LTV to improve the ratio?

Step 2: Strategies for lowering CAC

Nice thing about lowering your acquisition expenses is that it lowers your payback target as well and gets you on the path to profitable SaaS companies faster. For new SaaS companies, it's good if you can earn back what you spent on getting a customer within 5 to 12 months. This number might vary for those at the very beginning of their product’s life cycle, but try to make sure it doesn't take longer than a year. 

Here we’ve got some tips to help you reduce consumer acquisition cost:

1. Optimize your user onboarding

You’ll retain more newcomers if you have intuitive onboarding that brings the value up and front.

Attracted by the freemium offer, users may download your app. But unable to see the app’s value from the first minutes, they’ll abandon it without thinking twice. Customer friction that pops up on the very beginning of your SaaS customers’ journeys forces prospective customers to leave halfway to a purchase.

A well-designed onboarding experience increases the likelihood that new users will quickly understand your product's value, leading to higher activation rates and lower early-stage churn. This means you'll retain more of the customers you've already paid to acquire, effectively lowering your CAC.

We've seen this work in real life. We helped Habstash, a UK startup, make their sign-up process better. They needed a lot of information from users, which could be overwhelming. We made it easier by:

1. Breaking the process into small steps
2. Showing users how far along they are
3. Letting users save their progress and come back later
4. Showing users how the app can help them right away

These changes made more users finish signing up and become active customers. You can read more about what we did for Habstash in our article about SaaS user onboarding examples.

One more example from real life is Senja, a tool for collecting and managing testimonials, that more than doubled their activation after they optimized their onboarding strategy.

Remember, every user who completes onboarding and becomes an active customer effectively lowers your CAC by increasing the return on your acquisition spend. By applying right principles to your onboarding process, you can improve user activation rates and reduce early churn, ultimately lowering your overall CAC.

2. Optimize your marketing tactics

Calculate your CAC and your LTV within each marketing and advertising channel, so that you can understand their efficiency. 

Chances are you rely too much on non-recurring acquisition channels like pay-per-click advertising. Inorganic traffic costs much more money and brings immediate results that reduce to zero as soon as you stop pouring money into Google Ads.

Organic traffic is less expensive in most cases, and its positive effect lasts longer. With content marketing, for instance, it takes time to gain traction in search, but as a reward, you’ll get a compounding effect where traffic from previously published articles adds to traffic from newer articles.

Invest in Search Engine Optimization (SEO). Focus on creating high-quality, relevant content that addresses your potential customers' needs and questions. Optimize your website structure, use relevant keywords, and build quality backlinks. While SEO takes time to show results, it can significantly reduce your CAC in the long run. And though it may seem like with new AI era SEO is loosing its power, from our experience this tactic still works if addressing correctly.

3. Focus on audience segments that resonate better

With your early customer acquisition marketing, you may attract a broad variety of users. Many of those people won't be well-qualified; they won’t have a real need for your product and your offer might not be a great fit for them. 

If you measure CAC and LTV for all SaaS buyer personas you have, you might figure out that some of the customers are willing to pay a lot, but cost just as much to acquire. On the flipside, you have a group of customers who’re cheap, but willing to pay nothing.

To lower your expenses, focus your acquisition efforts on personas with the best LTV/CAC ratio. Check out how Superhuman pawed their way to success focusing only on the biggest project supporters and abandoning all the other segments of their audience.

4. Optimize your pricing strategy

‍Smart pricing isn't just about maximizing revenue—it can also help lower your CAC. Here's how:

• Encourage upfront payments: Offer discounts for annual or multi-year subscriptions. This reduces churn risk and provides upfront capital, effectively lowering your CAC by securing longer customer lifetimes.
• Implement value-based pricing: Align your pricing with the value users get. This can increase willingness to pay and reduce the perception of cost, making your CAC more efficient relative to customer value.‍
• Re-engage churned users: It's often cheaper to win back a former customer than acquire a new one. Use targeted re-engagement campaigns to bring churned users back, lowering your overall CAC.

This strategy can be highly effective because it addresses multiple aspects of customer acquisition and retention. However, it's important to note that pricing changes should be made carefully, with thorough market research and testing. Drastic or poorly planned pricing changes could potentially alienate existing customers or deter new ones. The key is to find the right balance that attracts customers efficiently while still providing value to your business.

5. Leverage referral programs

Referral programs turn your satisfied customers into a powerful, cost-effective marketing force. People trust recommendations from friends and family more than traditional advertising. What is more, customers tend to refer people similar to themselves, who are likely to be good fits for your product. This improves the quality of leads and increases conversion rates.

Finally, referral rewards typically cost less than traditional marketing methods. You only pay when you acquire a new customer, making it a performance-based model.

It may take some time to come up with effective referral program for your specific product. But here are few universal tips.

• Make it easy: Create a simple process for customers to refer others. This could be a shareable link, a unique code, or an in-app invitation feature.
• Offer valuable incentives: Reward both the referrer and the new customer. This could be account credits, extended free trials, or exclusive features.
• Time it right: Ask for referrals when customers are most satisfied, like after a positive interaction or when they've achieved success with your product.
• Track and optimize: Monitor which customers are referring, how many referrals convert, and the lifetime value of referred customers. Use this data to refine your program.
• Promote your program: Make sure your customers know about the referral program. Highlight it in your app, emails, and customer communications.

A well-designed referral program not only lowers CAC but also tends to bring in customers with higher lifetime value and lower churn rates. By turning your satisfied customers into advocates, you create a sustainable, low-cost growth engine for your SaaS business.

Step 3: Strategies for improving LTV

Increasing LTV is equally important for profitability as CAC. Obviously, our third and last step will be focused on optimizing this metric.

1. Upselling and cross-selling.

Upselling and cross-selling are powerful techniques to increase the value of existing customers without the high costs associated with new customer acquisition.

Upselling involves encouraging customers to purchase a higher-end product or upgrade their current subscription. For example, if a customer is on a basic plan, you might offer them enhanced features or increased usage limits for a slightly higher price.

Cross-selling, on the other hand, involves offering complementary products or services. For instance, if your SaaS product is a project management tool, you might offer an add-on time-tracking feature.To implement this effectively:

• Identify logical upgrade paths within your product
• Use data to target customers with relevant offers
• Time your offers strategically, such as when a customer is nearing their usage limits
• Ensure the additional value is clear and compelling

A simple example here may be Dropbox that effectively uses upselling by offering users who are close to their storage limit an easy option to upgrade to a higher tier.

2. Reduce churn

This point may seem a bit generic, still we couldn’t omit it. Churn is the enemy of LTV. The longer a customer stays with your service, the more valuable they become. Here are some strategies to reduce churn:

• Provide excellent customer support: Respond quickly to issues and be proactive in helping customers succeed with your product.
• Regular engagement: Use email campaigns, in-app messages, and other touchpoints to keep users engaged and remind them of your product's value.
• Onboarding and education: Ensure customers know how to use your product effectively. Offer tutorials, webinars, and help documentation.
• Monitor usage patterns: Identify customers at risk of churning based on declining usage and intervene with helpful resources or personal outreach.
• Gather and act on feedback: Regularly survey customers and act on their suggestions for improvements.

3. Implement a tiered pricing strategy

We’ve already mentioned pricing optimization in our step 2, however there’s a very important point that we missed – tailoring your pricing to different customer segments.

• Entry-level tier: Attract price-sensitive customers or those just starting out. This tier should offer enough value to get users hooked while leaving room for upgrades.
• Mid-level tier options for growing businesses: Offer additional features or higher usage limits to growing businesses or power users.
• Enterprise tier: Provide advanced features, higher limits, and often custom support for larger customers.

When implementing tiered pricing:

• Ensure clear differentiation between tiers
• Make the upgrade path obvious for your customers
• Consider offering a custom or "contact us" tier for enterprise clients

At the same time, don’t overload users with too many pricing plans. No more than 3-4 offerings.For instance, here’s a pricing page of Hello bar that helps with website optimization.

A clean, minimalist design with three distinct tiers catering to their main customer types. The central plan is highlighted as "most popular," drawing attention to their recommended option. This clear structure makes it easy for customers to understand the value proposition of each tier and choose the one that best fits their needs.  

4. Continuous product improvement and design iterations

Keeping your product fresh, relevant, and continuously improving is crucial for maintaining and increasing LTV. I mean, people won’t churn and go to more convenient competitors if you’re adding new features they need and do timely but not shocking (read: iterative) redesigns.

How to do it? 

• Continuously add new features based on customer feedback and market trends.
• Regularly optimize your product for speed and reliability.
• Continuously refine your user interface based on user behavior data and feedback.
• Keep an eye on competitors and ensure your product remains a leader in your space.

• Use data to drive decisions
• A/B test new features or design changes
• Implement changes gradually to avoid disrupting familiar workflows
• Communicate improvements clearly to your users

At Eleken, we always practice iterative design and work carefully when implementing either changes to existing design or new features. Take SEOcrawl's teamup with Eleken. They didn't go for a total makeover - instead, they kept adding cool new stuff their users actually wanted. We made sure these new features, like their Crawler tool, fit right in with what was already there. It's like upgrading your house room by room, instead of tearing the whole thing down. This way, SEOcrawl kept their users happy and even pulled in more fans. 

It goes to show that keeping your product fresh with smart, bite-sized updates can really pay off. Users stick around, and your SaaS becomes the go-to choice in a crowded market.

To sum up

A SaaS company is considered "profitable" when recurring revenue from current customers is able to cover new customers' acquisition costs. This critical juncture marks the transition from cash burn to sustainable growth, where each new customer becomes an investment rather than an expense.

We've explored three key steps to achieve SaaS profitability:

1. Optimizing unit economics, particularly the LTV/CAC ratio

2. Implementing strategies to lower CAC, such as improving onboarding and marketing tactics

3. Boosting LTV through upselling, continuous product improvement, and smart pricing strategies

Throughout this journey, the role of thoughtful design cannot be overstated. From creating intuitive onboarding experiences to implementing iterative UI improvements, design can right the ship to reducing CAC and increasing LTV.

If you're looking to enhance your SaaS profitability through strategic design, our team at Eleken is here to help. With our extensive experience in SaaS UI/UX design, we can help you optimize your user experience, reduce friction points, and create a product that keeps customers engaged and satisfied for the long term. 

Contact Eleken today, and let's design a path to sustainable growth for your business.