How do you manage profitability in a subscription business? The answer: Knowing and managing the breakeven point of your customer relationships. In the Subscription Economy, the longer the customer relationship, the more profitable the business model is. In fact, in the Subscription Economy, accelerating time to the breakeven point of a customer relationship is a critical imperative because of the high cost of customer acquisition, the deferral of revenues over time, and the risk of churn.
Let’s dig deeper into software-as-a-service (SaaS) for an example. Using benchmark information from Bessemer Venture Partners, Opexengine, River Cities, and others, the breakeven point in a customer relationship is on average 3.1 years in SaaS.
Does that seem like a long time? More than you expected? Let’s look into how to calculate the breakeven point. It turns out a company’s costs are often reported as percentage of revenues, which can be used to determine customer lifetime breakeven points. Most benchmarking, venture, and financial analysis firms publish reports on cost structure needed for this calculation, including
- Customer Acquisition Cost Ratio (CACR) –the sales and marketing costs to sign up a new customer as a ratio to customer revenue
- Customer Renewal Cost Ratio (CRCR) –the sales and marketing costs of closing a renewal as a ratio to revenue
- Research and Development Ratio (RDR) –the costs to invest in and make improvements to the service as a ratio to revenue
- Gross Margins (GM) – revenues minus the costs associated with hosting a service and providing customer support
- General and Administrative Ratio (GAR) – the cost associated with finance, management, and other functions as a ratio to revenue
- Churn Rate (CR) – the percentage of revenue not renewed at the end of a subscription term
- Profit Margin (PM) – the percentage of revenue counted as profits
These cost-to-revenue ratios can be used to calculate Average Customer Lifetime (ACLT) to reach specific points of profitability, as shown in the Customer Lifetime calculation below.
ACLT = (PM + CACR + CR) / (1-CRCR –RDR- (1-GM)-GAR-CR)
The equation is broken down in the following graphic:
So what do the experts set as a benchmark for each of these operational metrics?
- Customer Acquisition Cost Ratio (CACR) – 1
- CRCR – 10% (0.1)
- RDR – 10-15%
- GM – 80%
- GAR – 10-15%
- CR – 10%
- PM – 15%
Average Customer Lifetime for Breakeven = (0 + 1 + 0.1) / (1 – 0.1 – 0.15 – (1-0.8) – 0.1 – 0.1) = 3.14
Do you know how long your average customer lifetime value needs to be in order for it to be profitable? Can you measure the health of your customer relationships? How will you manage to profitability? Over the next several weeks, my column will answer these questions, and give you additional insight into
- What optics you need to manage to profitability
- The critical milestones in customer relationships
- How to measure revenue yield from customer relationships
- How to accelerate time to profit
Additionally, you can easily calculate your own breakeven point in customer relationships by entering your metrics into the Scout Breakeven Calculator, located here:
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