How to design a winning metrics framework: PLG SaaS edition
What metrics should your PLG SaaS company measure, monitor, and move?
In How to design a winning metrics framework, I outlined a general framework that companies can use to determine which metrics they need to measure to achieve their most important business goals.
While similar logic applies to PLG SaaS companies, this article will focus on the unique factors that founders and operators at product-led companies need to consider when building their metrics frameworks.
But first, let’s set the stage by exploring the different points of view among investors – this background provides helpful context that you can use when designing your own metrics framework.
OG SaaS metrics are dead… long live OG SaaS metrics!
…at least that’s the vibe within the SaaS world these days. A lot of virtual Substack ink has spilled decrying the death (or at least the inadequacy of) traditional SaaS metrics, especially for PLG (product-led growth) SaaS companies.
In Is it time to ditch the old SaaS metrics? Kyle Poyar writes that “The traditional SaaS metrics playbook can be extremely misleading when it comes to managing a PLG or consumption-based SaaS company.”
Kyle cites Battery Ventures in noting that these changes are largely due to machine learning and the economics of product-led growth.
SaaS startups are swimming in turbulent waters right now. In the third quarter of 2022, venture funding for the industry totaled $81 billion, marking a $90 billion (53%) year-over-year reduction and a $40 billion (33%) quarter-over-quarter decrease, according to Crunchbase.
There’s less venture capital flowing right now, and startups need to focus on “default investability,” per entrepreneur and investor David Sacks. Default investible means that your metrics are good enough to raise another round of funding.
The concept is formed squarely in terms of, wait for it… good ‘ol OG SaaS metrics.
Bottom line - there are a lot of SaaS companies facing down life or death decisions. For founders and operators, some clarity on the most important metrics to focus on would be nice…
So, which metrics should PLG SaaS companies focus on?
As a founder, COO, CFO, or other OKR wrangler, how do you decide which metrics to prioritize? How do you decide what to measure, and what to move, to build a thriving (and default investable) product-led software business?
It’s critical to get the answer right. You have limited resources, especially time, and if you measure everything, you measure nothing. If you try to move everything, you move backwards
That’s why you need a metrics framework, which is a blueprint that lays out the mission-critical data points that tie into your biggest business goals. Your metrics framework is a tool that will ensure everyone stays focused on moving the metrics that matter most.
How input, output, and outcome metrics fit into your metrics framework
Every metrics framework includes metrics from three categories:
- Outcomes, aka the most important “North Star” goals for the business, which are usually tied to revenue and financial performance.
- Outputs, aka the component parts that lead to your North Star outcomes.
- Inputs, which are the metrics you have the most control over.
You can learn more about the specifics of outcomes, outputs, and inputs here. This visual also sums up how everything fits together.
We’ll get into the specifics (and what they mean for your company) shortly. But first, we’ll use LemonOps, a fictitious PLG SaaS company, to demonstrate what a metrics framework looks like (and the logic behind the framework).
An example PLG metrics framework for LemonOps 🍋
Here’s some background on LemonOps:
- They’re a vertical SaaS business that serves small-to-medium-sized purveyors of lemonade. They have strong growth and high customer retention for their free iOS-based point-of-sale (POS) app.
- Three months ago, they introduced a paid product that helps lemonade stands manage their lemonade supplies and end-to-end supply chain.
- The paid product launched as a reverse trial where all users received free, two-week access to the full suite of paid plan features. After two weeks LemonOps prompts users to commit to a paid plan (in some cases the option for a brief trial extension is also provided).
- Users who don’t opt into the paid version revert to the freemium features.
- Post-trial conversions to paid plans have, thus far, been lower than expected.
- Despite lower-than-expected conversions to paid plans, LemonOps doesn’t have a top-of-funnel problem. They efficiently attract and acquire new users for their freemium product.
The LemonOps executive team has decided to set the following North Star goals for the year:
- 3x annual revenue growth (~20% monthly) – they’re hitting ~10% month on month revenue growth with their current paid conversions.
- 120%+ Net Revenue Retention. Early retention among paid customers has been strong, but it’s still too early to tell if this trend will continue.
With that background in mind, here’s what LemonOps’ metrics framework looks like:
Because their North Star goals are to grow annual revenue and increase revenue retention, LemonOps selected these output metrics, which directly “ladder up” to their desired outcomes:
- Post Trial Paid Conversion Rate
- Usage (segmented by feature, user type, and customer type)
- Feature Adoption Rate
With those outputs in mind, LemonOps chose the following input metrics:
- Feature volume
- Feature quality
- Entry price
- Billing product experience
- Customer touchpoint volume
- Sales touch volume and quality
LemonOps has direct control over these inputs. They decide which features to release, the price of their product, how often to communicate with customers, and so on. If LemonOps can move these input metrics, they’ll move their output metrics, and eventually see progress on their North Star outcomes.
A 3-step process to design a metrics framework for your PLG SaaS company
While PLG SaaS companies share certain similarities, your company’s metrics framework will undoubtedly look different from the LemonOps example above.
To design your framework, follow these three steps:
1. Pick and prioritize your North Star outcome metrics, remembering that outcomes typically concern revenue and need to balance the tradeoffs between growth, quality, and efficiency. Revenue may not have always been the vibe for startups, but it certainly is now.
2. Identify input and output metrics. As I explained above, inputs and outputs “ladder up” to your North Star outcomes. When you move these numbers, you get closer to (or further from) your goals.
3. Put it all together. Your set of input, output, and outcome metrics = your metrics framework.
Step 1: Pick and prioritize your North Star outcome metrics
Your North Star goals should tie directly to revenue, profitability, or another financial outcome. A tenuous connection between your North Star metric(s) and finances can lead to optimizing the business in the wrong direction.
However, note that there are cases where the connection between your North Star metric and financial outcomes are less direct. This is particularly true for early-stage PLG SaaS companies that aren’t yet monetizing.
“New School” PLG SaaS Metrics:
- Return on Incremental Invested Capital (ROIIC): Tracks the change in revenue in one period as a percentage of the change in investment during the previous period. Use it to assess the ROI of growth investments in marketing, sales, product, and elsewhere.
- New ARR vs. Cash Burned: The insights from this metric are similar to ROIIC – the more Annual Recurring Revenue you generate for every dollar you spend, the better.
- Natural Rate of Growth (NRG): Measures how quickly a company would grow without any marketing and sales efforts and outside investments. It helps PLG companies determine what percentage of their recurring revenue comes from organic channels and begins with the product.
- Cohort Retention by Customer Type: Segmenting customers into cohorts will show you differences in behavior (and spend) based on factors like channel, number of users, location, and more.
- Annuity Graph: An Annuity Graph combines lifetime value and Customer Acquisition Costs for different customer segments. It helps you visualize and compare customer journeys and financial results across channels (e.g., self-service vs. enterprise/sales-led), location, customer size, industry, and other factors.
“Old School” SaaS Metrics:
- Growth Rate: Measures a company's overall growth over a certain time period, tracked as a percentage.
- Gross Margin: Gross Margin measures the percentage of a company’s retained revenue after subtracting direct expenses or Cost of Goods Sold (COGS). A high Gross Margin shows that the company has enough revenue to cover its expenses.
- Net Revenue (Dollar) Retention: Measures the percentage of recurring revenue retained from existing customers over a specific period. NRR considers upgrades, downgrades, and Customer Churn to measure growth potential from the company's current customer base.
- CAC Payback Period: CAC measures how much money your organization spends to attract new users. The Payback component of the metric shows you many months it will take to earn back investments spent in acquiring customers.
- Burn Multiple: Burn Multiple measures the efficiency and sustainability of a company's growth model and contextualizes growth as it relates to investment.
The goal here is to focus on the fewest, simplest North Star metrics that will balance growth, quality, and efficiency. I call this the “Goldilocks Triangle” of business, representing the ever-present tradeoffs between growth, quality, and efficiency constraining every business, including PLG SaaS companies.
If you push too hard toward two of these outcomes, at least one or two of the others will suffer. You cannot have a consistently growing, consistently profitable business without balancing and periodically rebalancing your focus on Quality, Growth, and Efficiency.
Ideally, you’ll choose no more than 1-2 metrics for each category.
With that in mind, let’s narrow this list down to 2-3 outcome metrics, with 1-2 more as guardrails to keep an eye on as the company grows.
First, let’s group and consolidate the list based on our three categories.
Primary Growth Metrics:
- Natural Rate of Growth
- Growth Rate
Primary Quality Metrics:
- Cohort Retention by Customer Type and Net Revenue Retention (These are close enough to merge. Since our focus is on monetizing PLG companies, let’s go with Net Revenue Retention as our North Star quality metric.)
Primary Efficiency Metrics:
- Gross Margin
- Return on Incremental Invested Capital (ROIIC)
- New ARR vs. Cash Burned / Burn Multiple (Fun fact: These are the exact same metric.)
- CAC Payback Period
- Annuity Graph
Now that we've grouped the metrics, we have a few decisions to refine the list further. Here’s what I’d recommend and why:
⭐ Growth North Star Metric
Winner: Growth Rate
Natural Rate of Growth is certainly valuable, but it’s possible to over-optimize for non-paid viral or organic growth. Additionally, it’s often difficult to truly separate organic from non-organic traffic.
Plus, show me a startup that claims to be “growing without trying,” and I’ll show you a startup that’s either not being honest with itself or not growing as fast as it could. CAC Payback Period is a better measure for understanding how healthy and attractive your blend of organic versus paid growth is, if that’s what you want to measure (but it’s better suited as a measure of efficiency, as I’ll explain shortly.)
⭐ Quality North Star Metric
Winner: Net Revenue Retention
Why: If you had to pick only one North Star PLG SaaS metric that speaks to quality, it would be Net Revenue Retention. It measures how many customers are paying for your product, whether they like your product, and the degree to which they like it so much they want to continue paying for it.
⭐ Efficiency North Star Metrics
Winner: CAC Payback Period
Why: CAC Payback Period wins due to its simplicity and measurability. It factors in the main components of the core business (gross margin + sales and marketing costs). It’s also easy to understand and calculate and is relatively easy to measure and forecast.
LTV:CAC is an inferior North Star for efficiency, mainly because it has a significant recency bias. In the first one to three years of a company’s life, there’s no good way to predict how long customers will stick around without making some big assumptions. It also doesn’t take into account long-term Net Revenue Retention greater than 100%, which is a feature of the best PLG SaaS companies.
Lenny Rachitsky does a great job detailing optimal payback periods for different types of businesses:
If you want to put some guardrails in place for your efficiency metric, these are my suggestions:
Efficiency Guardrail #1
Winner: Gross Margin
Why: You need to demonstrate strong unit economics and the potential to create operating leverage to pay for your fixed costs like G&A and R&D.
Efficiency Guardrail #2
Winner: Burn Multiple
Why: It’s a helpful number to look at to ensure that your G&A and R&D investments are under control. At the same time, it also contextualizes the overall efficiency of your growth.
With all of the above in mind, here’s what my suggested North Star outcomes metrics framework would look like:
In summary, these are the North Star metrics a PLG SaaS company should measure, monitor, and attempt to move to grow revenue and increase profitability:
- Net Revenue Retention
- CAC Payback Period (calculated using Gross Profits)
- Growth Rate
And these two metrics can serve as guardrails:
- Gross Margin
- Burn Multiple
You'll be in good shape if you can nail the first three metrics and keep numbers four and five within recommended benchmark ranges for your industry.
Step 2: Identify the input and output metrics that ladder up to your North Star outcome goals
You have a high degree of control over input metrics. For example, your customer success team directly controls Average Response and Resolution Times, and those metrics directly impact outcome metrics like Customer Churn Rates.
Here’s the kicker with inputs and outputs, though: There are so many! It’s easy to get distracted and lose sight of your goals. When selecting input and outputs that ladder up to outcomes, I like to choose a focal point in the customer journey.
For example, suppose a SaaS company wants to increase Retention and has a North Star goal of increasing its Net Revenue Retention. They could focus on:
- Output metrics such as Customer Churn Rate, Product Engagement Scores, Feature Adoption Rates, and Net Revenue Churn
- Input metrics such as Average Resolution Time, Feature Volume / Quality, and Support Volume / Quality.
Your prioritization of growth, quality, and efficiency also impact which outcome metrics you ultimately include in your metrics framework.
Here’s a table that breaks it all down based on the customer journey and organizational priorities for growth/quality/efficiency.
As I said, there’s no shortage of potential inputs and outputs to include in your metrics framework. The AirOps PLG SaaS metrics dictionary is an excellent resource for learning more about the great big world of PLG SaaS metrics.
Step 3: Put it all together in a cohesive metrics framework
Now that you’ve identified your company’s most critical goals and the metrics that you need to move to reach them, you can lay everything out in your own metrics framework.
How to use your PLG SaaS metrics framework
The right metrics framework is your roadmap to growth and profitability. It gives you a quantifiable understanding of the true financial costs behind the KPIs that you track. It’s also much easier to prioritize problems and make educated, data-driven decisions that move the organization forward.
The work isn’t over yet, though. Now it’s time to model your data and implement the framework. In an upcoming post, AirOps’ Kyle Dempsey will do a more technical deep dive and demonstrate exactly how to build and implement your metrics framework.