This isn’t the “good old days” anymore.
It used to be that cloud companies could pursue growth at all costs and still garner the support of venture capitalists and other investors. In 2023, however, with costs rising and margins getting narrower every day, investors are now favoring companies that can ensure long-term profitability rather than just growth.
Now, more than ever before, it’s crucial to drive toward SaaS profitability as the ultimate goal.
If you want to secure funding and continue developing your business, you’ll have to be able to prove that your revenue can consistently outpace your costs. Let’s talk about how you can get there — even if you’re currently bleeding money.
How To Achieve SaaS Profitability In Today’s Economy
Traditionally, SaaS companies track a handful of metrics to make sure they’re staying in the green.
For instance, a company can subtract its cost of goods sold (COGS) from total revenue and use that figure as an overall representation of its profit margin.
Measuring success in these terms is simple. A large distance between revenue and COGS means your margin is healthy. If the two are too close for comfort — or if COGS is higher than revenue — you’re in trouble.
Some of the other common metrics SaaS companies like to track include Customer Lifetime Value (LTV) and Customer Acquisition Cost (CAC). Revenue and COGS play a role in determining these metrics as well.
If you’ll be seeking new funding soon, these are the metrics potential investors will most likely want to see.
However, these metrics are not all that useful for actually improving your situation. If you’re slowly sinking, watching your margin shrink is not going to give you any meaningful insights; it will only produce a sense of urgency to fix whatever is going wrong.
To make meaningful improvements to profitability, you’ll need to track an entirely separate set of metrics.
Specifically, you’ll need to measure your unit economics.
When we at CloudZero mention unit economics, we’re talking about the individual costs and profits associated with small “units” of your business.
The exact units you’ll want to measure can vary based on your specific situation, but most SaaS businesses will benefit greatly from tracking their:
- Costs per customer
- Costs per product
- Costs per feature
- Optional: costs for certain geographic regions, ongoing customer support, free trials and loss leaders, and other metrics
You’ll also want to have a clear picture of your revenue generated by each of these factors.
With these revenue and cost ratios in mind, you can perform the exact same margin calculation for every unit you’ve tracked. This means you can view every tiny piece of your business — individual products, features, customers, regions, cloud services, etc. — as a separate piece of the puzzle.
Some will have far healthier margins than others, and a few red flags may stand out as needing immediate attention. This knowledge makes it easy to refine your approach to maximize profits.
The tricky part isn’t doing the math, however.
If it were as simple as tracking your costs and profits for product A as opposed to product B, every company would be doing it.
In turn, every company would then be able to pattern their future decisions off of their most successful product, while slashing support for any products that are hemorrhaging money.
Unfortunately, breaking down the total cloud cost sum into its relevant parts is where most SaaS companies get stuck.
The Traditional Approach Leaves A Lot To Be Desired
Without a good way to find the exact costs associated with a given component of their business, many finance leaders try to emulate finding unit costs by using some broad back-of-the-napkin math.
For instance, if you can’t find what every single customer costs and how much revenue they generate, the easy — if suboptimal — solution is to take the total customer costs and divide that figure by the number of customers you support.
This is your average customer cost, which you can use to gauge, in broad strokes, whether costs rise and fall in noticeable trends or whether your margin is sufficient to generate consistent profits.
The problem is, a lot of information gets lost in those broad strokes and averages.
What if, as a simple example, your average cost per customer is $20 and your product sells for $40. With a 50% margin, you might think your business is in decent shape. You’d like to get your margin to 80% — which is ideal for a SaaS company — but you’ve got a solid starting point.
So Where Do You Go From There?
If you could look into your individual costs instead of looking at your average, your avenues for progress would be easily apparent:
Architecture and code inefficiencies
Perhaps there’s a feature getting bogged down by inefficiencies, and it requires optimization to get it to a point where it brings in more money than it costs.
Unprofitable pricing tiers
Or, it could be that your pricing tiers need to be reorganized to compensate for heavy users churning through expensive resources.
We’ve worked with a client who should by all accounts have had great margins, but they were losing money every month because they were unaware their free trials and loss leaders were the most expensive products they offered.
Once they discovered that their free products were weighing them down, they were able to fix the problem quickly.
Not targeting the most profitable customer segment
Or, maybe you’re leaving a lot of money on the table by not targeting a particular product toward your most profitable customer segment.
Another client, upon drilling down into its costs per customer, was astonished to find that over half of its customers weren’t even close to being profitable.
The remaining customers were keeping the whole company afloat, but couldn’t bring in enough revenue to fully make up for the losses.
If they hadn’t ever examined their costs per customer in detail, they may have wasted years — and plenty of money — restructuring their engineering processes to squeeze out a fraction more cost savings and perhaps slow the bleeding.
Thankfully, they discovered the issue in time and they began adjusting pricing and strategically targeting specific customers immediately.
In other words, there could be any number of things going on beneath the surface, and you’d never know it if you can’t see beneath the surface of your averages.
Tricky or not, tracking your unit costs is the way to ensure SaaS profitability.
This is true even during the best of times, but it’s especially important when you have several variables affecting your numbers in any given month.
Variables could include a new product launch, a bloated and inefficient feature, a brand new power-user customer, or an external factor like inflation, but there is always something that will affect your averages in one direction or the other.
You can’t solve your problems and build on your successes without being able to see the finer details of your company’s complete picture.
Maximizing SaaS Profitability Is Important Even If Your Business Is Already In Good Shape
If investors’ extreme focus on profitability has arisen from current economic struggles, it’s reasonable to assume that, one day, the economy will rebound and SaaS companies can go back to prioritizing massive growth above all else.
Many business leaders have this sense of urgency to fix profits right now and then hold on for dear life until they can go back to “normal.”
However, we believe that failing to optimize your profits, even if your business is churning along at a healthy rate, would be a mistake.
It’s unlikely that things will ever go back to exactly the way they were.
The early days of the cloud allowed for pioneers to enter the space on a fairly even playing field. He who spent the most had a good chance of winning the game and becoming “the next big thing.”
Those pioneering days have given way to our current state of rebalancing priorities. Once this shift is over, we’ll probably enter a new phase.
We suspect this phase will bring with it the lessons from both previous eras; grow quickly, but stay efficient and adaptable, just in case.
If everyone else is playing catch-up, the best thing you can do is use this time wisely and start training for the next round.
Business leaders who can use this time to get their profitability in order before the next surge of growth commences could position themselves for massive, unprecedented success.
Make the effort to find opportunities for efficiency and pass those savings down to the consumer. When the economy comes roaring back, you’ll be poised and ready to take off like a rocket.
CloudZero Is The Lens That Brings Your Fuzzy Unit Economics Into Clear Focus
The good news is that achieving visibility into your unit economics doesn’t have to be difficult.
With the right solutions — such as the platform offered by CloudZero — you can find out exactly where each dollar belongs. You can even uncover and optimize third-party service costs, such as those incurred by Snowflake or Kubernetes, that would normally be hidden under layers of obscurity.
with our experts to see how CloudZero can help your business attain profitability.
The Cloud Cost Playbook
The step-by-step guide to cost maturity
