The software-as-a-service (SaaS) industry is one that, as you might expect, relies heavily on marginal data. Finding ways to reduce marginal costs, such as the cost of acquiring new customers (or even keeping a customer), can help companies improve their overall financial performance and gain a competitive edge.
For software companies looking to gain this competitive edge and improve their profitability, they must pay close attention to their SaaS unit economics. Measuring and monitoring unit economics can help SaaS brands make informed business and engineering decisions.
Understanding unit economics has become even more important for SaaS companies in the past few years. Take the pandemic in 2020 for example. For some companies, the disruption and shift to work from home meant 100x in usage almost overnight; for others, usage completely collapsed.
Both scenarios are risky and require extreme elasticity from a SaaS company’s technical infrastructure. Increased levels of volatility, the rapid migration of data and capital to the cloud, and changing user preferences all caused the SaaS industry to need good data amidst its rapid growth.
But how do you get that data and what exactly are your unit economics? This is what we will look to define in this guide. We’ll cover exactly what SaaS unit economics are, metrics you should monitor, how to calculate your unit economics, and the tools you can use to be successful.
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Unit economics are used to refer to the revenue and cost of a business measured on a per-unit basis. Often, they describe how a specific unit will impact a company’s costs, revenues, and other essential financial metrics. Within the SaaS industry, this usually refers to how the addition (or loss) of a new customer will influence the company’s bottom line and financial performance.
But what exactly is a “unit”?
A unit will always represent a customer in one way or another. How this is defined depends on the business and industry.
SaaS typically uses a “units-as-customers” model where each customer is one unit, no matter how many subscriptions they buy. For example, say you have a large organization that purchases several subscriptions of your software (or several user seats). Even though this company has purchased several subscriptions, they are still treated as one unit.
Compare this to the “units-as-products-sold” model, where each subscription is counted as one unit. This model is more common for physical products where there are production costs for each item sold.
Understanding your unit cost as a SaaS company is vital to making informed business, product, and engineering decisions. For example, if you know that specific customers (or customer segments) cost your business more, you may decide to adjust your pricing tiers or rearchitect your software to make a segment more profitable.
We’ve covered how SaaS unit economics are defined and highlighted a few benefits, but let’s dive deeper into this topic. Why should you care about SaaS unit economics and why are they important for your business to track?
Ultimately, the answer is simple. Understanding your unit economics will allow your company to make informed decisions with cost in mind. For example, if you know that a specific customer segment costs your business more, you can:
There are a number of moves you can make but you won’t know how to move forward unless you know your unit costs. Understanding your unit costs becomes even more important as your business scales.
Again, let’s look at the scenario covered briefly in the intro of this article. There, we mentioned the Covid-19 pandemic where many companies saw a drastic increase or decrease in usage of their software.
For companies that saw a dramatic increase in usage, they’d want to know:
Increasing the number of users is only good news if each new user can be served profitably. Companies don’t want to get into a situation where they are scaling up but losing more money the more customers they have, or are scrambling to address the tech debt from an inefficient system in the midst of a usage explosion.
While you grow and bring on more and more customers, it’s natural that your costs will increase. What’s important to know is how your unit economics are affected by this growth (whether they remain flat, increase, or decrease) so you can ensure profitability for your company.
On the flip side, what about the businesses that saw their customers nearly evaporate overnight?
In this case, ideally, cloud costs would have scaled down too. If they didn’t, though, it’s because these companies had some fixed capacity (often related to storage) that doesn’t scale down automatically. While scalability and elasticity are core advantages of using the public cloud, it’s also a mistake to think that they are out-of-the-box features.
The reality is that cost elasticity has to be a part of the architectural design — it's not an automatic result of moving to the cloud. In most cases, though, as long as you have the system visibility to see where the costs are coming from, you can scale down manually.
If users decline, a detailed understanding of your unit economics, your fixed costs and elastic costs, and how to reduce costs as much as possible during the downturn can be the difference between scaling back up in six months or closing your doors forever.
Let’s look at one more example of how understanding your unit economics can be beneficial — determining your free tier offerings.
At face value, giving away anything for free might seem like an “economically irrational” decision. However, the freemium model has proven to be effective within the SaaS industry and may pay long-term dividends for your business. The key here, however, is to understand how your free tier is used by customers and what it costs your business to offer specific features or products for free, per customer.
A free tier can be a great way to attract new signups but it can also be dangerous as the company isn’t generating any revenue from these new users.
Take for example Drift in March 2020. During this time, the company saw free-tier users of their chatbot increase significantly — and suddenly their unit economics were totally off. Too many free tier users could tank the company if increasing cloud costs were left unchecked.
Luckily, Drift already had visibility into their costs, so they were able to:
Again, understanding your unit economics and knowing just how much specific features, products, and customers cost your business, allows you to make informed decisions that drive profitability for your company.
Utilizing the right unit economic metrics can help SaaS companies identify opportunities and plan for the future.
Some key SaaS unit economic metrics to pay attention to include:
Many of the metrics mentioned in the previous section use a consistent formula, making it easier to track your business’ performance over time and also compare it to similar organizations.
Some of the information needed to calculate and measure unit economics can be found on your two most important financial statements: the income statement and the balance sheet. The rest of the information can be found on your performance reports.
Some of the most useful SaaS unit economic formulas include:
Most SaaS unit economic metrics are simple ratios, or at least indirect derivatives of these ratios. Calculating these metrics is fairly straightforward, as long as the numbers you are inputting are accurate.
Identifying and measuring metrics like cost per customer or cost per feature can be more difficult, though. For example, if you use AWS as your cloud service provider, you may receive a bill at the month showing you what you spent on the different services you use but have no context of how those costs translate to your business.
For this, you will need a cloud cost intelligence platform that can map costs to specific features, products, and more in your business — and show you exactly what AWS services cost you the most and why. With that in mind, let’s move on to some different tools and software you can use to monitor your unit economics.
Unit economics play an important role within the SaaS industry. As you might expect, there are currently many different SaaS tools available to choose from.
Here are a few for you to consider:
CloudZero is a cloud cost intelligence platform that enables SaaS companies to map cloud costs to products, features, teams, and more, as well as identify and monitor unit cost such as cost per customer.
For instance, CloudZero’s Cost Per Customer report allows teams to see how individual customers drive their cloud spend and how specific customers drive their feature costs.
CloudZero also enables engineering teams to drill into cost data from a high-level down to the individual components that drive their cloud spend — and see exactly what AWS services cost them the most and why.
With detailed cloud cost intelligence, you can make informed decisions to reduce spend or rearchitect infrastructure for profitability. To see CloudZero in action, request a demo here.
Updata offers a useful unit economic framework that specifically caters to SaaS companies. The framework can be used to break down expenses by unit, helping decision-makers gain deeper insights.
Chart Mogul offers a straightforward platform that can help companies chart a range of SaaS analytics. The easy-to-read dashboard, combined with clear charts, help make this platform popular within the industry. The tool is specifically helpful for measuring SaaS metrics like numbers of customers and churn rate.
There is no denying that in a data-driven industry, unit economics play a very important role. With an understanding of your unit economics, you can make informed business, product, and engineering decisions with cost in mind. Doing so, however, means you need to have the right cost data and deep insight into your unit cost and cost per customer.
For SaaS businesses, cloud spend is a big component of cost per customer, and being able to identify and measure this metric is nearly impossible with traditional cloud cost management tools or tools provided by cloud service providers. This is where a cloud cost intelligence platform, like CloudZero, comes in.
CloudZero can help your SaaS company map costs to specific products, features, teams, and more, as well as identify cost per customer. To see how CloudZero can help your team uncover your unit costs, schedule a demo today.