Subscription business models have been growing in popularity over the last decade, with new businesses seemingly popping up every day. From a modeling standpoint, subscription-based key performance indicators (KPIs) are unique compared to those used by traditional transactional businesses. Because subscription models place an emphasis on the customer, subscription business KPIs involve metrics related to acquisition, revenue and retention.
Tracking KPIs specific to your business model is important for understanding business needs and supporting the decision-making process necessary for business growth. The right KPIs can help you evaluate the current performance of the company, identify and manage key drivers, forecast future demand and understand future profitability. By comparing your KPIs against industry- or company-specific benchmarks, you can also highlight areas of improvement.
As finance professionals, we often get bogged down with different metrics regarding company performance. However, developing an awareness of the most important metrics and focusing on them can help us understand which levers drive profitability and sustainability. With that in mind, let’s take a look at some essential subscription business KPIs.
Customer Acquisition Cost (CAC)
CAC is an important subscription business KPI, as customer acquisition is a large expense that can become detrimental to smaller businesses. By tracking the total cost of sales and marketing efforts to acquire a customer, companies can:
- Better understand where marketing dollars should be spent.
- Identify cheaper or more effective channels for acquiring customers.
- Set realistic expectations for ROI on marketing and sales spend.
To calculate CAC, simply divide the costs of acquiring new customers by the customers acquired during that same time. For example:
In July, Company X spent $20,000 on ads / 2,000 customers were gained from those ads = $10 CAC
Overall, CAC is essential for assessing a subscriber’s return on investment and how much money you’ll be generating per customer acquisition. It also helps keep your marketing or ad spend budget in check.
I should also note that your CAC should include all costs that result in acquiring a customer, such as the money you spent on advertising, other forms of digital marketing and any other associated expenses. As your company grows, it is natural to spend more money on advertising as you want to increase your customer base—which will inherently increase your CAC over time.
Churn, or attrition, calculates the rate that you lose customers each month. This rate depends on several factors and will typically fluctuate month over month. Churn is one of the critical subscription business KPIs because a churn rate higher than your growth will lead to fewer customers.
To calculate your churn rate, simply divide the customers you lost during a given period by the number of customers you had to begin the period. For example:
Company X had 2,000 customers at the beginning of the period / 50 customers were lost during that month = 2.5% churn rate
To grow the business, we would now need to acquire more than 10 customers during the next period. Understanding churn essentially predicts the sustainability of your business: as the churn rate increases, your ability to grow and scale your business becomes even more challenging. Customer acquisition costs will undoubtedly increase as you have to replace the customers you lost with new ones.
Average Revenue per User (ARPU)
ARPU tracks the average revenue amount you’re getting from an individual customer, which helps you understand the value your customers provide to your company. ARPU is also helpful when your company offers different tiers of services or membership.
To calculate ARPU, simply divide your monthly revenue by the total number of customers during that period. For example:
Company X had $150,000 in revenue / 1,500 subscribers = $100 ARPU
By including ARPU as one of your subscription business KPIs, you can help inform about sales efforts, opportunities to upsell or down sell packages, retention strategies and a host of other valuable takeaways. ARPU allows the business to track the monetary value of their users, especially when your subscription business offers multiple product tiers. When used correctly, ARPU helps inform the business about trends within a customer group against cohorts from different periods. It can help identify the different price points customers prefer and typically can be used to upsell higher priced products when you need higher revenue.
You can even break ARPU down by new subscribers versus recurring subscribers, which will help illustrate if new customers are paying more for your services.
Customer Lifetime Value (LTV)
LTV is often seen as one of the core metrics for subscription-based businesses, since getting customers to stick around for as long as possible is essential to business sustainability. The higher your LTV, the more value you’re perceived to have from your customers’ standpoint. LTV measures the revenue an average customer earns for the business from the day they sign up to when they stop using your services (i.e., when they churn).
To calculate LTV, you take the entire historical earnings of a customer, then divide it by your churn rate. For example:
$100 ARPU / 2.5% churn rate = $4,000 LTV
In order for your subscription business to be successful, your LTV should be higher than your CAC – meaning over a customer’s lifetime, they bring in more revenue than what you spent to acquire them. This helps you distinguish the limit of how much you should spend on marketing efforts and can identify who your most valuable customers are.
How Subscription Business KPIs Support Modeling
Focusing only on the metrics tied to revenue (i.e., the KPIs of a traditional B2B business) doesn’t give you the entire picture of your company’s sustainability. Tracking the aforementioned subscription business KPIs offer many benefits, especially when they’re precise and specific to your business. From an organizational perspective, presenting these metrics monthly during board meetings can help each department understand which levers actually drive business performance. That understanding can help business leaders make more informed decisions, better understand their subscribers and focus on the segments and activities that are most valuable to the business in the long run.
If you’d like to learn more about modeling for subscription-based businesses, you might be interested in the resource below. If you’d like to learn more about working with our finance and accounting consulting team, we invite you to reach out to us through our contact page.