Is the LTV/CAC Equation Obsolete?
July 11, 2019 | Contributed by: Neal Polachek
My colleague Greg Sterling pushed this article, entitled “The Death of the SaaS LTV/CAC,” in front of me earlier this week. I encourage anyone in the SMB SaaS space to read it in full. Its author, Canaan VC partner Michael Gilroy, makes a compelling argument that the traditional approach for valuing SaaS — Long Term Value divided by Customer Acquisition Costs e.g., LTV/CAC is due for a refresh.
His primary argument is that over the last decade we have seen a shift from traditional Go To Market (GTM) approaches utilizing MQLs, SDRs, BDRs, and AEs to newer, more bottoms-up approach. He cites companies such as Square, Twilio, Zoom, and Shopify that leverage landing pages and self-buying models for customer acquisition. As such, the LTV/CAC is out of sync with these new realities.
Instead, Michael suggests that cohort analysis is considerably more helpful in evaluating the health of a SaaS business – particularly ones that are selling to consumers and SMBs. He points to Square as an example of a SaaS business that offers a volume or usage approach for monetization. As such, monthly revenues will fluctuate as businesses will pay by the number of invoices issued, the number of gift cards issued, etc. Since these are variable revenues and will go up and down, it is difficult to place a clear LTV on any individual business.
This speaks to our notion that over time, we will see more and more SMB SaaS business models morph into a multi-dimensional model. Most likely there will be a fixed monthly component and a volume sensitive component, for example, the number of invoices issued or perhaps a transaction value. While this will complicate the valuation approaches analysts will use to place an enterprise value on SMB SaaS companies, new approaches like the one Gilroy offers will be helpful. As an industry analyst – not a financial analyst — why this matters is that we do believe SMB SaaS companies will have to evolve their business models to reflect the realities of an ever-changing SMB customer market.