7 actions to improve the profitability of a subscription business in 2024

2023 was the year when the VCS tap was turned off and the end of an era of unbridled hypergrowth, where growth was the only metric that mattered. Then came the layoffs, the adjustments, the fears. 2023 was consecrated as the year of profitability in the startup world. In 2024 it seems that this trend will continue, as it always should. We go back to setting up businesses as we have done all our lives.

In this article we will talk about 7 actions to improve the profitability of a subscription business in 2024. There could be 5, 8 or 3, but 7 are the ones I have come up with. Actions that can help you to have a more sustainable business:

1. Upgrade your Arpa: Raise your prices

In the Spanish market, we tend to undervalue or be attracted to low pricing strategies based on the leading startup looking for hypergrowth. I have not met any startup that has gone overboard with its pricing.

Although there are solutions with lower prices, we can differentiate ourselves from them, with other functionalities, another way of reaching our customers or simply improving customer service. An SME does not go directly to the startup of the moment.

We tend to set b2C prices, when B2B businesses are less price sensitive. To invoice 5000 euros in MRR there are several ways:

1. You may need 834 customers with an average price of 6 euros.
2. You may need 34 customers with a 150 euro Arpa.
3. You may need 16 customers with a 300 euro Arpa.

And so on… Which one do you choose?

It costs a lot to capture a customer, check your economics. Businesses with low Arpa, usually have much more churn.

Evaluates the ARPA by region:

Simplify pricing, no more than 3 plans helps the customer to choose. Try to upgrade satisfied customers. Reduce the use of discounts. Choose your pricing strategy well, because other metrics come into play here, such as Lifetime Value, Cac…

2. Optimize your acquisition costs:

CAC is a metric that can give you a lot of information or very little. It makes no sense to analyze CAC as a global metric. Analyzing this type of metric should be used to obtain insights and activate actionable ones, not to make it look pretty in a report.

Do not analyze the CAC with aggregated data, calculate the different CACs in search of inefficiencies.

• Calculate the CAC for each plan.
• Calculates the CAC for each country or region.
• Calculates the CAC at each stage and each acquisition source:
• Cost per Lead (CPL).
• User acquisition cost (Caac user) in freemium or free trial models.
• Cac Sales: Cost of acquisition taking into account the sales team and the tools they use. For example Hubspot, if shared with marketing apply a % to each department.
• Cac marketing: Cost of acquisition taking into account the marketing team, ads and tools.
• Cac Campaign: Caac taking into account only marketing campaigns.

Analyze your sales funnel for inefficiencies. A 1% improvement in a low stage of the funnel can be significant.

3. Churn

In a SaaS (Software as a Service) business, churn is the key metric and refers to the loss of customers or subscribers. There are several types of churn that are important to identify:

1. Voluntary Churn: Occurs when a customer actively decides to cancel his subscription or service…
2. Involuntary Churn: This type of churn occurs when the cancellation is not a direct decision of the customer. For example, it may be due to problems with the payment method, such as an expired credit card, or technical problems that prevent the automatic renewal of the subscription.

This second type of churn is actionable and we must identify when it occurs, to try to recover it the following days. It is lazy, yes, but it is more difficult to capture a customer, and we can automate the process to alert us when this happens:

1. Create alerts of churn increase variations.
2. Identify which countries or plans are most susceptible to churn.
3. Create alerts that create alerts or send messages to slack or email when unintentional churn occurs, so that customer service can retrieve them.

Churn should be a metric that allows for some configuration. Would you consider churn to be users who pay one month and leave?

4. MRR Movements

MRR movements are changes in recurring monthly revenues due to plan changes made by customers.

1. New MRR: This is the revenue generated by new customers subscribing to the service. It represents the growth of the business through the acquisition of new customers.
2. Expansion MRR: This additional revenue comes from existing customers, either by upgrading to more expensive plans, purchasing additional features, or acquiring more licenses.
3. Contraction MRR: The loss of revenue due to existing customers switching to a lower plan.
4. Reactivation MRR: Refers to revenue generated by customers who previously cancelled their subscription but later returned to the service. It is an indicator of the effectiveness of recovery strategies.
5. Churn MRR: Represents the loss of revenue due to customers cancelling their subscriptions.

Tracking and analyzing these MRR movements allows SaaS companies to better understand their revenue streams. Upgrading to a higher plan also helps us increase our ARPA. Increasing retention can help us increase our growth.

5. Unit Economics

Review your customers and their economics according to your different pricing plans:

LTV/CAC ratio: This ratio compares the lifetime value of a customer with the cost of acquiring it. A ratio greater than 1 indicates that the value obtained from a customer is greater than the cost of acquiring it, which is essential for the sustainability of the business.

LTV (Lifetime Value): Customer Lifetime Value (LTV) is a prediction of the total net value a customer will bring to the company for as long as they remain a customer. This metric is crucial to understanding how much a company can spend to acquire a customer (CAC) and still maintain profitability. There are several ways to calculate it; we will look at it in future issues.

Payback Period: It is the time in months we need to recover the CAC through the revenue generated by the customer. A shorter payback period improves cash flow.

Net Burn Rate: Refers to the rate at which a company is burning its cash each month. For example, if a company is spending 100,000 euros per month but is also generating 30,000 euros, its net burn rate would be 70,000 euros per month.

Check your gross margin and that you are attributing items where they belong:

It is calculated by subtracting cost of goods sold (COGSs) from total revenues and dividing the result by total revenues. This is commonly expressed as a percentage.

The formula for calculating the gross margin is as follows:

Do you have onboarding or initial set up? Remember to put the percentage of time your customer support team spends on it in the margin, even in the Cac.

Are you using Google cloud or AWS but not yet paying for servers because you have perks? Estimate the cost as if you don’t have them, to analyze the feasibility.

6. Product Efficiency

As a startup founder, it is crucial to focus on the features of your product that really bring value to your users. Avoid the temptation to develop new features that are not essential. It’s time to re-evaluate and possibly adjust your product roadmap to make sure you’re on the right track.

• Feedback and Bug Monitoring: Pay attention to support tickets and strive to respond to them within 48 hours. Keep a close track of bugs and response time of your application to constantly improve the user experience.
• Freemium Model Evaluation :Carefully analyze your freemium model. Consider maintenance costs such as servers and customer support, and evaluate what percentage of freemium users you manage to convert into paying customers. Understand the LTV and ARPA of the freemium model to see if it is profitable.
  Freemium is free for your users, not for you.
  7. Extend your Runway
  The Runway is the cash months you have left:
• Review your cash flow and make sure it is aligned with your financial projections.
• If you have cash and your numbers are positive, consider bank financing before you really need it.
• Close convertible notes with interested investors who did not participate in your last financing round.
• Before hiring new people to the team, evaluate whether it is strictly necessary. Often, the need for more staff arises from inefficiencies in existing processes. Use the revenue generated per employee metric (ARR / Total full-time employees) to maintain a realistic perspective.
• Adjust your Burn Rate: The Burn Rate is how much money you burn. Pay attention to the Burn Multiple, a key metric that measures efficiency by dividing the money you burn each month by the net new revenue you generate.

Bonus. Real case of investment trend change: Gonzalo Román Zinkee

This is a whats up conversation I had with my friend Gonzalo from Zinkee, a process digitalization solution for SMEs, about the current situation.

Gonzalo closed several rounds with the previous trend and is now in the process of closing one.

I tell you the conversation as it is:
Well, yes, well, the truth is that this is basically what you were saying. Before, they used to ask you, above all, for growth, that they had an expectation of growth, that they could grow by a factor of three next year. And now they don’t care so much about growth. That is to say, I remember talking to funds and to our partners about saying well, next year, with one and a half or two percent, we are doing well, because things are tight. But we never go below 18 months of cash. That is to say, right now I think that they are very focused on the acquisition cost and on never having less than 18 months of cash.

And then also, another important change I have seen has been the change of criteria in acquisition channels. That is to say, now they don’t like outbound sales so much, nor paid. Before it was more SDR, more money to the machine. Now they are focusing much more on more organic acquisition channels. That has also been a change that I have seen quite important.

In short…

Forget about putting pretty data and focus on analyzing your business by user cohorts.

Averages, medians or averages only serve to deceive oneself, metrics such as projections in excel can be adapted to say what we are interested in showing.

For example, if a Venture Capital, Business Angels or whatever, asks you for the retention, and the one of the last months is not very good. Very easy:

• Make a rolling average of the last 6–12 months.
• Pull metrics with a user cohort that favors you.

But in the end, this is lying, both to you and to the bottom line, and it doesn’t usually end well. A relationship is based on trust.

Review all your metrics. Forget about making them pretty and focus on how to improve them.

You can track everithing at Nextscenario.com