By Eric Mersch
SaaS companies that provide software services at low price points need to use low unit cost Inbound Marketing strategies because unit profit is so low. This dynamic is also common among Business-to-Consumer companies that offer low-cost apps with inbound marketing tactics to generate maximum awareness, adoption, and conversion among users. Examples include consumer-facing solutions (products and services) such as personal lifestyle apps (finance app Mint; family safety app Life260, workout app JRNY by Nautilus, meditation app Calm) and business productivity apps (Calendly, DocuSign, Dropbox, Hootsuite, HubSpot, Mailchimp, SurveyMonkey). Many Enterprise SaaS companies have low-price point offerings that are designed to serve a specific use case or to generate demand for enterprise software solutions (Lens by Mirantis, Mayhem for API by ForAllSecure).
Unit Economics for B-to-C SaaS Offerings
In the chart below, you can see a small sample of business productivity tools priced between $96 per year and $588 per year. The unit of measurement here is the Average Revenue per User and is shown on an annual basis.
At these entry price points it’s impossible to justify selling apps to individual users one at a time using high cost direct or indirect salespeople. By using SaaS unit economics and benchmarks, we can estimate the investment needed to acquire customers for these apps. The key unit economic metric is the Customer Lifetime Value (CLTV) to Customer Acquisition Cost (CAC), or the CLTV/CAC ratio. The common benchmark for this metric is 3.0, meaning that the CLTV must be three times larger than the CAC.
Let’s assume we’re selling an app priced at $120 per year. Our B2C SaaS gross margins are typically at 90% or better so our gross profit will be around $110. SaaS subscribers tend to be fickle with annual churn rates of 30% – 40%, which are acceptable for B2C businesses. So, our CLTV will be approximately $40. To hit our 3.0x benchmark at a $120 price point, we can only spend $13 to acquire the average customer.
Therefore, to make these unit economics work, we need to employ a mass market, freemium strategy led by the Chief Marketing Officer. In this strategy, we attempt to reach a broad range of potential customers through low-cost mass marketing strategies and entice usage through free offerings that drive conversion to paid subscriptions. Marketing channels used here tend to be cost-effective digital channels and virtual events, versus traditional high-cost channels (print, radio and television advertising, live in-person events).
Cost-Effective Digital Marketing Channels
Digital Marketing is a broad term because it refers to all online channels used to access potential consumers. It forms an essential part of the Go-To-Market strategy for B-to-C and emerging smaller SaaS companies.
Digital marketing strategies include a number of subcategories:
Search Engine Optimization (SEO) – SEO refers to the optimization of your company’s website for maximum visibility to search engine algorithms (page one of search terms displayed to users who search for a specific term). The objective is to get your website ranked highly for organic keyword searches. Prospective customers who click on these listings are referred to as Organic Leads. The leads are free when users click; however, there are marketing costs associated with conducting website search optimization.
Search Engine Marketing (SEM) – Search engine marketing refers to the use of paid advertisements that also appear on search engine results pages. Marketers bid on keywords that trigger paid advertisement placements in search results. These leads are called Paid Leads. Paid SEM platforms include Google Ads, Bing Ads and Facebook Ads.
Digital Advertising – Digital Advertising is the practice of purchasing paid placements on websites to run display ads, in-video ads, and sponsored content (native ads). Digital Advertising vehicles are typically lower cost because this channel has more limited user targeting features (demographic, geographic variables, etc.).
Direct Notification – This direct-to-consumer digital marketing strategy refers to email campaigns, mobile campaigns using SMS/text, and other online and mobile push notifications. Contact lists are purchased from third-party vendors and house lists are collected by the company itself at events such as symposiums, trade shows, panel discussions, and webinars.
Social Media Marketing – This strategy embraces advertising campaigns on social media platforms (Facebook’s Ads Manager, Twitter ads, LinkedIn’s Campaign Manager).
Affiliate Marketing – Distributing ads via Distribution Partners or Affiliate Partners that manage a network of websites can also be effective if the audience at the partner site matches a company’s target market. Affiliates are paid for lead generation. Payment method varies from revenue sharing or pay per sale (PPS) to cost per action (CPA), and Cost per Click (CPM, referring to the pricing in cost per thousand clicks).
Influencer Marketing – Influencers are individuals who are paid to help distribute content to their social media followers. They have established credibility among a specific demographic and can wield their credibility to drive purchase decisions. The financial relationship typically takes the form of payment for a product testimonial woven into the influencer’s content, such as an Instagram feed, a YouTube video, or podcast.
Content marketing – While more common in B-to-B marketing, content marketing refers to outbound distribution of thought leader proprietary content to social media, publishing platforms and third-party sites, and on the company’s owned channels. These can take the form of social media posts, company blogposts, vblogs, podcasts, webinars, and white papers. The objective of content marketing is to motivate and influence purchase and conversion.
The marketer’s objective is to drive the lowest aggregate Cost per Lead. The chart below highlights the lower cost of digital marketing channels when compared with more traditional marketing strategies:
The CFO plays an important role here in evaluating the effectiveness of each marketing channel and each campaign with the ultimate goal of developing a Return of Investment (ROI) estimate. With this knowledge, the CFO can work in collaboration with the head of marketing at the SaaS company to better test and manage investments in marketing over both short and long term time horizons.
Free Offerings: Free Trials to Freemium
Free Offerings are also often used by SaaS companies to increase user awareness and conversion rates. These reduce the friction at the point of conversion (signing up potential paying customers) with the goal of driving engagement and conversion to paid subscriptions. Free Offerings allow users to experience the product without risk. The company can then use various forms of incentives to convert the user to a paid subscription. The company’s product team can also mine user activity data to develop product features and enhancements that further improve conversion rates.
Free offerings take the form of Free-Trial, Freemium or just plain Free, or Non-Committal product incentives.
All three free offering options provide lead generation are very efficient Go-To-Market strategies, driving down CAC due to lower sales and marketing costs and (assuming customer retention), increasing customer lifetime value. These strategies are considered cost-effective if the cost to service free customers (pre-conversion) is lower than the cost to acquire new paying customers via other marketing strategies.
Free-Trial marketing offers gives consumers use of the basic product for a limited time period, usually 14 days to one month, and are offered on an Opt-In or Opt-Out basis. Opt-In Free Trials do not require a credit card to start using the product; instead, consumers enter their name, email and sometimes a phone number to initiate their trial. Later, indirect sales representatives attempt to convert these free users to paid subscriptions. Opt-Out Free Trials require a credit card to start the subscription; consumers are automatically billed at the end of the period unless they choose to opt-out. Key success factors for Free-Trial approaches are the length of time offered to prospective consumers in order to incent conversion and the retention rate for converted customers.
Freemium offers allows consumers to use an abbreviated version of the product with “light functionality” for an indefinite period of time during which the users are frequently prompted to upgrade to a paid subscription. Light functionality can mean fewer features or lower storage limits.
Users have a much lower propensity to convert compared to those in Free Trials. Email marketing is typically used to encourage user engagement. Freemium models are used by lifestyle app Calm, productivity tools Dropbox, Hootsuite, Trello, Zoom, and most mobile gaming customers.
Accounting for Free Trial and Freemium offerings
There’s an interesting accounting change required for companies using Free Offerings. The cost associated with such free offerings are typically the same as those costs incurred for paid subscription users. These are mainly the direct costs of hosting and infrastructure, which typically reside in Cost of Revenue. But to ensure accurate financial reporting, the costs of serving non-paying customers should actually be allocated to Sales and Marketing. Note that Customer Support and other third-party data fees are typically not included here since these services and features are not offered to free users.
Making this allocation will not affect the CLTV/CAC calculation since it uses gross margin in the numerator and Sales and Marketing cost in the denominator. However, if this allocation is not made to Sales and Marketing costs, benchmarking will not be as accurate since both Gross Margin and Sales and Marketing will be lower than that of comparable SaaS companies. And the difference can be material. For example, Dropbox did not make this allocation in fiscal years 2015, 2016, and 2017 and this resulted in abnormally low gross margins for the company of 33%, 54%, and 67%.
Using an Inbound Marketing strategy can be a powerful lead generator because it relies on minimal direct cost of labor and low cost to deliver the SaaS product that enables Freemium and Free Trial offerings. Successfully executed strategies can deliver lead costs that allow for an LTV/CAC of above 3.0x for even low price point product offerings. While this strategy works well for B2C companies, the potential for lead generation efficiencies means that middle market and enterprise companies need to employ Inbound Marketing as part of their larger go-to-market strategy.