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Understanding the Real Impact of Improving Customer Retention
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Did you know: For every 1% increase in revenue retention, a SaaS company’s valuation increases by 12% after five years?
This was just one of the takeaways from our well-attended webinar this week on- Understanding the Real Impact of Improving Retention and Customer Success Best Practices.
To better understand the impact, we had Rob Belcher, Managing Director at SaaS Capital share benchmarking data from their eighth annual survey of private B2B SaaS companies. We also had You Mon Tsang, CEO and Founder of ChurnZero share tried and true ways to improve customer retention.
You should view this webinar on-demand to learn:
- How your company ranks in terms of net and gross churn compared to companies with similar ACV’s and ARR
- How to measure the impact of churn on your company
- How to structure and compensate a Customer Success team
- How to develop a customer health score and key customer events to track
We also had a really outstanding Q&A session with our speakers. Since we thought there were some valuable takeaways, we wanted to share the Q&A recap here.
Speakers:
Q&A Recap
Q: Can you talk about the trade-offs between gross margin and churn as it relates to LTV and CAC?
Rob: So, this is a profitability point. If you can increase retention a customer becomes more profitable. So, LTV (lifetime value) and CAC (customer acquisition cost) increase quite a bit, your profit margin increases, and you can then reinvest all those dollars back into sales and other growth initiatives that are compounding.
You Mon: I’m not a huge fan of LTV. I think the way it’s calculated can be highly manipulated. It can really fluctuate, because the denominator is churn and a little change, can really change your LTV.
What I focus on, as an alternative, is the payback period, and that is – how many months does it take for your customer to become profitable. That’s a different version of LTV over CAC.
I would say best in class companies, will spend six to twenty-four months to get payback from a customer. If you’re selling a smaller deal size, you should be at the lower end of that, and if you are selling a larger deal size, you can be at the higher end of that. And that is a straight line to profitability.
Rob: Payback period is a great one, and from talking to folks out there and other VCs and private equity firms, twelve months is a good target. It’s especially great if you get payment up front and then know that customer is profitable from that point on.
Q: Do you think the percentage of spending on Customer Success is too small, especially given the thesis of this presentation and the impact it can have?
Rob: I would say there are definitely certain ways to go about it, and I think it all depends, and is why we will do a whole research report on that spending data. Because ACV is important, vertical vs. horizontal is important.
We had one of our portfolio companies with 60% of their headcount reporting up through CS, and that’s how they focused and was the culture of the business. So, it all depends on your business and how you decide to structure your team.
You Mon: I agree, this is a big, it depends answer for sure. I will say that, I think the market is changing a lot, and we’re slowly moving away from an era where new sales dominated the conversation to one where CS will.
I’ll encourage folks to think about it this way. If you’re a land and expand type of company, in other words, you sell a small piece first and then your thing is to expand, you should spend much more of your revenue on CS, because CS will be driving a lot of incremental revenue.
For example, Slack is a great land and expand type strategy. You go in with maybe one team using it, or maybe in fact you’re using the free version, so you’re getting almost nothing in terms of revenue. But then over time with Customer Marketing and Customer Success, people love to use Slack and then all of a sudden, it’s expanding. So, the initial sale is very small, and all the sale is upsell.
Now, if you are selling something like an ERP system, which is a huge decision and will change the whole company, there might not really be much to upsell, since the initial sale is so big. So here, it’s really all about new sales. Therefore, your Customer Success has to be a smaller part, just because you don’t have much to expand later.
If I were to predict what will happen if SaaS Capital does this same survey ten years from now, my prediction would be that – the percentage devoted to Customer Success will rise but maybe by single percentage points.
Q: How do you go about convincing an executive team to buy into a model where it’s a more proactive Customer Success team versus a traditional reactive Customer Support team?
You Mon: That’s a great question. Typically, what people say is – who would you rather buy from? Would you rather buy from the CS person who’s been with you on the journey all the way from when you bought the product up until you saw success with hand holding the whole way, doing regular calls, making sure that you’re doing well. Basically, someone that is on your side, and when they ask for something, you’re more likely to say yes. Rather than, an Account Manager who at month nine or month ten reaches out, really just in time for the renewal, and all they do is ask you for more money with an upsell. Who would you rather buy from?
So, that’s sort of the typical thought process there. You of course would rather buy from your CS person. For that point of view, if you are trying to make the argument for CS to own expansion, I think that’s your best bet. You want to make sure your business partner is asking for the expansion.
On the other hand, there’s reasons not to do it. One of them being it is hard to find a CS person who is customer focused and business outcomes oriented and that can also ask for money. Those virtues often don’t sit in the same person, so it’s kind of hard to find that unicorn.
Rob: I think it’s a bit of chicken and the egg. If you have more products and features that you can upsell, then yes, go to your CEO and say I want to build a team that goes and sells these things.
There’s one other anecdote I would share. Generally speaking, portfolio companies, or just companies we’ve met and talked to overtime, seem to have pretty good luck with small price increases. Generally speaking, a small price increase each year, hasn’t been met with customers voting with their feet and churning out. If you make it a culture, where we increase prices by a small percent each year, and you just take that hard line. To You Mon’s point- about trying to find someone who can ask for more money, you might have success with that.
Q: When going through the Customer Success best practices, can you explain what the term “champion” refers to?
You Mon: Your champion is the person who either bought your product or is the person who’s really dedicated to making your product successful on the customer side. They champion your product, they love it, they expound the virtues and they work hard to make it successful. And when you lose your champion, oftentimes your product or service will go rudderless. Software requires a lot of feeding and attention and the champion is the person who is doing the gardening. So, if they’re not there, then you’re really at a high risk of that customer churning.
Some people call it POC (point-of-contact), decision maker, buyer, all of these are variations of the term champion.
Q: Would you recommend having CSMs complete onboarding to own the relationship from the beginning?
You Mon: This is a great question, and one we think about a lot even at ChurnZero. I think it really depends on how technical or unique each of the onboardings are. So, if your onboarding is – let me give you some training and you have these five things to do that can be fairly straightforward, then let the CSMs do it. But if your onboarding is more technical, where it requires data integration, maybe there’s some coding, a lot of change management, a lot of meetings and project management – stuff that requires specialized skills, you may need an onboarding specialist. So, it really depends on the kind of offering that you have, and the more complex the offering the more likely you are to want to split onboarding as its own thing.
Q: Can you go over how you calculate churn?
Rob: The way we look at things is annual retention. So, we look at your total MRR, let’s call it – February of last year, and then what did they do for you in February of this year? You don’t count any new sales that happened in March through the rest of the year (that’s not retention, that’s new net adds), and you exclude churn and contraction. When you are doing net dollar retention you can include cross-sells, upsells, and price increases. If you are doing gross dollar retention, you don’t include any of that, you just remove out any churn or contraction. So, gross retention can be up to 100% but can’t be any better than 100%. You can do what you did last year, with no price increases or contractions or churn, and that’s as much as it can be. On net retention, it can be infinite with price increases, upsells and expansion. So, it can be greater than 100%.
That’s the way we look at it. If you do multi-year contracts that’s probably a more specific way of doing it. Some companies that do month-to-month contracts might track monthly churn cohorts, and all kinds of stuff like- first year versus veteran customer. You could slice and dice however you want, or whatever is useful for you. But in the end, I think it’s important for investors and your board or stakeholders to know annual retention rate.
You Mon: The last thing I would add here, is that this is not GAAP finances, so generally accepted accounting principles. You know, when I say margin and EBITA and it means the same thing no matter where I live the terms churn and retention, are not that. So, when you’re comparing churn to churn you almost have to ask each other – what do you mean? How do you calculate it? What Rob shared is actually the most common way. The industry will start to consolidate so if you’re doing something different, you’re going to be an outlier real soon and your numbers are not going to mean much.
We’re not there yet, there’s still a lot of definitions out there on how to calculate churn. Too many even. There should really only be one definitive way.
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- How to Let Customers Know About Prices Increases – Learn how to inform customers about price increases without making them mad and creating a churn risk.