Powerful Factor in Building a Sustainable Software Business

Bob Casey | 7 MIN READ

Albert Einstein is credited with saying that “the most powerful force in the universe is compound interest.” The most powerful force in software businesses is revenue retention. High revenue retention rates create extremely valuable businesses, given that in a business with 100% revenue retention, each new sale provides pure incremental growth. A company with a highly stable customer base and a strong sales engine offers reliable, predictable, and growing cash flows over time – the hallmark of a great business. However, not all subscription businesses are created equally. As SaaS Capital and others have found, there is significant variability in the rates of customer churn across SaaS businesses, and as a result, significant differences in business quality. 

Churn is the Enemy

The enemy of revenue retention is churn. For every dollar lost, another dollar of new sales must occur in order to maintain the same size of the business, much less to grow it. As a result, customer retention and its antithesis, churn, are the most important metrics in any subscription business.  While some level of churn is unavoidable, best in class subscription businesses have built repeatable processes and systems to help ensure customer success and renewal, thereby facilitating faster growth. These systems focus on customer enablement and success, and are built on effectively training, engaging, and enabling customers to get the most out of the product. 

Digging Into Churn

In 2016 Ajay Argawal, a partner at Bain Capital Ventures, examined data from SaaSRadar, McKinsey’s database of pre-IPO SaaS companies. Ajay and his colleague Ben Vonwiller determined that gross churn is by far the most impactful metric in understanding which customer success metric most impacts growth within a subscription business. The very best SaaS companies have extremely low gross churn, and achieve growth within their existing customer base by upselling and expanding accounts that they have already signed up. In businesses with high gross churn, expansion efforts with existing customers must first replace revenue that has been lost before it can contribute to real revenue expansion.

The question remains, what are the most significant drivers of gross churn? What are the best ways to combat it? How do best-in-class firms address churn? Unfortunately, gross churn data is typically very difficult to access. Public SaaS companies typically conceal their gross churn numbers, while managers and investors both tend to speak in terms of net churn, or churn after upgrades from within the existing customer base are taken into account.

The Tale of Two Surveys: Some Interesting Churn Statistics

Two recent surveys have provided further valuable insights into the growth rates, churn characteristics, and customer success practices of a variety of Software as a Service (SaaS) companies – ranging from small startups with less than $1m in revenue to large, public companies. Last year at Harvard Business School, I worked with Gainsight to design a joint survey targeted mainly at larger software businesses. Another survey was conducted by SaaS Capital, a SaaS-focused investment firm, to evaluate churn trends within the software industry. Both surveys were conducted in March of 2017, and garnered over 800 responses.

SaaS Capital’s 2017 survey showed mean net revenue retention of 99.6%, and average gross revenue retention of 88.3%, implying mean annual gross churn of 11.7% across the set of responses. The HBS / Gainsight survey, conducted over the same time period returned similar but slightly better gross retention numbers, with 91% mean gross revenue retention. Smaller companies fared slightly better in their self-reported churn-data in both surveys; in the SaaS Capital dataset, firms with revenue between $1 and $10m in the prior year reported gross churn of 10% and net churn of -0.7%, while firms with revenues between $10m and $50m reported 13.6% gross churn and 1.5% net churn.

Analysis shows the strongest correlation between a firm’s average contract value (“ACV”) and its rate of customer retention. The more expensive the product, the less likely the customer is to churn. This underscores anecdotal evidence that serving SMBs is inherently a more difficult business, as there is greater structural churn as these businesses often close or change course. Furthermore, when a customer is selecting an expensive product, they are more likely to invest behind it, to build their business around it, and to integrate with it (these core systems of record are also able to command a much higher price than “vitamin” products that are nice to have but not absolutely necessary to a firm’s operation). Systems of record and highly integrated products are far more difficult to replace than discreet, stand alone tools. 

The Power of Customer Success

Jason Lemkin, the founder of Echosign and a prominent SaaS investor likes to say that “customer success is the secret sauce in SaaS.” In many SaaS businesses, a significant portion of growth comes from the existing customer base – for instance, at IPO Twilio had a net dollar revenue retention rate of ~170%, Veeva had a net dollar revenue retention rate of 170%, and Box had a net dollar revenue retention rate of ~130%. These striking figures illustrate the potential power of expanding customers to fuel growth.

Most software companies seem to recognize this, and invest behind customer success organizations that are focused on serving the existing customer base. SaaS Capital found via their 2017 survey that the average SaaS business spends 15% of total revenue on customer success and support. In interviews with a number of customer success leaders at SaaS businesses ranging from small private companies with ~$10m in revenue to large, publicly traded companies, three themes consistently came to the forefront:

1. It All Starts with the Product – Customer Success Is the Feedback Loop

Churn can occur for a variety of reasons, but the single most common issue that the product does not needs of the customer. In some instances, this might be a result of poor product selection on the part of the customer or a specific use case that the product does not support. However, particularly in businesses that are below $10m in revenue, this might be a reflection of a lack of product market fit. Customer meetings provide an opportunity to understand these issues and to adjust accordingly.

As Karen Flathers, the Chief Customer Officer at Blackline Software shared, “It is easy to blame churn on external factors, but usually there are some deeper issues to understand. Spend time with customers, conduct an NPS survey, and try and diagnose issues on customer success. A lot of times this has to do with product… it may have been oversold, the sales team may have chosen the wrong customers, all that stuff. Sometimes changes need to be made in sales to sell what you have.” Whether the issue originates with the product’s capabilities, how it is positioned in the marketplace, or something else, consistent conversations with customers allows this to surface and should then be funneled back to the product, sales, and marketing teams.

2. Invest in Onboarding

As Mike Randolph, the VP of Client Services at Appfolio noted “The first 60 days of usage is crucial. If a customer is going to churn, we can tell in the first few months.” Onboarding is critical for any SaaS company. Everyday that goes by without system usage increases the risk of churn, yet often the prospect of uploading data, integrating systems, and training users is daunting for customers.

Karen Flathers at Blackline takes a unique approach here. Blackline’s software is an accounting platform, built for use by financial professionals. Given the technical nature of its customer audience, Blackline decided that they should focus on hiring accountants as CSMs and implementation managers. As Flathers noted, “Accountants are picky about talking to accountants. One challenge is that our CSMs are not inherently services or sales people, but for our customer set, they are much more likely to talk to another accountant.” The implementation team at Blackline lays out a clear timeline with regular milestones, and follows up consistently with the customer throughout the onboarding process. Implementation specialists are available to assist with integrations and data input, and during the first couple of months are engaged with the customer on a nearly daily basis, ensuring that there is not an opportunity for the process to slow down.

Smaller firms with contract sizes below the point at which a fully dedicated onboarding team makes sense can still benefit from this advice by ensuring that they provide detailed, easy to use training content and by ensuring that they front-load more frequent customer success touchpoints during this critical onboarding period.

3. Engage Consistently!

As Russell Grey, the VP of Customer Success at Logic Monitor noted, “Unhappy clients don’t always churn, but clients that are silent or that you don’t engage with do churn.” Friendly check-ins, Quarterly Business Reviews (QBRs), and executive sponsorship touch points at various levels within the customer’s organization are vitally important within any customer success team. These interactions raise product issues before the become problems, giving the SaaS provider an opportunity to address them head on. If an internal champion leaves their role, it gives the CSM the opportunity to build new relationships before the time for renewal. In the absence of regular communication, renewal conversations become more difficult, and churn becomes harder to understand. 

Conclusion

In real estate, the name of the game is location, location, location. In SaaS, it is retention, retention, retention. Driving retention requires an absolute focus and a customer centric organization. At Mindflash, our learning management system is built to help companies enable their customers and end users by offering training on how to best use their product. Software companies like Namely (the HR software provider) and Orion (a software provider to financial service firms) use Mindflash to train their end users, thereby lowering support costs while enabling customers to more easily access critical product information. 

Internally, we’ve also recognized that we need to invest our resources in customer success. As a result, we’ve built a dedicated customer success organization that accounts for over 20% of our employees. This team is involved in every decision that we make – from product roadmap prioritization to helping our marketing organization tell stories of customer success. Our success is predicated on making our customers successful, and my #1 job as our CEO is to ensure that we are achieving that goal.

Please reach out to me at bob@mindflash.com or to our team if you’d like to learn more about how Mindflash can help drive customer success at your software company!

 

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