Right from the Start: Customer Revenue and Retention for SaaS Company Valuation

Transcription

1 Right from the Start: Customer Revenue and Retention for SaaS Company Valuation The prime directive for any new SaaS company is naturally to acquire paying customers, to create the necessary income streams that will fuel the company s growth. Both investors and founders are in full agreement on this point, for the customer acquisition rate proves the business case and provides the revenues that will bring the firm to profitability as quickly as possible. But in the urgency of grabbing market share and building an initial customer base, there is often another decision being made about customers that can also have a very substantial financial impact to all concerned. By postponing dealing with customer retention and account optimization issues from the beginning, SaaS vendors can easily sacrifice half of their company s potential valuation. Avoiding that loss scenario, returning those very real dollars to your bottom line, requires making a strategic choice based on a clear understanding of the nature of the risk and then consistent follow-through by senior management. The Danger in the Dark A fast influx of customers can be a very heady brew for a company. The money is flooding in, and the pressure is on to get everybody on-boarded and up and running. So long as the number of incoming new customers stays high, it s all too easy to overlook or simply dismiss the ones that leave. The thinking is often that we ll deal with turnover later when we have more resources to devote to it. Unfortunately, the negative effect of departing customers begins with the very first one to leave and it doesn t stop. The real results of churn are like compound interest in reverse: the income lost this year is also lost for the years after that. As the months and years roll on, the cumulative value of the lost revenues can more than equal the amount that was retained Mikael Blaisdell All Rights Reserved 1

2 There are a number of ways to look at churn, the loss of customer relationships and the concomitant need to replace them. In the SaaS sector, it s common to hear people talking about churn only in terms of customer accounts. We started with 100 customers at the beginning of the year, and we ended with 99, so our retention rate is therefore 99%. Others will calculate based on the number of subscription seats that were not renewed, or combine the numbers of losses with the numbers of new customers gained. The result of such fuzzy calculations is at best misleading, and the confusion will enable the quiet leaching of value from the company. By postponing dealing with customer retention and account optimization issues from the beginning, SaaS vendors can easily sacrifice half of their company s potential valuation. The clearest view of churn is to present it in terms of revenue retention. How much of your SaaS firm s monthly recurring revenue did you retain this year, and how much was lost? What will the compound effect of the lost revenue be over (typically) five years? These are questions that your CFO can answer precisely, and the answers will provide a starting point for some very important follow-on questions. Why were those accounts and their revenue lost? What could have been done to avoid those losses? A Tale of Two Companies and Significant Money SaaS-Capital [ is a funding company specializing in SaaS firms. To illustrate the substantial harm that churn can do, they developed a model to show the financials of two example SaaS vendors. One had a customer retention rate of 95%, the other only 80%. All other factors (spend on customer acquisition, customer acquisition rate, pricing of subscriptions, etc.,) were the same for both companies, so that the outcomes of the model could zero in on the specific effects of churn. Both Company A and Company B acquire 10 customers per month, each customer generating $1K per month in subscription income. Same cost of marketing, sales; both spend the same amount on retention. They start off on equal footing. What does the picture look like 60 months later? One senior management team would be smiling. The other, not so much. Company A, with a 95% retention rate, is doing very well. They have 532 customers, monthly revenue is $531K, and the annual growth rate is 22%. Contribution after customer acquisition cost is $411, Mikael Blaisdell All Rights Reserved 2

3 Company B, who is retaining 80% of its customer revenue streams, is not looking as well. B has only 381 customers and $381K in monthly revenue. Their annual growth rate is 15%, and the contribution after CAC is only $261, The greatest difference between the two firms, beyond the substantial gap in bottom line contributions, is that Company B s calculated value is around 24 million dollars less than Company A. Here is where the compounding effect of churn can be seen very plainly. The above, of course, is only a model, and it doesn t take all of the possible factors fully into account. The meaning, however, is clear: churn isn t something that a SaaS company can ignore. What s happening down on your company s bottom line? Do you look more like SaaS- Capital s Company A or Company B? No Churn: The Beginning of the Retention Path It s one thing to perceive the damage that churn does to a company s value. Successfully acting on that picture, however, takes some doing. The first required step is a commitment. Deciding to get a handle on churn and taking the necessary steps to effectively manage customer retention are strategic initiatives that require effective senior management leadership. The operational and organizational changes that flow from the decision have to be implemented, monitored and reinforced throughout the company. Without consistent executive vision and support, such efforts are doomed to failure. In order to supply that vision and support, the senior management team must start by acquiring a clear understanding of the key factors that drive churn, and identifying which are the most critically applicable to your company. Research done over the past few years by The HotLine Magazine has revealed that churn in the on-demand industry is the result of four major factors. The first, which opens the door to the risk of churn is the lack of a formally designated and authentically accountable owner of the ongoing customer relationship. Past that point, while there can be many possible reasons for the ending of a customer relationship, there are three major causes that are most often cited as the principal churn-generators in the SaaS industry: Disconnection, the failure to fully adopt the vendor s application, and the downturn or merger/acquisition of the customer s business Mikael Blaisdell All Rights Reserved 3

4 For Lack of an Owner Very few SaaS/Cloud companies have formally designated and authentically accountable owners of their ongoing customer relationships. This ownership gap is a primarily an organizational fault, a holdover from the perpetual license-based software model. While it is often assumed that Sales owns the customer relationship, the typical sales compensation structure virtually assures that sales will always focus exclusively on customer acquisition. After the initial contract is signed, the responsibility for interacting with the customer is passed successively to other teams, each with its own different performance metrics, none of which is about retention. The Implementation group focuses on selling and delivering their professional services. The Training team delivers the content of their courses. Support stands ready to fix anything that breaks while Operations keeps the application available within the specifications of the service level agreement. Sales, meanwhile, returns to its prime function, and will most likely not re-engage with the customer until closer to renewal time. It is within the cracks of this complex customer management structure that the ownership gap emerges and exposes the company to higher risk of churn. Another effect is that no one is responsible for analyzing the customer base to determine value tiers, usage trends and renewal patterns Mikael Blaisdell All Rights Reserved 4

5 Designating ownership for each customer relationship is inherently proactive. Waiting for a customer to express dissatisfaction, ask for help, or only reaching out to customers at renewal time is a very risky strategy. When no single individual or team in your organization is truly accountable for maintaining the customer relationships, the stage is set for unpleasant surprises. The Disconnected Relationship Any disconnection between your company and the customers decision-makers and influencers is potentially lethal to customer relationships in the SaaS/Cloud model. By definition, no SaaS or subscription-based sale is ever final. Whether at the end of the first year, two years or three however long the contract term the issue of renewal will arise. In many cases, however, the decision to extend or end the relationship has been made long before the contract term is up. The strength of your relationship with your customers will determine if you find out about issues that will affect your revenue before it s too late. Typically, when a customer has elected to depart, their data will have already been migrated to a new solution before the end of the contract and all that remains is to inform you that there will be no renewal. If a key decision maker or proponent has left the organization without your notice the account relationship may suffer when new or uninformed parties begin to make decisions about your solution. Regardless of the reason for a disconnection, if your organization is not fully focused on retention, the notice of the intent to not renew usually takes place when the sales team attempts to re-engage for renewal. By then, it s too late. To avoid disconnection in the customer relationship, it is recommended that your designated account team periodically check in with your sponsor at each customer. If a key stakeholder or sponsor has changed, try to reach the prior sponsor first. They can be a wealth of knowledge about the real status of the application, the new person in charge of the relationship, and if they have left the organization, one of your best new leads to hand back to Sales. If your accounts are too small to do direct outreach, monitor changes in addresses for your customer contacts and generate regular campaigns to engage new users. Failure to Fully Use/Adopt It is not hard to identify the retention risk for a customer who has contracted for 100 licenses but is only actively using 10 licenses. When renewal time rolls around, if the contract is renewed at all, it almost certainly will be renegotiated for a sharply reduced number of licenses and lower fees. If only a fraction of the purchased seats is in use at a given client, the time to address the issue is soon after implementation or with not training, not right before renewal Mikael Blaisdell All Rights Reserved 5

6 Our research has also revealed substantial reductions in churn if the customer goes through a formal implementation by either the vendor or a third party. For many SaaS companies a formal implementation is required, but in cases where it is optional, the vendor should factor in the long-term benefits of getting it right up front. Any investment a SaaS company makes during the original implementation may pay for itself many times over in improved retention. A metric we have seen SaaS companies use to measure usage and adoption is (total usage)/(total possible usage). The units differ by application, but for some it is as simple as a count of (sign-ons)/(seats) that is tracked and reported daily. However, individual license logons are not the only usage metrics that need to be tracked and understood in order to reduce your churn. We explore other key metrics in the Customer Intelligence section of this white paper (see below). Downturn / Mergers & Acquisitions Any investment a SaaS company makes during the original implementation may pay for itself many times over in improved retention. The tough economic climate over the past few years has had significant impact all across the industry. Companies have had to downsize; many have closed their doors and gone out of business entirely, while others have been acquired. All of these factors will affect their relationships with a SaaS application vendor. The loss of a major customer can require a company to scale its operations back sharply. Reducing the number of employees in turn means that their former employer needs fewer licenses for business applications. If a company is acquired, it s very common to find that the acquiring company will want the new acquisition to make changes in their IT structure. In all of these three major churn-generators, timing can be crucial. The earlier that the at-risk condition is detected, the more options there are likely to be for avoiding the loss. Alerts still require effective action, however, and that means that there needs to be the kind of organization that knows how and is able to respond. Creating the No-Churn Organization Once the senior management team makes the strategic decision to address churn seriously, the process of implementation begins. The key milestones include: Creating an owner of the customer Building the supporting organization Developing customer intelligence 2012 Mikael Blaisdell All Rights Reserved 6

7 The Chief Retention Officer The customer owner, by whatever title, must be a member of the CxO team, reporting directly to the CEO and with equal (if not greater) status with the senior Sales exec. The prime performance metrics for the new role should be increasing customer retention and optimizing per-customer profitability. Under this model, whenever a new contract is signed, the new role assumes responsibility for the customer relationship. Simultaneously, Sales disengages completely, and the customer management group takes full charge for as long as the customer remains active. While the investment required to retain a true customer relationship executive may seem daunting, especially in the early stages of a SaaS/Cloud company, much of the cost will be offset by improved retention and increased revenues. The Retention Organization With a true customer relationship owner in place, the next step is to build an effective supporting organization. This task is not about hiring additional resources; it is much more concerned with properly deploying and utilizing the team you already have. Many of the basic functional disciplines of a sound relationship-management group are probably already in place: Implementation/Professional Services, Training, Customer Support and user-level Quality Assurance. Customer Intelligence (discussed below) may need to be created in some companies. All of these seemingly discrete disciplines need to be pulled together into a single team with specific retention goals will create an organization that has the resources and focus to substantially reduce churn. Customer Intelligence It s what you don t know about your customer relationships that can cause you to lose them. Failing to properly use the information you have is another recipe for disaster. There is already a lot of knowledge about your customer relationships to be found in the application databases of the various customer-facing team members. All of the information about your customer and its employees that Marketing & Sales gathered during sales process is still of enormous value. The Implementation team should have records of their interactions as they took the customer to go-live, as did the Training team afterwards. Support reps tend to learn a great deal in the process of handling their cases about usage and individual users, as well. All of this existing knowledge needs to be synthesized and made accessible for analysis Mikael Blaisdell All Rights Reserved 7

8 Adding to that data, most of which you already have, is the actual usage data of the application itself. In addition to simple login data, which should be closely monitored and analyzed, every application has a number of key features at its core. If It s what you don t know about your customer relationships that cause you to lose them. these features are not used, there is no value to be gained from the subscription. One of the main advantages of the SaaS model over the traditional onpremised approach is that the on-demand distribution allows you to see in real time what the customers are, (or are not!) doing with the application s features and functionality. While most SaaS applications were simply not designed to support such monitoring, there are currently five vendors offering bolt-on solutions that enable feature usage tracking. Customer intelligence in and of itself, however, is of little value if there is no one in the organization that also owns the monitoring and interpretation of the data. If you wish to fully understand churn, it is important that your Customer Retention team be able to tell you: Which are the key features and functions of the application that are most used by the most valuable or stable customers? What does a healthy customer adoption curve look like? What is the profile of our prime or most profitable customer? Which specific customer behaviors reveal opportunities for secondary sales? Perhaps most importantly, which behaviors are reliable early-warning indicators of an at-risk state? Creating an owner of the customer and giving them the tools to truly understand the customer s needs and usage patterns will allow them to build stronger relationships and drive deeper adoption Mikael Blaisdell All Rights Reserved 8

9 Moving Forward SaaS companies come in all shapes, sizes, and stages of development and all have inherently different levels of churn. What we set out to understand better in this paper is the quantifiable impact of that churn, and what can be done about it. In summary, while you can tinker with the math, a company s valuation is highly sensitive to changes in renewal rate because it impacts all the drivers of the company s value. Any reduction in churn will have a multi-million dollar effect on valuation in a relatively short period of time. There are concrete steps SaaS organizations can take to reduce churn. They should align the organization to have a comprehensive view of the customer from Sales, to support, to actual application usage. There should be a single team or person accountable for churn measurement, reporting and outcomes. Finally, companies should proactively monitor and maintain key relationships at the customer and react quickly to changes in personnel. Mikael Blaisdell Mikael Blaisdell is the leading voice in the SaaS/Cloud sector on the strategy, process, people and technology of customer retention and increased per-customer profitability. Drawing upon the experience of more than 30 years in the support/service field, he provides a range of consulting services for SaaS/Cloud firms of all types and sizes, especially in the area of the emerging profession and practice of Customer Success Management. Publisher of The HotLine Magazine, Mikael's vision and commentary about how companies can optimize customer relationships is read in over 135 countries around the world. He is also the Moderator of The Customer Success Management Forum on LinkedIn, and leads the monthly CSM Forum gatherings in the San Francisco area and elsewhere. Contact Mikael@mblaisdell.com (510) Alameda, California Twitter: MikaelBlaisdell Mikael Blaisdell All Rights Reserved 9