Subscription Scorecard Metric Deep Dive: Cost of Customer Retention

Transcription

1 Subscriptin Screcard Metric Deep Dive: Cst f Custmer Retentin Perspective by Waterstne Management Grup Andrew Lulusis, Manager Aman Singh, Senir Assciate September 2016 Chicag San Francisc (877)

2 Chicag San Francisc (877) Subscriptin Screcard Metric Deep Dive: Cst f Custmer Retentin At Waterstne, ne f the mst frequent questins that we field when helping cmpanies implement r update their subscriptinriented measures is, Hw shuld we calculate these metrics? T help answer this questin, Waterstne is develping a series f papers that explre varius Subscriptin Screcard metrics in depth. In this installment, we explre the different ways t calculate retentin, the value f higher retentin, and hw t determine the cst f custmer retentin. Why Retentin Is Imprtant In ur previus paper Subscriptin Screcard Metric Deep Dive: Custmer Lifetime Value (CLTV) and Custmer Acquisitin Cst (CAC), we examined the cst and benefit f acquiring new custmers. In that paper, we saw that a larger prtin f a custmer s value t a cmpany depended n having a lng and prfitable relatinship with that custmer. The Subscriptin Screcard T better gauge, drive, and predict the value f subscriptin businesses, Waterstne develped the Subscriptin Screcard. This re-balanced screcard is centered arund the custmer and takes int accunt the unique nature f the subscriptin mdel, where recurring revenue and grwth drivers matter the mst and nnfinancial-statement metrics have increasing weight. In the subscriptin ecnmy, cmpanies must ensure that they are retaining and maximizing value frm their existing custmers. As a result, SaaS cmpanies need t enhance their understanding f what their retentin actually is and hw their spend shuld be allcated twards maintaining and imprving that custmer retentin. The ability t cst effectively retain custmers can be a testament t bth the natural stickiness f a business and a cmpany s targeted investment, rganizatinal, and peratinal decisins. Befre we delve int the cst f retentin, we first need t understand hw SaaS cmpanies currently reprt n retentin metrics. Cmpanies determine and assess their retentin measures Within each f the fur fcus areas, there key metrics that shuld be tracked. This paper explres tw f thse metrics: custmer lifetime value and custmer acquisitin cst. in a variety f ways, depending n what aligns best with their business mdel. Sme cmpanies may fcus n the number f custmers churned, while thers may fcus n the actual dllar value retained. Furthermre, cmpanies typically chse t measure these metrics ver a pre-defined time perid in rder t reduce the statistical variance arising frm a specific custmer event, such as a user add r cancellatin. In the fllwing pages, we nte the drivers f retentin and utline three different ways t calculate it. Cpyright 2016 Waterstne Management Grup LLC. All rights reserved. Page 2

3 Chicag San Francisc (877) Methd 1: Custmer r Lg Retentin Rate We define custmer r lg retentin as the rate f renewal f custmers ver a given time perid. Fr a given custmer chrt, it will track the number f custmers that still remain at the end f a given time perid ut f the ttal number f custmers signed at the beginning f that perid. This rati is typically expressed as a percentage and usually ranges frm 70% t 99%: # f Custmers t current perid # f Custmers t previus perid Fr example, if a cmpany signs 100 custmers at the beginning f the year and 95 f them chse t renew their subscriptins at the end f the year, then the custmer retentin rate is 95% with a 5% churn. As a real-wrld example, Carbnite is a publicly traded cmpany that chses t reprt its annual retentin rate (96% in ) n a custmer basis. Carbnite specifies its calculatin as the percentage f custmers n the last day f the prir year wh remain custmers n the last day f the current year, r fr quarterly presentatins, the percentage f custmers n the last day f the cmparable quarter in the prir year wh remain custmers n the last day f the current quarter. 2 Methds 2 & 3: Dllar Retentin Rate Grss and Net Dllar-based retentin is defined as the recurring revenue at the end f a defined perid divided by the recurring revenue fr the same client base at the end f the prir perid. Again, this is typically calculated n a mnthly, quarterly, annual, and/r chrt basis. Methd 2: Grss Dllar Retentin Grss dllar retentin r renewal rate is similar t the custmer retentin rate; it examines the ttal annual recurring revenue (ARR) dllar amunt signed at the beginning f a given perid against hw much f it still remains at the end f that perid. It is calculated as fllws and is reprted as a percentage, which typically falls between 70% and 99%: $ Recurring Revenue t current perid $ Recurring Revenue t previus perid Fr example, if a cmpany signs $500 in ARR frm a chrt f cmpanies at the beginning f the year and then renews $450 f that initial ARR at the end f the year, its grss dllar retentin rate is 90% ($450 / $500). As a real-wrld example, ServiceNw reprts its retentin metric n a dllar basis, excluding the benefit f upsells. Its grss dllar retentin rate was 97% as f mid ServiceNw calculates this retentin rate by subtracting ur attritin rate frm 100%. Our attritin rate is equal t the annual cntract value frm custmers that are due fr renewal in the perid and did nt renew, divided by the ttal annual cntract value frm all custmers due fr renewal during the perid. 4 Other cmpanies, such as Ultimate Sftware, reprt their retentin metric similarly. Cpyright 2016 Waterstne Management Grup LLC. All rights reserved. Page 3

4 Chrt ARR Chicag San Francisc (877) Methd 3: Net Dllar Retentin Sme cmpanies may chse t reprt net dllar retentin, which builds ff f the grss dllar retentin methd. In additin t the grss renewal amunt f the starting ARR dllar amunt, this calculatin als accunts fr upsells, crss-sells, and ther expansin revenues. This will generate the higher retentin rate f all three methds and can ften be ver 100%. $ Recurring Revenue (incl. Expansin Rev) t current perid $ Recurring Revenue (incl. Expansin Rev) t previus perid Fr example, if a cmpany signs $500 in ARR frm a chrt f cmpanies at the beginning f the year, renews $450 f that initial ARR, and sells an additinal $100 f new recurring revenue t thse same remaining custmers, then its net dllar retentin is 110% ($550 / $450). As a real-wrld example, Zendesk calculates its dllar-based net expansin rate by dividing ur retained revenue net f cntractin and churn by ur base revenue. Its retentin rate was 123% at the end f Impact f Retentin n ARR T demnstrate the magnitude f impact that retentin has n recurring revenue, we present a simple example: Let s say we have 100 custmers within a chrt with an average ARR f $5M per custmer fr a ttal starting ARR f $500M. If we cmpare the difference between 96% and 94% grss dllar retentin, we see the resulting year-by-year deviatins in ARR retained belw: ARR Impact f Custmer Retentin Differences $500 $400 $300 $200 $ Years After Custmer Acquisitin Full Retentin 96% Retentin 94% Retentin After 1 year, the 96% retentin has $10M mre in ARR; after 5 years, the gap accelerates t $41M, and after 10 years, the difference grws t $63M in ARR. Cumulatively, thse differences result in lst Cpyright 2016 Waterstne Management Grup LLC. All rights reserved. Page 4

5 Chicag San Francisc (877) revenues f $131M ver 5 years, and $408M ver 10 years. The key lessn here is that a relatively small increase in custmer retentin can translate int a very large revenue pprtunity ver time. Nw that we can see the value assciated with higher retentin, it is imprtant fr cmpanies t understand what activities are cntributing t that retentin value, hw much these activities cst, and hw t strategically invest in prfitable retentin. Cst f Custmer Retentin (CCR) One f the challenges with fcusing n retentin is understanding hw much mney is currently being invested (r shuld be invested) n retentin effrts and what specific functins and activities thrughut the custmer lifecycle are actually driving custmer renewals/expansins. The cst f custmer retentin (CCR) represents all f the nging csts assciated with retaining custmers (and expanding within this installed base) fr a cmpany. Detailing which csts shuld be attributed t retentin will vary by cmpany maturity and perating mdel; hwever, we will highlight sme general cnsideratins and methds t help yu determine the applicable csts fr yur business. Cst f Custmer Retentin Simple Methd CCR = Accunt Management (AM) Csts AM Time Allcated t Retentin Activities (%) This calculatin methd fcuses n the accunt management r sales activities directly related t retaining custmers; typically, this invlves cmmunicating with custmers, negtiating renewal terms, and executing the renewal transactin. Wh perfrms these activities will vary by cmpany; fr example, it culd be the assigned accunt manager, sales representative, r a dedicated renewals team. The majr drawback f this methd is that it fcuses primarily n sales activities and the renewal transactin, bth f which nly take place fr a small part f the custmer s relatinship with the cmpany; it misses many f the n-ging investments that a cmpany makes in building and maintaining a successful custmer relatinship and high satisfactin. Sales/Accunt Management & Custmer Retentin Sales is typically the primary cntact fr establishing and maintaining custmer relatinships Amunt f time spent addressing needs f existing custmers (e.g., mnitring business value, negtiating/executing renewals transactins, handling ther inquiries) versus time spent with new custmers can be cunted twards custmer retentin csts Retentin-fcused activities f Sales team will vary depending n the ther functins that rganizatins utilize (e.g., in situatins where a dedicated Renewal team exists, Sales is still likely t be invlved in develping renewal strategies, etc.) Cpyright 2016 Waterstne Management Grup LLC. All rights reserved. Page 5

6 Chicag San Francisc (877) Analysis f Custmer Retentin Csts Cmpanies vary significantly with regards t the functins, prgrams, and tls they use t drive retentin. Belw, we have detailed sme f the cmmn elements acrss these three categries that may be tied t driving retentin. Detailed descriptins f each cst categry can be fund in the appendix. Additinal Custmer Retentin Csts Labr Csts Prgrams & Training Retentin Tls & Tech Sales/Accunt Management Webinars Custmer Prtal Renewals Team Wrkshps Custmer Health/Mnitring Custmer Relatinship Resurces Training Custmer Success Platfrms Custmer Success Prgram Cmmunity Engagement Campaign Management Tls Relatinship Marketing Advcacy Prgrams Retentin-fcused labr activities extend beynd the pint f renewal t encmpass the entire custmer lifecycle. Prgrams and tls are put in place t supprt these retentin effrts acrss the lifecycle. Cmpanies shuld expand n the baseline cst f retentin calculatin methd nted previusly and apply the retentin elements that are relevant fr their business t yield a mre accurate picture f retentin spend. Sme key cnsideratins fr determining yur cst f retentin include the fllwing: Allcating time/resurce spend fr retentin desn t need t be exact, but it shuld be thught ut and cnsistent n an nging basis. It is als imprtant t match all csts frm a timing perspective. Sme f these csts (in particular labr csts) may vary by custmer segment/tier; in such cases, yu may want t split ut csts t get a mre detailed picture f yur retentin spend. This granularity can be imprtant when cnsidering future investments. Custmer retentin csts shuld be cnsidered t be nging/annual. There may be timing cnsideratins fr sme f these (e.g., tls/tech may be a ne-time fee r require larger upfrnt investments). Hwever, n an annual basis, many f these csts (e.g., prgrams & training) will remain cnsistent. Labr csts may vary based n where an individual custmer is in its lifecycle; hwever, in aggregate (fr a mre mature cmpany), these csts shuld average ut ver time. Yu can chse t include separate expansin activity csts as well, but it is imprtant t remain cnsistent in calculating and analyzing. Cpyright 2016 Waterstne Management Grup LLC. All rights reserved. Page 6

7 Chicag San Francisc (877) Cst f Custmer Retentin Alternative Methds Once yu ve develped the full view f hw much yur cmpany is spending n retaining custmers, yu can determine the average cst f retaining ne custmer. T perfrm this calculatin, we recmmend the fllwing: Annual Cst f Retentin per Custmer = Annual Cst f Retentin (per previus calc. ) Ttal # f Custmers This calculatin is usually brken ut by custmer segment, size, r prduct. Again, the annual cst f retentin and ttal number f custmers need t align in terms f the segmentatin used (as wuld the lifetime value). We use ttal number f custmers because, inherently, yur retentin effrts are geared twards keeping every existing custmer frm the day they first start using yur prduct r service. If needed, yu can als extraplate this annual cst t reflect the ttal cst f retaining a custmer ver its lifetime by multiplying this annual number by the expected custmer lifetime. Cst f Custmer Retentin Rati (CCR Rati) It is imprtant fr cmpanies t understand the value being driven by their retentin effrts relative t the cst f thse effrts in rder t gain insight int current peratins and infrm future investments and strategy. The challenge f matching renewal revenue t the assciated csts is that they ften dn t ccur in the same quarter r even year. Fr example, if a new custmer signs a 3-year cntract at the beginning f Year 1, varius retentin activities, prgrams, and tls will likely be leveraged and maintained each year leading up t renewal at end f Year 3. If the custmer renews, the rewards f the nging retentin effrts wuld be reflected in the renewal cntract, with revenue being recgnized after Year 3. As a result, the timing f the retentin csts and the renewal revenue d nt line up n a per custmer basis. In rder t mitigate this issue, we lk at nrmalizing the average renewal cntract value per custmer and the cst f retentin per custmer n an annual basis. This helps t align the revenue and csts n a per custmer basis, setting things up fr further analysis. One methd fr ding s is designed t illuminate, n average, hw much value are yu deriving frm yur retentin spend annually per custmer. T d this, we take the grss prfit f an average custmer renewal cntract (annualized) and divide it by the cst f retentin per custmer (annualized): Average Annual Renewal Cntract ($) x Grss Margin (%) Annual Cst f Retentin per Custmer ($) This rati tells us the amunt f grss prfit generated annually per custmer fr $1 f retentin spend. Cpyright 2016 Waterstne Management Grup LLC. All rights reserved. Page 7

8 Chicag San Francisc (877) Retentin Prfit Rati Example Year 1 Renewal Avg Cntract Value (ACV) Grss Prfit Avg ACV ($M) $5 Grss Margin % 80% ACV Grss Prfit $4 Avg Annual Cst f Retentin per Custmer ($M) $1 CCR Rati 4 Yu shuld have a rati that is greater than 1, shwing that yu are prfitably retaining custmers n an annual basis. It s typical fr cmpanies t reach r exceed a rati f 3x. If yur cmpany is belw 3, then we wuld suggest digging int yur custmer retentin effrts acrss the entire custmer jurney t ensure yu are perfrming the right activities and investing wisely. If yur rati is high, typically ver 10x, then yu shuld ensure that all retentin activities and csts are being allcated crrectly. Key Cnsideratins fr CCR Rati Sme f these cst categries may als functin as revenue drivers (e.g., training); in such instances, need t make sure the assciated csts are accunted fr (if nt already part f COGS/GM%) Csts may differ by custmer segment/tier; in such cases, it may make sense t split ut the calculatin accrdingly, e.g., (ACV fr Tier X * GM fr Tier X) / Cst f retentin fr Tier X Upsell/x-sell may be reflected in renewal cntract value; need t ensure alignment with csts (e.g., it is kay if yu are attributing csts that are inherently tied t bth renewals and expansins) Des nt highlight verall effectiveness f renewal spend given it is dne n a per custmer cntract basis This apprach can and shuld be adjusted fr yur cmpany and will vary based n factrs such as custmer segment, prducts, etc. One adjustment that cmpanies make is t re-calculate the grss margin % used in rder t remve any retentin csts that are included in the csts f gds sld (COGS) and wuld thus already be accunted fr in the grss margin %. Fr example, if the Custmer Success team is included in the prduct COGS versus Sales and Administrative csts, it shuld be pulled ut when calculating the grss margin % t avid duble cunting. Cmpanies als need t be cgnizant f the term f a renewal cntract versus the riginal cntract term. The lnger yur initial cntract, the lnger yur renewal term shuld be in rder t recup the retentin csts accrued and investment made in building the custmer relatinship ver the initial term. Fr example, let s cmpare a 3-year initial cntract and a 1-year initial cntract bth renewed fr 1 year. The ttal retentin csts accrued ver the 3-year cntract wuld be greater than the retentin csts fr the 1-year cntract fr the same renewal grss margin, resulting in a lwer cst f custmer retentin rati fr the 3-year cntract. Cpyright 2016 Waterstne Management Grup LLC. All rights reserved. Page 8

9 Chicag San Francisc (877) Cnclusin The guidance abve serves as a starting pint and reference fr cmpanies seeking t gain further insight int their retentin effrts and pprtunities. As cmpanies scale and becme mre mature, ne wuld expect mre emphasis and spend t be allcated twards retaining custmers. Gaining visibility int what activities cntribute t retentin and hw they shuld be accunted fr is a challenging exercise that can vary significantly by cmpany depending n factrs such as perating mdel, rganizatinal structure, strategy, and maturity. It is imprtant t have a clear understanding f these csts and t be methdical and cnsistent in capturing them. Ding s allws cmpanies t further analyze the relative value a cmpany s verall business (r chrt, prduct, gegraphy, etc.) is deriving frm retentin effrts and use this infrmatin t infrm future decisins such as what segments t fcus n, what the budgetary mix fr acquisitin versus retentin shuld be, etc. In future installments f the Subscriptin Screcard Metric Deep Dive series, we will highlight ther metrics that can help yu better manage, infrm, and drive yur subscriptin business. T ensure yu receive them, be sure t subscribe t ur quarterly newsletter, Waterstne Currents. Waterstne Management Grup helps technlgy cmpanies and investrs create measurable value by identifying and capitalizing n disruptive grwth pprtunities and driving excellence in Services, Clud, and Custmer Success perfrmance. Shuld yu have any questins n this tpic r wish t learn mre abut the Subscriptin Screcard verall and hw it can be used t maximize Custmer Success and drive crprate value within yur rganizatin, please cntact: Andrew Lulusis, Manager (312) alulusis@waterstnegrup.cm Aman Singh, Senir Assciate (312) asingh@waterstnegrup.cm 1 Carbnite, Inc. FQ Earnings Call, May 3, Carbnite, Inc. 424B4, Octber, ServiceNw, Inc. Q Earnings Call, July 29, ServiceNw, Inc. 424B4, June, Zendesk, Inc. Q Earnings Call, February 16, 2016 Cpyright 2016 Waterstne Management Grup LLC. All rights reserved. Page 9

10 Chicag San Francisc (877) Appendix Labr Csts These are functinal labr csts that are designed t capture the resurces that engage in retentinfcused activities thrughut the custmer lifecycle. These can range frm whle teams with a dedicated retentin fcus (e.g., Custmer Success) t designated individuals within a brader team wh execute n targeted retentin activities (e.g., Relatinship Marketing). Renewals Can be a designated team r existing functins respnsible fr develping accunt renewal strategies and frmally executing n renewal transactins and negtiatins. Depending n the rganizatinal structure f a cmpany, the Renewals team may wrk directly with Sales and Custmer Success. Custmer Relatinship Resurces Respnsible fr strategic planning and assciated practive custmer engagement. Activities can include executive business reviews, aligning prduct radmap with custmers business gals, prviding additinal resurces t maximize prduct value, etc. These activities may be captured by anther team (i.e., Custmer Success) depending n the rganizatin, and the title f these resurces can vary. Examples f this functin may include accunt managers wh fcus n sales pprtunities fr upsells and crss-sells, practive relatinship managers wh are mnitring adptin, health scres, etc., and supprt functins that fcus n escalatins and making sure custmer requests are handled prperly. Custmer Success Prgram designed t ensure custmer value is being delivered pst-sale. This rganizatin generally has a dual mandate: drive retentin and adptin. It achieves these gals thrugh a variety f prgrams, tuchpints, and reviews designed t maximize the custmer experience. This grup can include Custmer Success directrs, managers, and peratins (i.e., sub-team that perfrms supprting Custmer Success activities such as develpment f cllateral, delivery f scalable prcesses/activities, etc.). Nte that while Custmer Success als has respnsibility fr upsell and crss-sell, depending n the maturity f the cmpany, ne can assume that the bulk f its activities are retentin driven; ftentimes, Custmer Success managers (CSMs) identify expansin pprtunities while the Sales team will execute. Relatinship Marketing Marketing functin fcused n maintaining and enhancing existing custmer relatinships with an ultimate gal f retaining these custmers and expanding within an accunt via targeted marketing utreach. An example f a relevant activity is an campaign t existing custmers t prvide supprting nbarding resurces, cmmunicate best practices, and highlight new releases. If marketing des perfrm these activities, it may be Cpyright 2016 Waterstne Management Grup LLC. All rights reserved. Page 10

11 Chicag San Francisc (877) Prgrams and Training reflected by either designated resurces as part f the brader Marketing department r by a separate Relatinship Marketing team. Hwever, these activities can be perfrmed by ther functinal resurces/teams (e.g., Custmer Success, Training, etc.) depending n the cmpany. These are direct csts assciated with prgrams and training designed t supprt custmer retentin. These can be reflective f specific initiatives r can be used t supprt resurces in their custmer retentin effrts. Webinars Csts assciated with setting up webinars fr custmers t utilize n demand r thrugh virtual instructr-led curses. These webinars are ften assciated with supprting resurces n a custmer prtal and are typically nt mnetized. They can include tpics such as best practices fr prduct usage, new features, etc. in rder t drive adptin. Wrkshps Wrkshps can cver a variety f tpics t help supprt custmer retentin. Depending n the tpic, they can be delivered by a variety f functinal resurces (e.g., Prduct Manager fr a technical prduct deep dive, Training fr train the trainer sessins, etc.). Training Training csts may be wrapped int ther retentin cst categries such as wrkshps and webinars, r can be reflective f the labr and material csts assciated with designated training prgrams/educatin paths. Many cmpanies sell training credits that can be redeemed by custmers fr specific tpics (i.e., cmpanies may recmmend educatin paths based n prducts purchased and business needs). Cmpanies can als ffer ther prgrammatic training such as adptin enablement (time t value/rapid implementatin), accreditatin prgrams, and thers. These ultimately help enable custmers in their use f the prducts and supprt verall custmer health, leading t higher retentin. Cmmunity Engagement and Advcacy Prgrams Cmmunity engagement can include prgrams/initiatives designed t facilitate custmer interactins and enable pprtunities t address issues, drive lyalty, etc. Sme f these initiatives can include peer-t-peer sessins, end-f-year cnferences, and lyalty/rewards prgrams. Furthermre, many cmpanies als ffer advcacy prgrams designed t drive lyalty, develp custmer insights, and prmte referrals. Csts assciated with these initiatives can include set-up fees, campaign management, etc. Cpyright 2016 Waterstne Management Grup LLC. All rights reserved. Page 11

12 Chicag San Francisc (877) Retentin Tls and Technlgy Technlgy and tls directly enable and supprt retentin effrts, ranging frm practive identificatin f custmer needs t driving scalable prcesses t engage with all custmers. The csts assciated with these tls can vary, but wuld likely be in the frm f sftware/hardware subscriptins r licenses. There may als be incremental csts fr things like hsting, supprt, maintenance, integratin, and resurces wh manage these tls (if nt captured in the labr csts abve). Custmer Prtal Custmer prtals are ften ffered t custmers as a hub fr n-demand resurce access (e.g., nline training, cmmunity frums, key annuncements, etc.). Custmer Health/Mnitring A custmer health/mnitring tl (e.g., dashbards) serves t prvide visibility int renewal risk and prduct adptin/usage. These can take the frm f stand-alne technlgy fferings r custm tls (e.g., excel spreadsheets) that aggregate and analyze relevant infrmatin. Existing CRM/incident management and reprting/analytics platfrms may als be leveraged. Custmer Success Custmer Success-specific platfrms may be used by CSMs t manage the pst-sale custmer relatinship (e.g., custmer health scres, key actins/playbks, reprting, etc.). Campaign Management Tls fr ne-t-many cmmunicatins (e.g., campaigns) are als likely t be utilized in custmer retentin effrts. These csts may fall under a specific rganizatin, such as Marketing, but a determinatin can be made n hw much it is being used fr retentin versus custmer acquisitin t prperly allcate csts. Cpyright 2016 Waterstne Management Grup LLC. All rights reserved. Page 12