Churn is the Quiet SaaS Killer

Retention truly is the foundation of growth for software as a service (SaaS) companies, but oftentimes, it is overlooked and undervalued. This is always a huge mistake. High SaaS churn is a corollary of poor retention - but it can creep up unannounced, and rather than deal a single fatal blow, it causes death by a thousand small cuts.

A high churn rate is highly undesirable as it shackles growth, is a source of friction and (rightly) raises tough questions about product/market fit. You need to understand retention and optimise for it.

So just why is retention so vital to the wellbeing, growth and success of a SaaS company? Well, it all comes down to basic economics. Put simply, in most cases, it is considerably cheaper to retain customers than acquire new ones. There’s little point in acquiring new customers if churn is out of control. Think of it like a leaky bucket - you need to fix the hole, rather than continually filling the bucket with more water.

Understanding SaaS Churn

The image below shows how high churn can quickly derail the growth of a SaaS company. If businesses with high churn continue to acquire new customers they’re going to waste time and resource, and have little to show for it.

acquisition-math.png

Source: HubSpot

Retention trumps acquisition
While new client acquisition often captures the attention of business leaders, in my experience, many companies are taking the wrong approach. They overestimate the importance of the initial sale and underestimate the importance of a client’s lifetime value (LTV). Now don’t get me wrong - the sales organisation plays a vital, absolutely vital role acquiring customers, but when you have a services organisation that typically retains clients for several years, you begin to realise that services is where the recurring revenue and big money is made.

In my mind, retention trumps acquisition and Tom Tunguz, venture capitalist (VC) at Redpoint shared five reasons why fixing churn is a better bet than chasing growth. Despite this, most SaaS leaders rank acquisition over retention. While they care about retention, the chart below shows that it’s clearly less of a priority.

acquisition-or-retention.png

Source: ProfitWell

We’ve covered why high churn is undesirable, but let’s turn our attention to why low churn is important and what it means for a SaaS business. Essentially, if you’re acquiring customers, and the rate at which they buy more is greater than the revenue lost from churn, then you’ve built a highly desirable business. A business that doesn’t have to sell anything new, but still grows is the holy grail of SaaS.

The key takeaway is to make tackling churn a priority early on, rather than reacting after the event.

Calculating churn
As I hope you’ll agree by now, churn matters and understanding how it’s calculated is really important. It may not be immediately apparent, but there’s some important differences between monthly and annual churn. Allow me to explain. A 5% annual churn rate means that monthly churn is 0.42%, whereas a 5% monthly churn equates into a hugely troubling 46% annual churn rate. Or put another way, a 5% monthly churn rate means that if you started January with 100 customers you’d only have 54 customers left at the end of December. In order to record any kind of growth you’d have to acquire another 47 new customers. Just think back to the leaky bucket again.

While each industry and company is different, a 5% monthly churn rate isn’t a solid foundation for a SaaS business, and in all honesty a business in that situation should seek to ramp up retention and dial down acquisition. Otherwise, it’s burning through money. High churn becomes even more troublesome if you have a limited total addressable market (TAM) and you’re capturing it quickly - when businesses acquire customers and then lose them, it’s very difficult to re-win their trust and business at a later date.

LTV:CAC for SaaS businesses
LTV:CAC is perhaps the most important of all SaaS metrics, so it’s invaluable to know how churn impacts it. LTV:CAC is the lifetime value of a customer divided by the customer acquisition cost. Looking at these numbers as a ratio helps you understand how effective a business is at making money. You can clearly see what the return will be from every dollar, euro or pound invested. An LTV:CAC of 3:1 is widely regarded within the SaaS industry as the foundation of a solid business (an even greater LTV is better).

SaaS businesses have unique characteristics which means it makes sense for them to be measured differently. They typically incur high up-front costs to deliver products and acquire customers, but follow the path to profitability by retaining and adding customers over time, many of whom upgrade or buy more. SaaS businesses often operate on a subscription basis, so monthly or yearly subscription value is low, but lifetime value is high. This makes retention and keeping a handle on churn absolutely vital.

SaaS growth levers
At a high level, retention matters as there’s only ever three levers to grow a SaaS business:

  1. Increase number of customers

  2. Increase average revenue per user (ARPU)

  3. Reduce customer churn

Let’s take a look at the results businesses can achieve by optimising each lever. Although, the scenarios below are completely theoretical, the table shows how each growth lever acts as a multiplier and that incremental improvements can have a transformational impact on the performance of a SaaS business.

Seemingly small improvements can have a dramatic impact on the health and success of a SaaS company.

Metric

Scenario A

Scenario B

Difference

ARPU

$100K

$120K

+20%

Number of customers

1K

1.2K

+20%

Annual churn rate

10%

5%

-50%

ARR

$90M

$136.8M

+52%

Where SaaS businesses choose to invest their time, energy and money is hugely important. They need to strike the fine balance between customer acquisition, retention and account growth. The best companies understand how to retain customers, all the while increasing ARPU, and once these metrics have created a flywheel effect, they then (and only then) double down on customer acquisition with sales and marketing. That’s the winning growth playbook followed by the leading SaaS businesses.

The importance of customer success
I’m sure it’s abundantly clear by now, but SaaS companies need to invest in some form of customer success. But what should “customer success” include? While it’s hard to generalise, for lower cost products, customer success will likely include self guided education, such as videos, forums and FAQs pages and at the higher end it will mean dedicated staff, such as a customer success manager or professional services, while the middle will take a blended approach.

Businesses need to remember the “services” part of SaaS - too often they forget they’re not just selling software. After all, the act of purchasing software never makes a customer successful. They need education, training and support to leverage it effectively. Once they’ve acquired this knowledge (or hired a third party with it), then and only then, are they on the way to achieving success.

Calculating customer success
One of the best ways to understand the success of your customer base is net promoter score (NPS). It’s an index ranging from -100 to 100 that measures the willingness of customers to recommend a company's products or services.

While NPS may lack detail and qualitative data, it does provide an effective indicator of the health of a client and if they’re a churn risk. For those unfamiliar with NPS, its scoring system means that you’re penalised heavily for a poor rating (0-6 are classified as detractors), receive nothing for mediocre ratings (7-8 are classified as passives) and are only rewarded for high ratings (9-10 are classified as promoters).

net-promoter-score.png

Source: Wootric

What represents a “good” NPS changes between industry and product, however, you should track your own NPS, as well as conduct research to track and benchmark key competitors.

For SaaS businesses to turn a profit they need clients to succeed and continue paying for their products over a long period of time. This is what increases LTV, retention and recurring revenue. By investing in customer success teams to provide strategic guidance, account management and support, businesses are well placed to reduce churn and increase spend per client. Customer success is a vital cog in the SaaS sales engine - it has the potential to generate considerably more recurring revenue than the original sale.

Strategies to help SaaS companies reduce churn
Based on my experiences at HubSpot, Indeed.com and Automation Anywhere, I’ve identified five high impact strategies to lower churn:

1. Develop an integration ecosystem
There’s much data to suggest that integrations with other products help SaaS businesses to reduce churn. This makes perfect sense - integrations often provide customers with more value, which in turn increases usage and gives them more reasons to engage with your product. It’s a virtuous circle, and you should consider building or enabling other companies to build products that integrate with yours.

The graph below shows that customer retention is closely tied to the number of integrations they have - in fact, just one integration has a significant impact on retention.

customer-retention-and-integrations.png

Source: ProfitWell

Integrations are an important weapon in your armour as they give your clients more ways and reasons to use your product - this typically leads to higher usage, which creates more value and often equates to greater retention.

2. Optimise your qualification process
There’s a school of thought which states that only poor fit customers churn. I don’t quite see things as clear cut as that, however, the fact remains - by optimising your qualification process you can screen out poor fit clients early on and defend against churn down the line.

You can get started with optimising your qualification process by looking at the profile of successful customers and unsuccessful ones. Depending on what you uncover it could lead you to take action such as, focussing on targeted accounts like the Fortune 1000, or refining your value proposition. This could mean moving away from being perceived as a money saving product to one that helps companies make money or increases productivity. It could also lead you to targeting people in specific job roles or moving from mid-market to enterprise sized companies.

The key learning here is to recognise that your qualification process needs to be in a continual state of optimisation. There’s no guarantee what worked yesterday will continue to work in the future. You need to understand who wins (and loses) with your product.

3. Increase ARPU with up and cross-selling
There’s a large body of research which shows that higher ARPU leads to less churn. Perhaps understandably, if a client is continuing to spend a high amount of money, it stands to reason they’re deriving value and therefore less likely to churn.

higher-arpu-and-lower-churn.png

Source: ProfitWell

SaaS businesses have two options when it comes to increasing ARPU - they can either upsell, meaning to sell more of the same product, a higher value plan or add-ons. The second way to increase ARPU is by cross-selling, which is to sell a suite of different products to the customer.

Up and cross-selling is important as you’re more likely to be successful selling to existing customers than new ones - the book Marketing Metrics: The Definitive Guide to Measuring Marketing Performance states that the probability of a successful sale with a new prospect is 5%-20%, whereas the probability of a successful sale with an existing customer is a lofty 60%-70%. Again, this makes a lot of sense - you’ve already established trust and credibility with existing customers, so it stands to reason they’d buy from you once more.

selling-to-existing-customers.png

Source: Marketing Metrics

In the interests of fairness, it’s important to understand that higher ARPU deals often have inherent characteristics which help mitigate churn. For instance, it’s not uncommon for larger value deals to have minimum contract lengths, such as 12 months, and in some cases, multi-year. This is often less to do with churn and more typically a reflection of how long it takes for the customer to see value.

By way of example, there are many differences between MailChimp and Oracle Eloqua, and this is reflected in their respective go-to-market (GTM) strategies:

GTM Strategy

MailChimp

Oracle Eloqua

Ideal persona

Small business

Enterprise

Buying process

Touchless

Field sales rep

Price

Low

High

Onboarding

Self-serve

In-person training

Contract terms

Contractless

Minimum 12 month contract

Before implementing a strategy to increase ARPU it’s important to consider your growth stage. If you have 100 customers and your ACV is low, it’s likely a better investment to focus on acquisition, but if you have 100K customers and ACV is low or moderate, then increasing ARPU should be explored.

4. Build a customer success early warning system
As the name suggests, most SaaS companies have a customer success team whose role is to ensure clients succeed and therefore mitigate churn. To achieve this goal, customer success teams need to identify, track and defend against red flag metrics - the numbers which indicate if a client is likely to churn (usage rates, last login date and customer satisfaction are potential examples).

By tracking user behaviour it becomes easier to predict when someone is at risk of churning. Casey Armstrong, chief marketing office (CMO) at ShipBob sums it up well, “Before cancellation ever happens, there are clear signals that a customer is in danger of churning.” He adds, “Engagement lags, and your product or service goes from an everyday occurrence to being used once a week, then once a month. Finally, they decide it’s a waste of money altogether.”

Intercom’s Des Traynor shares a similar outlook, “ Typically customers gradually stop using products, from using it every morning to every week to once a month...At some point down the road you’ll remember you’re paying for something you don’t need and don’t use, and then you ‘churn’, even though the decision was made months ago.”

It’s hard to prescribe exactly what the right red flag metrics will be, (although ZOKRI lists 16 in this blog post) - instead, you should look at customers that have churned and identify trends between them. Then it’s time to act. You need to invest time in both the discovery and then running programmes to defend against red flag metrics.

5. Request an annual or multi-year commitment
One foolproof way to lower churn is by reducing the frequency of renewals - this can best be achieved by requesting an annual or multi-year commitment from clients. The chart below shows that SaaS companies with annual contracts report lower churn than those with monthly contracts - by requesting an annual or multi-year deal over monthly (or contractless), you’re reducing the number of purchasing decisions per year and therefore, opportunities to churn.

annual-contracts-reduce-churn.png

Source: ProfitWell

While this is an effective approach, it obviously needs to be acceptable within your market. The good news is that as SaaS companies grow there’s often a move towards enterprise clients, which typically means larger ACV, as well as switching from monthly billing to annual or multi-year. The chart below shows that products with smaller ACV tend to be on monthly contracts and larger ACV products have multi-year deals.

contract-length-segmented-by-acv.png

Source: SaaS Capital

Once more, you also need to consider your company’s growth stage - if you’re still finding product/market fit, giving customers the option to up sticks and leave each month can provide you with invaluable feedback much more quickly than an annual contract.

It’s also important to understand when is the appropriate time to request a longer commitment. Discounting is a big challenge within the SaaS industry, so companies typically request a longer contract in exchange for giving a discount. Subsequently, understanding how and when to discount is literally one of the quickest and easiest ways to maximise or damage revenue potential. If you do find yourself in a negotiation, it is advisable to take a “give-to-get” approach and request a greater commitment (more product, multi-year contract, payment upfront) in return for a discount.

Although, customer success teams speak with clients day in, day out, increasing retention really is a team sport - each and every employee has an important part to play. The best and indeed, only way to retain clients for the long term is to continually provide value. Like a lot of important lessons, it’s easier said than done, but the leading SaaS companies of today and tomorrow understand that retention is the new frontier of growth. How is your business tackling the twin challenges of reducing churn and increasing the value it provides? The time to act was yesterday.