I recently wrote about the seeds of churn being sown in the first few weeks following the sale. A wise friend and colleague pointed out that often the seeds are actually planted during the later stages of the sales cycle. Buying decisions take on a life of their own, and buyers get wrapped up in their commitment to get “something” done. Sometimes, they fall out of love with their choice before the deal is ever closed, but the deal momentum carries them through to signing. When this happens, they are disengaged before they ever become fully engaged, so the post-sale tasks become even harder.
SaaS businesses focus a ton of attention on new-logo sales. They closely monitor key SaaS metrics such as ‘Customer Acquisition Cost’ (CAC), and the CAC Ratio which measures the relationship between bookings and the sales and marketing expense required to achieve the new revenue. However, once the deal is signed, they metaphorically throw the new client over the fence to the post-sale team. From that point forward, our next important measures are ‘gross retention’ and ‘net retention,’ which do not become visible until long after the deal is signed.
It got me thinking about how vendors allocate their investments to maximize retention and avoid churn. How do companies know if they are adequately investing in their post-sales functions to ensure client satisfaction and avoid churn? According to SaaS Capital’s “2024 Spending Benchmarks for Private B2B SaaS Companies” https://www.saas-capital.com/blog-posts/spending-benchmarks-for-private-b2b-saas-companies/ the median percent of annual recurring revenue spent on customer support and customer success was 8.5%, down from 10% the previous year. The same study found that companies spend about three times as much on Sales and Marketing for customer acquisition.
Every year, SaaS vendors aim to renew and expand their recurring revenue (ARR). Hopefully, there are multi-year contracts in place that auto-renew, but invariably a large percentage of the ARR needs to be re-signed each year. If a SaaS business has been around for a few years, and if they have been relatively successful at retaining customers, then the retention ARR is far bigger than the new-logo ARR. After all, the base is the sum of all of the years of new-logo selling. And yet, on average we are spending one third or less on retention than we are on new sales and marketing.
Simple math tells us that investing to retain a customer is a solid investment. Consider a $100,000 annual revenue account, with a retention expectation of four years. That account is worth $400,000 to the vendor, not to mention upsell potential. At 8.5% average investment, we will spend $8,500 per year to keep the account. Depending on the business, that may be an adequate amount, but if churn is a problem, then we have to view our post-sale investment with a different perspective. It will cost us $50,000 or more to replace the same revenue, so maybe spending a bit more to make the customer happy is a better investment. Understandably, winning a new logo is typically harder than keeping a satisfied customer, but still it seems a bit odd that the investment in retaining the vast majority of the revenue is so much lower than what is spent on new logos.
I suggest that in addition to tracking the gross and net churn numbers, SaaS businesses should also benchmark their investment in retention. My suggestion is a Customer Retention Cost Ratio (CRC). Just as the CAC Ratio measures the relationship between bookings and the sales/marketing expense for new revenue, the CRC Ratio should measure the relationship between renewal revenue and the investment in customer support and customer success. For good measure, we could include any investment in customer marketing, and maybe even the engineering investment in bug fixing. The goal of measuring the level of investment in retention is to complement gross and net retention measures. If retention is dropping, the CRC Ratio will give us a perspective on what we are investing to keep the revenue, and provide a benchmark for comparison to other companies.
From an investor’s perspective, companies with strong customer retention and low CRC should be highly valued, while companies with high CRC and low retention are exhibiting a low value problematic profile. ‘Growth rate is positively and exponentially correlated with net revenue retention. Increasing Net Revenue Retention (NRR) from the 90% to 100% range to the 100% to 110% range improves growth rate by 10 percentage points. Companies with the highest NRR report median growth that is more than double the population median. This is a rare example of increasing returns from investment in upsells and cross-sells.’ (https://www.saas-capital.com/blog-posts/growth-benchmarks-for-private-saas-companies/) It is also estimated that ‘for every 1% increase in revenue retention, a SaaS company’s value increases by 12% after five years’ (https://churnzero.com/churnopedia/net-revenue-retention/) Investing in retention is one of the most capital efficient paths to growth and maximizing value.
The bottom line is that retention is a powerful growth lever, and companies need to be thoughtful about the relationship between what they are investing to retain customers, and their actual rate of retention. Small increases in retention can manifest significant increases in corporate valuation. The Customer Retention Cost Ratio is a tool to understand the relative investment in retention and the impact it is having on revenue.