In several courses that I am doing in this semester – most of them related to marketing field – Marketing Strategy, Data Driven Marketing, Consumer Behavior and one of my favorite – Design thinking, there is one underlying theme – “Customer”. It should not be surprising because in today’s world customers have lot of power in their hand and businesses make money by delighting their customers.
The way companies sell enterprise software products over the years have undergone significant changes. One such change is Software as a Service (SaaS). In such business models, the service providers generate revenue through subscriptions. It is very different from traditional models, where service providers used to just charge upfront for the services and then go through installation. A subscription model gives customers flexibility to terminate their subscription if they are not satisfied. This has made companies to improve their customer support and constantly innovate to provide best services so that they can avoid customers switching to their competitors. In order to track growth and performance, companies keep track of several metrics which measure subscriber growth, revenue generation and long term value of its customers.
There are few metrics that are key in SaaS or subscription based business models:
- Monthly Recurring Revenue (MRR)
- Average Revenue Per User (ARPU)
- Churn Rate (R)
- Customer Acquisition Cost (CAC)
- Customer Lifetime Value (CLV)
Although we can use a complex formula to come up with the CLV using the growth and discount rate, much simpler back of the envelope calculations are useful in determining upper limit on acquisition cost and where if any improvements can be made. A simple formula to calculate the CLV would be :
CLV = ( M × MRR ) ⁄ R
where, M = Percentage Margin
We can clearly see that Monthly Recurring Revenue (MRR) and Churn Rate (R) drives the Customer Lifetime Value (CLV), assuming Percentage Margin (M) does not change a lot. But what is more important is that compared to MRR, churn rate has significant impact on CLV even with minor fluctuations. To help get my point across, let’s use a hypothetical company example. Let’s say the company has 100 customers at the beginning of last month and on average monthly revenue per customer is $400. The data shows that 3 of the customers cancelled subscription in the last month. Therefore with the MRR = $400, R = 3% and M = 70% (assumed), the lifetime value of a customer would be:
CLV = (70% x $400) / 3% = $9,333
If someone asks you, how long customers are staying with the firm, then with the above churn rate you can say 33 months (using 1/3%). Now, to measure CLV’s sensitivity to churn rate, let’s just change the churn rate by only 0.2%. We see that if the churn rate decreases from 3% to 2.8%, the CLV jumps to $10,000 from $9,333, which is an increase of $667. If we were to use the MRR lever to have the similar jump in CLV, keeping others constant then the MRR should increase from $400 to $429, a change of around 7%. Clearly, this shows that churn rate is much powerful lever to move CLV.
This help us prove that customer retention is very important to build a sustainable business. That is where the idea of “Customer Success” comes into the picture. It is important to acquire new customers, but what is even more important and often neglected is to retain customers. Especially in startups when the focus is on acquiring more and more customers, the company can drive more value and avoid need to raise more capital by making sure that they are able to retain as many customers as possible. Companies have realized the importance of post-sale relationship with customers and have started focusing on customer success. I looked for “customer success” on Google Trends just to find out the level of interest on this topic.
From the above chart, we can see that in the last one year there has been a surge of more than 40%. This shows that people are increasingly looking for “Customer Success” as an approach to drive retention and mitigate churn. Many companies these days have customer success managers (CSM) and all the way up they have Chief Customer Officer. Customer Success Manager’s job is to establish an enduring relationship of the company with the customer. Note that they come into picture post-sales. CSM must be proactively reaching out to customer when they find that customer’s product adoption is decreasing, which could mean that they are at a risk of churn. On the other hand, if CSM finds out that the customer seems to be engaged and really happy with the product, they could try to up-sell, which will increase the MRR.
Any business grows in four ways – Acquisition, Retention, Up-sell, Cross-Sell. In the early stage, companies mostly focus on acquisition, but hopefully through the argument I made above I was able to make a point that retention is equally important if not more. This new wave of “Customer Success” is step towards addressing churn and creating more happy customers.