Month-to-Month vs. Annual Contracts in B2B SaaS
Running a legal team allows me a unique perspective that nobody else in a company gets: the opportunity to see every single agreement that we sign. Because of this, I have negotiated and seen a lot of deals, with companies of all sizes and all levels of complexity.
One of the most common debates is whether to offer month-to-month agreements or annual commits. Annual commits are great because you get predictable, mostly guaranteed revenue. Investors and CFOs love this. M2M agreements are also great, though, because they are (theoretically) easier to close and reduce friction with prospects by commanding a lower overall price commitment.
Having seen a lot of both types of deals, I want to dispel some of the common arguments against annual commits and make the case for pushing them harder.
Myth #1: Clients don’t like committing to new products for a whole year. While this is sometimes true, you also need to realize that most B2B SaaS products represent a big technology commitment from the client. At a minimum, they require the client to invest time and resources into learning how to use the new tool. Often, the client also needs to migrate entire existing systems/data over to your product. This is very painful for the client, and not worth the time if they are only going to get a couple of months with you, their new partner. Because of this, clients don’t plan to use SaaS for only a month or two; they are making a real investment in your product and team.
An annual agreement isn’t scary at all in this context, and in fact may be a welcome sign that your company has confidence it will be around for a while. Annual commits give the client assurance that all their efforts pay off in the long term.
In situations where the client is cost-sensitive and hesitant to commit before trying, here’s a #protip that will give you the best of all worlds: sign them up for a 14-month contract where they can terminate without penalty any time in the first 2 months. This effectively allows for an easy trial period without forcing you to renegotiate later, while at the same time demonstrating the confidence you have in your product and team.
Myth #2: Our product will only get more expensive as it improves, so why not give ourselves price flexibility? This is probably the best argument for monthly agreements, but it ignores two key considerations:
- (1) Even though you like price flexibility in theory, you will not actually increase prices on your customers 6 months into their (new) relationship with you. This would anger your new partner, it will feel dirty, and when all is said and done you will decide you value their evangelism more than their dollars. It just doesn’t work in practice, at least not that early in your relationship. While at some point you probably will try to increase pricing, odds are that you’ll be waiting at least a year.
- (2) Competitors will constantly pressure you to drive your prices downward, even as your product improves. In competitive environments, price flexibility is a luxury most companies don’t have. You are fighting for your life. Precisely because of this, it’s far better to have annual committed revenue than price flexibility; that way your client is locked in to what is likely a higher price than you could charge today.
Myth #3: Sales teams hate being shackled by annual agreements. Okay, admittedly, this is generally true. Sales people love flexibility and the ability to do whatever they need to get the deal done. We love that about our sales teams.
But there’s a way to make annual agreements really attractive to sales teams. That is done by (a) paying commission off bookings instead of revenue, and (b) making the full commission payment in the month that the deal closes. As a reminder, bookings represent the full contract value (e.g. 12 months at $5,000/month is $60k in bookings), whereas revenue is only recognized when the services are performed (in the example above, revenue is recognized as $5k every month; not $60k up front). By paying your sales team on bookings, they get commission on $60k in the month they close the deal instead of 12 checks on sales of $5k each. If the same deal is done monthly, they wouldn’t have guaranteed commission, and they would still only get the $5k in sales each month. So while annual commits provide a bit less flexibility, when your sales team closes them and get paid on bookings, it will feel damn good and they will be hooked.
Conclusion: Annual commits have gotten a bad rap, and can be beneficial to the company, the customer, and the sales team. The reality is that early stage companies should have some flexibility and provide different plans — both annual and M2M— to address different customer needs and to give their sales team flexibility to get new clients in the door. That doesn’t mean, however, that as a CEO you shouldn’t push hard for annual agreements, or that you should make your standard plan a M2M plan. Annual commits are virtually always better for your company, and often better for your customers, too. Your team should know that it’s important to make them a priority.