FECS Part 2: Customer Count + Revenue Contribution
Do you know who loves you?
As Part 1 should have made obvious, the beauty of FECS lies in applying obvious solutions to problems. Some of these solutions may be hidden in plain sight, as nondescript as the buildings you walk past every day (think about it — do you know what exactly all of the buildings look like?). The metrics on your dashboard might be alerting you that something is wrong (the LTV:CAC says so!); you may even have a sense of where these problems are hiding. FECS provides a straightforward method to triage a company.
We ended Part 1 with the idea that only looking at overall growth can blur a more interesting and informative story. We charted Microsoft’s growth over three periods, unpacked those growth numbers by segment, and then further delved into month-by-month revenue.
For part 2, let’s start with the question:
Where does this revenue come from?
Or: Who loves you?
Before you roll your eyes, let me explain: this question touches on the heart of FECS, or Front End Customer Strategy. Ultimately our goal is to follow the money, and now we are following the trail to individual customers.
First, let’s look at how many customers you have. Let’s say we have two companies, Company A and Company B. Company A sells high-value services to a small set of 5 customers, while Company B sells cheaper services to a larger set of 100 customers. Revenue-wise, they generally make the same amount. The following charts show customers on the x axis and their contract values on the y axis:
Sure, Company A has high-value customers, especially compared to Company B. However, Company A has 5 customers, while Company B has 100 — Company B has literally 20x the number of Company A’s customers.
Why does this matter?
Let’s say Company A and Company B both lose 1 customer and gain another over the course of a year. While it’s an equivalent number, the proportion that the 1 customer represents is wildly different — for Company 1, it’s close to 20% logo churn (individual customers) while for Company 2, it’s much lower, close to 1% logo churn.
Here, the business risk from losing a single customer is much, much higher for Company A. By losing a single customer, Company A loses 20% of revenue!
Needless to say, this isn’t the full picture at all. There are definitely other dynamics within Company A and Company B that would inform whether they are great companies and investments (which, by the way, are not one and the same). However, year over year these numbers such as churn, retention, and average contract value provide a window into some crucial details— which we will cover in Part 3.
Just now, we uncovered the fact that while large contracts are great, revenue concentration, especially in a few customer accounts, poses a real business threat. Note that it is a real and natural part of many startups’ lives to spend some time in this state. If you want to count to 100, you need to count to 10 first. And a common way to reduce the business risk that comes with a small customer list is to have excellent customer service (and a good product).
However: this isn’t to say you should pad your customer list with a ton of random names. If you spend sales and marketing dollars for the sole purpose of stuffing your client list with warm bodies, you’re basically buying revenue. And that revenue can be low-quality, meaning that you’re going to have to handle complaints from customers who aren’t as invested in using your product / service, taking away time from those who are, leading to generally unhappier customers.
tl;dr: You should be aware of the business risk especially when you don’t have many clients, and that risk can be mitigated by catering to your core customers through good service and good product.
Who is your core customer, anyways?
Say we have Company C, which has a pretty packed customer list:
We’re at the point where it’s hard to see much beyond the fact that Company C has quite a few customers.
A really cool way to extend the analysis from the previous exercise of mapping out customers by contract value is to order them, largest to smallest:
Suddenly it looks quite orderly! It feels like there’s something there. What is it?
This something is known as The Pareto Principle, also known as The 80/20 Rule, The Principle of Factor Sparsity, The Law of the Vital Few, and probably many other names.
Whatever you call it, the general idea is that for many things, 80% of the effect (and value!) comes from 20% of the causes (customers!).
Here it is for Company C:
For Company C, around 23% of the clients contributed to 80% of the revenue. The implication is that if Company C were to completely stop catering to those customers below the 20% Threshold line and focus solely on the remaining base, it would only have to focus on 23% of its original customer base while retaining most of its revenue.
I probably should reiterate that none of what I say should be taken as a call to action, so don’t go Thanos snapping half of your customers out of existence.
The true power of the top ~20% of your customers is that they are your Core of the Core, or superfan, customers. They love (or at least use) your product so much to the point that they’re willing to pay above and beyond what most others pay for. It’s those customers to whom you need to pay specialattention.
Once you identify those superfans, there’s a lot you can do from here. You can slice and dice them even further — what industry are they hailing from? What are they using your product for, and when? Does that line up with the intended usage for your product? How do they differ in their retention compared to the entirety of your customer base (to be mentioned in Part 3)? Can you streamline your sales and marketing strategy to better get those types of customers?
What you do with this knowledge is up to you. There are definitely exceptions to the rule, but it’s definitely nice to know who your biggest fans are (and whose feedback to prioritize when thinking about your roadmap)!
In summary: The Pareto Principle, or 80/20 rule (or any other name you might know it by), is a pretty great way to maximize efficiency. In a business, nothing is different.
Up next is Part 3: Customer Retention.
