CHURN. It’s probably at the top on your list of cringe-worthy terms if you run a subscription-based SaaS business. If you think of acquisition and churn as two levers that impact customer growth, both need to work for you, to make your business profitable. While there’s a lot to speak about when it comes to churn, let’s focus on three key ideas,
- How does churn directly impact profitability?
- Is pushing for annual contracts the only answer?
- Are there different types of churn?
Low burn is every business owner’s sweet spot. But when you’re going from 0 to 1, top of the funnel prospects will require months of warm-up time to build trust. You can’t help but invest in customer acquisition marketing, inbound, outbound, field and sales business development efforts — it can get expensive. This way you’re spending 7x more to acquire a new customer versus retaining an existing one. Phew!
After months of hard wins, you start wondering if there’s a way to dramatically increase your recurring revenue and customer lifetime value that will help balance out the Customer Acquisition Cost (CAC).
Yes, there is — by reducing churn.
Every new acquisition not only brings on board a new customer but also an opportunity to earn their trust. By consistently delivering value as a business partner to your customer, you’re gearing them up to be an advocate for your service/product. This way, when the 12 months are up, they are more likely to purchase upgrades or try new products and less likely to churn.
The cost of acquiring new revenue differs widely based on the starting point: new customers vs. upsells vs. expansions vs. renewals and this decidedly makes a solid case for renewals.
The cost of acquiring new revenue encompasses two distinct components:
1. Customer Acquisition Cost when you acquire a new customer — the fully-loaded sales and marketing cost to acquire $1 of ACV (Annualized Contract Value) from a new customer.
2. Cost you spend to realize expansions, upsells and renewals to acquire a dollar of ACV.
Clearly, for renewals, your cost of acquiring $1 of ACV is just $0.13, or 12% of the CAC to acquire new customers. Lower churn = lower revenue acquisition costs.
As you grow, at a certain switch-over point, your existing customer base will contribute more to revenue growth than new customers. When this happens may depend heavily on your growth and churn rates. And when it does, retention, upsells and cross-sells become increasingly important.
Tomazs Tungus, with this hypothetical SaaS startup’s year end data shows how recurring revenue begins to fuel the company as it grows.
Safe to say that as the company grows, renewals become a larger and larger contributor to annual revenue. Quite often, pricing is the tool of choice that companies use to lock-in a customer for multiple years.
Customer lock-in is driven by enabling and incentivizing the sales teams to sell multi-year deals. You craft your pitch to sell a long-term commitment, offer benefits and discounts to prospects and position the deal as an investment in your relationship with the customer. But this is all based on the premise that customers will opt in for annual subscriptions in the first place. That’s a lot easier if there is a healthy product fit and the customer trusts your services and sees you as a value-adding business partner.
Despite all the benefits of annual/multi-year deals, just 45% of SaaS companies bill annually.
Is driving annual/multi-year deals the right solution for all scenarios? What if you can’t provide all the value that you promised you would? By ignoring customer happiness and locking them in regardless, you not only lose out on long-term revenue but also compromise on customer advocacy.
Introducing hard and soft churn
A hard churn is when a customer gives notice and leaves for good. This is not ideal but it’s going to happen. Partnerships fall through for a variety of reasons and it’s important to be aware of the cost of saving a relationship. So, let’s cut hard churn some slack. It isn’t all bad.
However, this problem can get worse when companies push for a larger market share and acquire customers with porous product fits (and in turn little success potential), it’s most likely that these customers won’t stick around for too long.
By pushing for annual contracts (because the math adds up), you may have secured false loyalty and predictability. While the finance types in your company will definitely cheer this predictability, is this really a long-term win?
No. You’ve just fueled soft churn — when a customer has mentally checked out and has decided to move on. He/she is waiting for the contract to expire, or fighting it legally and is actively bad-mouthing your product/company in the meantime.
When you come to think of it, annual contracts are eerily like skipping to the wedding after a first date. Your hard-won annual contract ties in a customer for a year and ensures payment. But this doesn’t guarantee success, growth, upsells or renewal after 12 months. Just like how a fairytale wedding doesn’t always promise a happy marriage.
Undoubtedly, soft churn is the bigger villain because it catches you off guard and leads to collateral damage. Like when a long, strained relationship with little communication, finally crumbles. Heartbreak there, $$$ lost in ARR here.
Soft churn can happen due to a whole bunch of reasons. Let’s talk about those key touchpoints that most companies ignore.
- Acquisition — converting prospective customers into paying customers
- Onboarding — introducing new customers to essential information and key elements of a product to help them make the most of it
- Client shift — shift in customer requirements due to their internal business changes
- Value shift — shift in customer requirements due to low product value addition/competition
- Renewals — customer signing up for another fixed term to use a product
Churn is likely at any of these touchpoints. Imagine having 0% annual subscriptions now. You may have prevented 12 opportunities to churn but you’ve plausibly set yourself up for compounded annual churn. This leaky bucket in your business model will hit you hard!
What you thought was a year of growth was in the end an illusion!
Imagine you didn’t aggressively target annual contracts and spent time assessing your technical/functional/competence/experience/cultural fit with the customer? Work your way slowly through monthly subscriptions and build trust. Eventually, based on both yours and your customer’s joint accountabilities, discuss an annual contract. Now that’s a happy marriage. :)
What may seem like a painfully slow process with no immediate incentive will earn you customer loyalty and advocacy that you can count on.
Let’s try and fix your leaky bucket now. All you need to focus on is value-addition at key touchpoints in your customer journey. How? Keep a look out for the next series, “How to fix your leaky bucket: Identifying gaps in your business model”.
But, I’m curious. Would you rather go on a date or get hitched right away?
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