The mass effect of SMB SaaS
Sustaining high customer acquisition growth rates in an SMB focused SaaS business gets a lot harder every year that you run.
For the last couple of months I’ve had the privilege of mentoring a tech start-up through the Barclays Accelerator programme run in London by Techstars. AgentCASH is cool team with a very clear vision about how to fix a problem almost every independent retailer has to deal with when it comes to managing sales and a universal inventory across multiple retail channels in both online and offline retail — often referred to as Omnichannel retail.
The guys at AgentCASH are still way early in their businesses development to have to worry too much about sustaining high multi-year growth rates and managing churn just yet, but generally speaking I’ve found it’s an area not many small business oriented or low ARPU SaaS start-ups spend enough time thinking about until it’s too late. And the nature of the problem can mean it also usually doesn’t present as a problem until it’s too late to do anything about it.
A rocket ship that gets heavier the higher it climbs
The first two or three years are easy. Let’s assume you’re adding 100 customers a month and within each new monthly cohort let’s also assume 10–15% soon decide it’s not for them and cancel a month or two down the line. And then the natural churn, that is customers who use the product for a longer period of time but who later cancel for one of a number of reasons that are often outside your control such as they ceased trading, outgrew your product, got acquired by another business etc., well that also looks fine, for the sake of this example let’s assume your churn rate is a tiny 2% per month.
It all looks quite rosy because every month you bring in a fresh batch of another 100 new customers, your cumulative customer count (net of the 10–15% post signup cancellations and the regular 2% monthly churn) increments by 80–85 customers. Almost all your focus is spent on acquiring the next monthly batch of new customers and the vital cash flow they’ll bring you.
Which for quite a while makes for a healthy rate of growth and so you set that aside and focus on other areas like building out your product, customer service, marketing or stand-up desks.
However, in this simplistic example let’s assume you only sustain your rate of net customer acquisition at 80–85 every month, you don’t manage to increase it. Then on a long enough timeline the effect of the seemingly tiny 2% of your customers that churn out every month also scales up as the cumulative size of your customer base grows, slowly increasing drag on your net monthly increment until — in this example it would take more than ten years — the number of customers leaving you eventually grows to become equal to and then greater than the number of new customers joining you every month.
Harder than actual rocket science
Which also likely means you’ve probably just reached your start-up’s terminal share of market. Just because you have a few thousand very happy customers generating enough cash every month for you to keep the lights on, pay your team well, deliver an excellent service, have great coffee and afford some of Herman Miller’s finest doesn’t mean your business will continue to grow. In fact the higher your rocket ship climbs, the harder it becomes to keep climbing with anything like the efficiency you experienced during the first phase of your ascent. Unlike actual rocket science where the air thins the higher you climb and therefore the more efficient your forward thrust becomes.
But that’s easy to fix, right? We can just work harder to grow the number of new customers coming in? Not so fast. Remember the bigger your base then the higher the absolute quantity of customers you’ll ultimately see churning out every month. So, as you work harder to add a greater number of customers every year to outstrip the effect of churn today, in doing so you’re also scaling up tomorrow’s churn number.
Outpacing the effect of future massive churn also requires a huge investment of capital to (burn) invest in increased customer acquisition which is generally hard to come by, whether you’re in a niche or if you’re in a crowded space with a bunch of competitors doing the same thing.
How about stopping churn? Theoretically you could try that, but remember it’s only 2% per month and while some of those who leave may be doing so because of price, functionality or service quality and could possibly be persuaded to stay — which would also require additional operational effort on your part — and you might actually discover that the majority of churn could just be impossible to prevent, or prevent cost effectively.
As I said, this often doesn’t look like a problem you need to worry about at the beginning of your SMB SaaS startup’s life, you have much bigger problems to focus on then like building product, hiring people, customer service, raising capital, marketing and getting the brand known.
But the hard reality is, at any stage in your SaaS start-up’s growth it’s actually relatively simple to model your current growth rate, the future impact of churn, and to predict either when your business will hit a natural growth ceiling or, preferably, which moves you need to make early on to overcome this problem.
