INSUBCONTINENT EXCLUSIVE:
More posts by this contributorVenture-backed companies must walk the line between fast growth and efficient growth
Even as VCs value high-quality revenue, companies are still held to a minimum growth rate
We think of this threshold as the “Mendoza Line,” a baseball term we’ve adapted to track the minimum growth needed to get access to
Above this line, startups are generally attractive to investors and even have a good chance for a strong exit.To achieve sustainable growth,
maximizing customer lifetime value is an important component and one that is often underestimated, particularly for SaaS and other
subscription-based businesses that generate recurring revenue
It is estimated to cost somewhere between five to 25 times more to acquire a new customer than to keep one you already have
Additionally, Bain research has shown that a five percent increase in retention rates can increase profits by 25 to 95 percent
Even by conservative estimates, retention is a powerful mechanism for growth.As companies face greater pressure to grow both quickly and
responsibly, we are placing more value on customer retention as a barometer for long-term success
And we are seeing smart startups invest in measuring customer happiness in more sophisticated and consistent ways.In looking at SaaS deals
over the past 10 years, we’ve found that a few key metrics and best practices are predictive of healthy business fundamentals
Here’s the advice I give startups looking to achieve smart growth through customer retention.Create a system for measuring customer
happinessFirst, measurement must be an executive priority
Ensure you have a system in place to measure retention on a quarterly basis (at least) and meet as an executive team to diagnose potential
While benchmarking against similar businesses can be helpful, trending your own metrics is the best way to see how your performance is
improving or deteriorating.You’ll need to identify the specific metrics that work best for your business
I recommend looking at how efficiently you’re putting resources toward customer retention, which gives you insight into customer happiness
and predicts the profitability of your growth.The percent of ARR spent on retention tells you how much you’re spending to keep your
customers happy; let’s call it your Retention Efficiency
You can measure this with a simple calculation:(Quarterly cost of customer retention) x 4Ending annual recurring revenue (ARR) baseThe
ability to keep this number low means you’re retaining your customers without burning money
This means you can invest sales resources toward acquiring net new customers rather than replacing revenue from those that have left.I’d
also recommend looking at the Customer Retention Cost (CRC), which measures how much on average you’re spending to retain each
customer:(Quarterly cost of customer retention) x 4Total # of customers in your baseNote, this number may increase over time if you’re
moving upmarket — enterprise customers generally require more resources to retain than small to mid-sized companies
If your retention costs are going up, this per-customer number can help you explain why in the context of your go-to-market strategy.Don’t
just measure churn rateMost startups measure retention in terms of churn rate: dollars that left in a given quarter divided by total ARR
In my experience, churn is a vanity metric and not particularly accurate because it combines customers that are eligible to leave and those
contracts that were signed in the past month).Renewal rate is harder to benchmark, but tells you more about your customer happiness and
health of the business overall
Gross Renewal Rate shows you the dollars that renewed as a percentage of all dollars that were eligible to be renewed
Calculate this metric (Gross Renewal Rate) by summing all renewed contracts and dividing that total by the dollars that were up for
renewal:Dollars renewedDollars eligible to renewNet Renewal Rate is a measurement of the growth of your existing customer base, net of any
churn, as a percentage of all dollars that were eligible to renew
Include any expansion dollars with your renewed dollars in your calculation to get Net Renewal Rate:(Dollars renewed + dollars
expanded)Dollars eligible to renewCalculating renewal rate by segment is even more helpful in diagnosing issues of customer dissatisfaction
For instance, if your renewal rates are trending down in the SMB segment but not at the enterprise level, you might identify a problem with
Perhaps the product is too complex for SMB customers, while enterprise customers need those features.Don’t look to customer success as the
fix-all solutionIf you’re looking to improve retention, the answer isn’t necessarily to pour resources into your customer success
Retention is one area that can be impacted by several functions
Look into the factors that play into customer lifetime value, including:Product: Increases in churn or retention costs could signal that
you’re drifting from product-market fit or that your product faces increased competitive pressure.Marketing and sales: Ask yourself the
following: Does your marketing accurately message your value proposition How much is your sales team promising above and beyond what the
product can doCustomer success: Make sure you’re engaging with customers beyond the first three months of their deployment; the next six
to nine months are critical for success
Measure customer success throughout the life cycle to ensure users are getting the most out of the product and understand how to use
it.Define a product engagement metricUnderstanding how much your customers actually use and depend on your product is the best indicator of
Engaged customers are more likely to renew their contract — which helps to keep your retention numbers steady
They’re also more likely to tell others about their experience with your product, which improves top-line growth.Experiment with an
engagement metric that works for your business: for DocuSign, it’s the number of envelopes sent; for JFrog, it’s the volume of binaries
distributed; for Textio, it’s the number of job requisitions written in the platform.Your ability to keep customers happy without spending
a ton of resources speaks to the value you’re delivering
And if you retain customers efficiently, you can spend more on acquiring new customers
In evaluating a portfolio company, I’d much rather see a business with good growth and high-quality customer retention than one with
explosive growth but low retention
VCs will hold you to these metrics — make sure you’re accountable for them.
