Why SaaS companies need to focus on retention?

Previously we’ve looked at the equation which outlines how the SaaS business model works (see our previous blog titled CLV = TRC – CAC – CSC). Today, we’re going to look at the ‘Cost of Servicing a Customer’ element by extending the life of a customer as long as possible.

Is it possible to quantify the importance of retention activity? By quantifying this we would then be able to understand how much to invest in this activity and also identify where the best return for that investment is made.

Why is extending the life of a customer valuable?

As a SaaS publisher you will have a number of important costs, the biggest of which is probably the cost for acquiring a new customer. This is significant and important. But following on from that, you will also have a regular monthly cost of servicing that customer. Complicating this, there can be ‘free trial’ periods, other incentives, up-sell and cross-sell propositions – all of which make the retention calculation more complicated (but not impossible).

There are a number of fairly standard equations that can be used to make this quantification more objective. These include: Breakeven (where the upfront cost of acquisition is finally paid off and the customer becomes ‘profitable’). Other calculations that can be used to calculate the worth of a customer – NPV (net present value) or IRR (internal rate of return) are two that are relatively common and quite useful.

The important factor here is time – you have a major upfront cost and then an income stream afterwards. Using these types of calculation can give an objective view on the increase on profitability as customers stay for longer.

What sort of impact does extending the average length of stay make?

You should be making a calculation which shows how extending the average life affects profitability: for example, I’ve made a quick financial model today for myself using typical SaaS figures (cost of customer acquisition £50 / monthly subscription £10 / first 3 months free / monthly cost of servicing client £2 / interest 2% / average length of stay 2 years). A model like this can guide you about the customer and how much better is it if he stays either 6 or 12 months longer than average:
Breakeven point is at Month 10 (quite a significant proportion of the 24 month average length of stay)
• If the average length of customer stay is 24 months then extending this by six months (+25% in time) increases profit by +37%
• Increasing the average length of stay by twelve months (+50% in time) increases the profit by +71%

So, you can see that there is a disproportionately beneficial effect for keeping customers longer than average. It would be a worthwhile commercial activity in encouraging greater length of stay.

The first simple recommendation for SaaS publishers is: know how long it takes to reach breakeven point and identify if and why customer leave before that point. Having a working financial model like this will allow those involved in setting pricing and developing retention programmes to more accurately work out what is economically possible and sensible – retaining unprofitable customers or retaining customers unprofitably are equally ruinous in the long run.

There is one more very important aspect to be considered here: not all customers are the same. In fact, let’s be totally brutal about this; there are some customers that you will want to keep and those that might actually be costing you to keep. You need to data and the analysis to enable you to understand who falls into which group. At that point you can focus additional effort on which customers you definitely want to retain.

Where should you focus your retention activity?

Metrics and customer data is incredibly important. There will be groups of customers that are more important than others and that your retention activity should be focused on these higher priority groups. But what are these? Here are some suggestions:
• Customers that have already purchased at least one cross-sell or up-sell service from you
• Customers that are within three months of achieving the average length of customer stay (on average they might be in danger of leaving and, by the logic above, it is worthwhile in doing something to keep them longer)
• Customers that have multiple users. Multiple user accounts probably deserve some form of proactive account management as they will control a significant proportion of your revenue
• Customers that have marked you highly in any customer satisfaction rating you run
• Loyalty bonuses for customers that have spent a very long time with you (greater than one year over the average length of stay). Perhaps they need to be appreciated formally
• Take up by very new clients (but this needs to be done cost-effectively i.e. don’t throw good money after bad). If the breakeven is at Month 10 and the customer isn’t using the system after Month 3 then there needs to be some online help to get them started again

How much do you spend on each customer to keep them? Well, that depends on how long you can encourage them to stay. If an additional six months is what is added and that would normally generate, say, £50 in profit, then the figure is somewhere below £50 as, beyond that, you would losing money. Perhaps a reasonable figure might be £20 (given as a two month free period or a discount to another product within your range).

The importance of balancing investment

Once you know the customer segments where you want to focus more of your retention activity, you should use your model to understand just exactly how much you can spend per customer to get them to stay. If you are going to incentivise someone to stay for another six months, you should try to ensure the incentive doesn’t apply at the start of the period.

Some companies keep their best incentives for brand new customers. This is not a sensible policy for SaaS publishers. Profitable customers that have passed their breakeven point should be treated like gold dust in your organisation. Focus your best incentives on this group and reap the rewards.

We hope that gives a summary of our thinking about which SaaS retention strategies might be right for you.

If you would like to know more or speak to us please contact Grant Sayer on M: 07588 444302 or John Stoddart on M: 07788 445903 or Email: info@centriclogic.com or see our website at http://www.centriclogic.com

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