Like mobile operators, the economics of Software-as-a-Service (SaaS) vendors are profoundly affected by churn - the rate at which they lose existing customers. Any SaaS organisation with high customer acquisition costs should be particularly concerned about the impact of churn on their bottom line.
The challenge of churn increases over time - and the larger a SaaS-based business gets, the harder it becomes to replace the lost revenues. So the need to minimise churn is fairly well understood - but a recent blog by David Skok of Matrix Partners has highlighted the potential impact of a much less frequently discussed phenomenon - “negative churn”.
Are you leaving money on the table?
Negative churn happens when you succeed in upselling your existing customer base so effectively that it more than compensates for any loss in revenue from customers who fail to renew. And as Skok vividly points out (see chart), negative churn can have a dramatic impact on cumulative monthly revenue.
Clearly, you’ll always want to be adding new customers. But the basic lesson seems to be “don’t leave money on the table”. So what steps can SaaS companies take to maximise their upselling opportunities, and increase average revenue per customer?
If you have seat-based pricing, the most obvious route might appear to be to increase the number of users subscribing to the product. But in the absence of sustained employment growth within the customer, there’s a clear upper limit to the addressable internal market once 100% of the relevant employees are actively using the product.
Generating negative churn
Skok points out a number of alternative paths to negative churn - and I’d like to suggest some more.
First, your pricing model can be based on some other usage factor that is likely to grow over time, driven by product adoption. Skok identifies DropBox as an example where the charges are proportionate to the amount of storage consumed. Marketing automation vendors like HubSpot often charge proportionately to the number of contacts managed or the volume of emails sent.
Other SaaS applications charge on the basis of transaction volumes, and as long as the pricing axes are set thoughtfully - in a way that does not have the effect of discouraging usage - this form of proportional pricing can be highly effective.
A second approach - one that is widely used by Salesforce.com and other SaaS vendors, is to adopt a tiered product structure with a number of different editions. The key here seems to be to carefully choose the functionality that is included in each tier so as to give users a reason to upgrade.
Each incremental level needs to have at least one “killer capability” that’s going to make experienced users (or demanding new users) see the value in upgrading from their existing level. Choosing these features wisely is key to opening up the potential for upgrades.
Third, vendors can develop a family of products that address different and complementary needs or users within the target customer base. Salesforce’s expansion from CRM into customer service and other applications and the provision of platform-as-a-service offerings are excellent examples of this strategy.
A fourth strategy might involve selling information feeds - for example, third party or proprietary data sources that complement the core application and support the decision process. You can probably identify other approaches that could suit your business model.
Identifying layers of value
I’ve suggested that in order for upselling (and therefore negative churn) to work, you have to clearly identify where the layers of value are in your solution. You need to have enough in the base product to attract a large and growing customer base, yet offer enough incremental capability in each additional layer for users to see the value of upgrading and not feel they have been ripped off.
Judging where these value lines need to be drawn could prove to be some of the most significant decisions you could make when it comes to how to structure and evolve your offering. Get it wrong, and you could be denying yourself an incremental revenue stream that could make a significant difference to your long-term success.
Leveraging your valuation
These are not trivial choices, but I sometimes get the sense that SaaS vendors don’t pay enough attention to them. If you want proof of their importance you’ve only got to consider a report that Skok quotes from a leading investment bank that suggests that an incremental 2% increase in retention returns a 20% higher valuation multiple, and a 2% increase in upsell results in a 28% higher multiple.
Given these figures, if you’ve got a SaaS offering, are you really paying as much attention as you should to maximising your upsell opportunities? - and if not, what’s the most obvious way in which you could improve your outcomes?