We’ve all heard the statistics: It cost 5 times as much to acquire a customer than to keep one (Forrester), reduce churn by 5 percent and increase profits up to 125 percent (Leading on the Edge of Chaos), and that 70 percent of churn is attributable to poor customer experience (Forum Corporate Research)
It’s not a new revelation that customer loyalty is a table stake for sustainable growth. We all know that loyal customers are more profitable and yield a higher lifetime value. It’s common sense to invest in understanding what drives loyalty, value and the triggers of repeat purchases.
Yet, most companies don’t understand what it takes to build loyalty. That often results in an investment strategy that works against the very thing they are trying to achieve – for SaaS/Cloud companies, that is making sure that 90 percent of customers renew. SaaS/Cloud companies routinely over invest in new customer acquisition at the expense of loyalty.
Why? Because companies do not really understand or accurately measure the real costs of customer retention.
Kaiser Mulla-Feroze, Chief Marketing Officer of Totango, a customer success and user engagement vendor for cloud applications, together with Bruce Cleveland of InterWest Partners, have defined and operationalized a customer retention cost (CRC) metric that shines the light on what the real costs are to keep the right customers loyal.
“Working with a large number of SaaS companies, we saw the urgent need for a new set of metrics that reflects the operational realities and demands of a subscription business,” shared Mulla-Feroze. “We developed the CRC metric to help SaaS companies measure their performance, calibrate their financial health, and steer their investment decisions. As against traditional financial indicators, the CRC metric combined with CAC goes to the essence of running a subscription business.”
The CRC metric is surprisingly straightforward and includes all the expenses a company incurs in retaining and nurturing its customer base. The first step is to calculate the CRC.
The second step is to calculate the average cost of retaining each customer segment.
The third step calculates the CRC Ratio. That answers the question of how much an organization should spend to retain every dollar of revenue from the customer base, taking into account the costs and revenue associated with professional services.
The power of Totango’s CRC metric lies not just in the simplicity of the equation, but also in its actionable benchmarking framework that guides how to invest in customer success.
“I’ve spent most of my career as a CFO in recurring revenue businesses. We succeed or fail based on whether we can economically acquire and retain customers. A lot of great CAC metrics have been developed over the years, but good metrics on the cost of retaining customers have been missing,” shared Mark Klebanoff, Chief Financial Officer of PayScale, a real-time and market-enabled compensation data company. “I love the thinking that has gone into the development of the CRC framework. It fills a void in how we measure, evaluate, and benchmark SaaS companies.”
SaaS companies have implemented CAC, customer acquisition costs, metrics and guidelines. Those guidelines recommend a CAC ratio of 1 or less; the reality is that most SaaS companies actually operate at a CAC ratio 1.5 or higher. Meaning the cost to acquire new customers is 150 to 200 percent of first year revenue and that translates into significant operating losses.
A better question to ask: “What are the right acquisition and retention investment levels needed to yield a sustainable, profitable and growing business?”
The answer lies in a mindset shift away from optimizing for top-line growth. A balanced investment in both CAC and CRC should be equal to 30 percent of revenue with a target 20 percent gross margin. The actual split between CAC and CRC is heavily influenced by three factors.
1. Your staffing model
Revenue per Customer Success Manager (CSM) is how most organizations think about staffing. With Jason Limekin’s popular quoted figure of $2M revenue per CSM, many organizations believe they can optimize CSM revenue by increasing the account-to-CSM ratio. The viability of that depends on the average deal size and complexity of your business which is comprised of the degree of ‘touch’ your product requires, the maturity of your category, and the size of your organization.
Rules of Thumb: Totango recommends that highly complex and medium- to high-price-point businesses are best served with a low account-to-CSM ratio with one CSM assigned for every $1M in ARR (30% of ARR). Each CSM, on average, manages between a handful to less than 50 customers. Conversely, low complexity best practices are one CSM for every $4M in ARR (7.5% of ARR) with each CSM managing between 200 and 400 accounts.
2. Customer success systems and productivity tools
Information, knowledge and value-centered customer engagement are key to customer loyalty. The rise of systems and tools to support CSMs and other functional teams doesn’t come without a cost which needs to be included in the CRC calculation. Think of these investments as a per-CSM or per-employee cost. Customer success monitoring systems typically track events or activities and are based on big data and predictive analytics that calculate health scores and produce early warning alerts of churn and up-/cross-sell opportunities.
Rules of Thumb: Totango found that successful companies spend about one percent of the CSM team cost on customer success productivity tools which works out to be approximately 0.1 to 0.3 percent of revenue. Customer monitoring systems costs on average about 0.5 to 1 percent of revenue.
3. Customer programs
Best practice is to include customer nurturing and retention programs under the scope of the customer success organization. These programs focus on best practice development and executing campaigns that drive product usage, education and customer engagement.
Rules of Thumb: Totango recommends that companies spend 1 to 2 percent of revenue on customer success programs.
“I look forward to incorporating CRC principles into how we run our business and guide our investment choices for the future. It brings much-needed focus to the operational levers that drive the success of SaaS,” states Jeremy King, VP Finance and Operations of InsightSquared.
Calculating and benchmarking CRC is a big step forward in understanding the real cost of customer loyalty and how to optimize the investment to yield sustainable growth and profits.