Law 8: Deeply Understand Your Customer Metrics

Author: Kathleen Lord, Vice President of Sales and Customer Success, Intacct

Relevance

Executive Summary

Successful subscription-based companies must deeply understand the details of churn and retention if they are going to maintain and accelerate their revenue growth. Nothing slows your company's growth rate faster than having revenue from your installed base evaporate. As your installed base revenues grow, even a 1 percent increase in churn can make a huge difference in your company's velocity. If you are at a $25 million run rate and are trying to maintain a 50 percent or more growth rate, a 1 percent increase in churn means your sales team will have to close an extra 20 percent in new business sales to maintain your growth rate. The following five steps will help you define and gain a deep understanding of churn and retention to help your company focus on the right priorities, accelerate growth, and keep your customers for life.

The biggest issue early-stage, subscription-based companies face is how to accelerate customer acquisition. In fact, the majority of a company's resources (time and money) are spent figuring out how to solve this problem and prove that the company has a viable business model. However, as soon as a company has successfully solved the challenge of accelerating customer acquisition, someone—your CEO or a finance person most likely—starts to notice that the company's total customer count and committed monthly recurring revenue (CMRR) are declining.

CMRR is defined as the combined value of all of the recognized recurring subscription revenue on a monthly basis, plus signed contracts currently committed and going into production, minus churn. Churn is the monthly recurring revenue that is no longer committed from customers that have turned off the service or are anticipated to do so in the future. Your sales VP might wonder how this could be, considering that he or she is doing such a great job driving new business. Unfortunately, many companies do not invest enough company resources to successfully retain the customers on whom they've spent a significant amount of the company's resources to acquire. And, as the driving force behind this book, this is exactly how the organization commonly known as customer success came into being.

To sustain a subscription-based company for the long term, your company must have a deep understanding of both churn and retention: churn from the standpoint of understanding why and how often customers leave and retention from the standpoint of why and how often customers stay and continue using your product or service. The earlier in your company's lifecycle churn and retention are addressed, the easier the problem is to solve.

Companies can follow five steps to capture, measure, and understand churn and retention:

1. Define what you are measuring, and components of CMRR.
2. Define the period of measurement and frequency.
3. Determine the expected CMRR and categories of churn.
4. Determine how to identify suspected/at-risk churn.
5. Align with your executive leadership to develop a set of standard definitions and reports for churn/retention.

Step 1: Companies must first define how they are going to measure churn and retention. Does it make more sense to measure on a per-customer basis, on a per-contract basis, or both? This decision will depend a lot on customer size (SMB versus enterprise) and whether your company has multiple contracts that are managed separately under a single customer umbrella (e.g., a company might have five different divisions of GE as customers). In addition, it is fundamental in determining how your company needs to operationalize the way it captures and calculates churn and retention on a go-forward basis. The necessary operational changes include the ability to capture churn and retention both from a CMRR dollar perspective and from a count perspective.

The next step is to determine how you will define CMRR. The typical components of CMRR usually include new CMRR, add-on CMRR, renewal CMRR, and churn. Figure 12.1 is a graphical representation of how each of these components is combined with your period-beginning CMRR to calculate your period-ending CMRR, with the difference being your net change in CMRR. Net change in CMRR is the amount you grew your business period over period, and it provides the clearest forward-looking view into the health of your business.

The best practice is to have an even-more granular view by breaking down renewal CMRR into multiple buckets, including cancellations, downgrades, upgrades, and first-time archives. (Note: many cloud companies offer an archive service at a percentage of the former annual subscription fees to provide ongoing read-only access to the data after a customer is no longer actively using the service.) This granular breakdown of the renewal CMRR provides insight into your renewal business so your company can more effectively pinpoint where there is a potential problem versus just providing high-level churn and retention rate numbers.

For example, let's say the customer had a $50,000 contract that they renewed, and the new contract was worth $55,000. Celebrate, right? Definitely, but not so fast. Let's examine the details:

• $45,000 apples-to-apples renewal of products A and C
• $8,000 churn of product B
• $14,000 upsell of additional licenses for product A
• $4,000 increase because discount went from 25 percent to 22 percent

Somebody cares a lot about each of those line items—the product manager for product B for sure, and your CFO almost certainly. There's no time like the present for figuring out how you are going to track at this level of detail.

Your company will need to build out its order process to capture the necessary data at the level of granularity in which your company wants to be able to report on churn and retention (customer, contract, etc.). This includes capturing order type (new, add-on, renewal), upgrade/downgrade amounts on the renewal (recommended to track actual new product add-ons separately), reasons for downgrade at the stock-keeping unit (SKU) level, and reasons for cancellation. Best practice in your CRM system is to have both a picklist of reasons for ease of standardized reporting, as well as a freeform comment field to capture additional color commentary. Ideally, your company's order process is set up to capture the difference between a quantity downgrade versus a price downgrade, for these are very different churn problems to address.

In addition, having the downgrade/churn reasons automatically populate a churn-type field will greatly facilitate real-time reporting of avoidable versus unavoidable churn. For reference, unavoidable churn is often referred to as death and marriage. In other words, churn caused when a customer goes out of business or gets acquired is generally accepted as unavoidable. This will become very important as you begin reporting on your downgrade and churn reasons and prioritize the ones you need to address first. Although most enterprise resource planning (ERP) or customer success applications enable you to track this level of detail through different transaction types, some burden will be placed on your sales and finance operations teams.

Step 2: Once your company has determined the basis against which it is measuring churn and retention, it must determine the period of measurement and frequency of that measurement. Depending on your company's business model, it may make sense to measure churn and retention weekly, monthly, quarterly, or annually. This should be determined by the length of commitment customers are required to make and align with how the company plans CMRR and churn to facilitate comparisons versus plan. Often companies measure churn and retention on a more granular basis—say, monthly—but report these metrics as an annualized rate for key stakeholders. This approach makes it easier for key stakeholders to have a clearer picture of the annualized effects of churn and retention.

In addition, it's important to define how you will handle both early and late renewals relative to the period of measurement. In terms of booking renewals early, this is a very good thing for your company. However, you need to make sure the renewal is booked in the period in which it is due; booking in an earlier period will significantly throw off churn and retention metrics. When handling late renewals, the best practice for keeping your company's churn and retention metrics accurate is to move the expected CMRR and expected customer count to the next period while maintaining the same subscription start and end dates. This approach enables the company to accurately measure churn and retention while also being able to report on late renewals. This is a key metric that the company should measure. Ideally, all renewals are completed 30 to 60 days in advance of their subscription end date.

Step 3: Determining how your company will calculate renewal rates starts with determining how you will define expected CMRR. The best practice for determining expected CMRR is to add the CMRR of the prior-period renewal to the annualized value of any add-ons during the period. This becomes the basis for calculating your company's churn and retention. This approach also means the churn plan you set at the beginning of your fiscal year will change over the course of the year as customers add on incremental subscriptions.

Customer success and finance need to agree on the point in time when your company will lock in your expected CMRR. Best practice is at the beginning of the fiscal period during which the renewal is due (monthly or quarterly). If your customers are highly dynamic (e.g., regular cadence of death and marriage), then you should determine an appropriate churn run rate that is acceptable to your overall business model. For example, if your company determines that planning for a 10 percent churn rate is appropriate, then the original plan will model churn at 10 percent of expected CMRR at the beginning of your fiscal period and will be adjusted at the beginning of each new fiscal period to reflect 10 percent of the revised expected CMRR. Otherwise, midterm add-ons can significantly misrepresent the health of your business and mask potential churn issues. This type of churn is classified as unavoidable; you should build it into your overall bookings and revenue plans so you can provide more predictable forecasts for the business.

For example, calculating expected CMRR at the beginning of your fiscal year as the basis for your company plan might look like this:

• Prior-year renewals = $25 million
• Assumed 10 percent churn (due to death, marriage, etc.) = ($2.5 million)
• Planned expected CMRR = $22.5 million

A moderate approach to account for the annualized value of midterm add-ons is to update the expected CMRR plan at the beginning of each fiscal quarter. For example, you want to calculate updated expected CMRR at the beginning of your second fiscal quarter along these lines:

• Original planned expected CMRR = $22.5 million
• Added annualized value of midterm add-ons from fiscal Q1 = $1.76 million
• Updated planned expected CMRR = $24.26 million

The most conservative approach to accounting for the annualized value of midterm add-ons is updating expected CMRR at the close of each fiscal period (generally monthly if you are doing monthly closes). For example:

• Original planned expected CMRR for September = $1.5 million
• Added annualized value of midterm add-ons for September renewals = $225,000
• Updated planned expected CMRR = $1.725 million

If you have multiple customer segments in your business, you should calculate expected CMRR for each customer segment as part of your planning process, since each segment will usually have a different projected churn rate.

Step 4: An emerging area of focus for many companies is to take a much more forward-looking view of the company by measuring suspected or at-risk churn. There are two ways to forecast suspected churn or at-risk customers: (1) through human interaction and (2) by leveraging signals or data points. In a traditional enterprise, leveraging human interaction is much easier, because the company can typically afford to establish a customer success team. This team engages with customers on a frequent basis and can qualitatively assess and document a customer's likelihood of churn. The challenge with this approach is that as the company's customer success team begins to scale, it becomes harder and harder to maintain objective and consistent qualitative assessments of risk across your CSMs. For companies that sell to the SMB market, staffing a customer success team at low-enough ratios to develop deep-enough relationships to obtain good qualitative churn assessments is not fiscally possible.

Leveraging signals or data points is a great quantitative way to supplement the qualitative assessment from your human interactions in the enterprise model and is a much more cost-effective way of assessing likelihood of churn in the SMB market. The first steps are to define and gain agreement on the attributes of your happiest and healthiest customers and, then, define the attributes for your at-risk customers. These attributes could include use patterns, number of support cases, NPS, tenure, contract growth, or departure of key contacts or sponsors. Although it's certainly possible to try to capture and maintain this type of customer health information in your customer relationship management solution or Microsoft Excel, the company can be much more efficient and proactive by implementing a purpose-built customer success application.

Customer success management applications not only help automate the process of capturing and scoring customer health but also provide a centralized repository that all key customer-facing personnel across the company can access in real time when engaging with customers. In addition, they can provide you with the capability for doing tech touch for some deliverables or some set of customers; that is, driving relevant and timely touching of your customers through automated one-to-many channels instead of the expensive one-to-one processes.

Having a clear, forward-looking view of churn and retention enables the company to forecast much more accurately and to proactively address potential churn issues, both of which are critical to successfully growing your subscription base business.

Step 5: Aligning with executive leadership to develop a set of standard definitions and reports for churn and retention is needed to present key stakeholders with a clear view of the health of the business. The company should be measuring both CMRR and customer count churn and retention by the dimensions relevant to the company's business, for example, understanding churn and retention by industry, size, customer tenure, geographic region, sales channel, product line, or CSM, both from a CMRR perspective and a customer count perspective. To easily create these reports, the company needs to capture these dimensions at the level of granularity in which the company wants to measure churn and retention. Being thoughtful early on about the data you want to be able to report on, and setting your systems up to capture this information, provides the company with strategic insight on churn and retention that can help the company accelerate growth.

In addition, making these reports available to the executive on a consistent basis with changes over time highlighted enables the company to identify what needs to be addressed. Just as importantly, the reports highlight the impact of new programs and processes that have been rolled out. For example, product development and engineering need to understand prioritization of enhancements that will have the biggest impact on customer success.

Perhaps a segment of your customer base is consistently unsuccessful, and the sales team needs to be advised not to close more customers matching that profile. Or customers are consistently not getting the training they need to achieve long-term success. Understanding churn and retention at a very granular level can help guide every facet of the company with regard to focus, priority, and investment to accelerate performance and growth.

Figure 12.2 shows an operational-level dashboard available from the Gainsight customer success management application to help your company proactively manage churn and retention.

Figure 12.3 shows an executive metrics dashboard available from the Intacct ERP application that can easily be shared in real time across the key stakeholders of your company to understand the financial impact of churn and retention on the velocity of your business.

In addition to conducting regular deep dives into the quantitative information regarding your churn and retention, the best practice is to also leverage an unbiased third party to conduct interviews with customers who churn so your company can better understand what happened and why. (Many excellent firms offer just such a service.) Leveraging a third-party service for this process will yield greater insight than having internal resources from your company conduct these post-churn interviews. Approach these in the same way your company would leverage a third-party service to conduct win/loss surveys for your new business.

The preceding discussion will deepen your understanding of churn and retention at a level that will help your company focus on the right priorities and accelerate growth. However, this does not come without an operational cost to the organization. An emerging best practice is to hire a customer success operations headcount. Customer success operations can help operationalize your company's customer success programs cross-functionally; it's not realistic to expect your customer-facing resources to have the bandwidth or the skill set to project-manage these programs successfully. In addition, customer success operations should help manage the underlying systems that help automate processes and provide the insight and visibility your company needs to keep customers for life.

Additional Commentary

You'd be crazy to run a business without deeply understanding the fundamentals of that business, right? That's no less true for any recurring revenue business that depends on maximizing retention and minimizing churn for long-term success. But, as with any business, there are levels of understanding and then there are levels of understanding. It's one thing to know that your installed base ARR went up by 8 percent (net retention of 108%) last year. It's a whole 'nother thing to know the details:

• What percentage of customers increased their contract size?
• Which industry had the highest churn rate?
• What are our retention and growth rates by product?
• By what average amount did we reduce discounts at first renewal?
• What is the average contract size versus original contract size of all customers who have been customers more than three years?

Knowing the details, not just at the high-level, but within each and every transaction, is a critical component of properly managing your business.

High Touch

This law is critical across all tiers and all touch models. The one advantage with customers in the high-touch model is that you can talk to them. For example, it's really important to understand why a customer churned when that happens. It's one thing to have a field in your CRM system that forces a CSM to pick from a drop-down list. That's a must for sure. But you will learn so much more by actually having a conversation with that customer. In life, we learn much more from our failures than from our successes, so we should take advantage of these failures and learn everything we can in order to avoid them in the future.

Low Touch

Following this law is mostly about financial mechanics. Can you track the details of every transaction in a granular way so you completely understand the nuances of your retention/churn or growth if you are purely pay-as-you-go. The one thing that is not purely financial mechanics is the why. Why did customer X churn? Why has customer Y grown by 243 percent in two years? You'll have some of these answers anecdotally within your company, and you'll have to weigh the value of having someone talk to some subset of them to get more information. You may also be able to find out more through a survey than you would otherwise, so that's worth considering.

Tech Touch

Again, you could identify some customers and talk to them but most likely you'll want to use some kind of digital methodology to learn what you can outside of the transactional specifics. Handpicking a subset of customers and providing an incentive for responding to a survey might be a useful tactic.