In the world of SaaS, customer churn rate (how often customers are leaving your business) determines success and longevity.
Unlike other businesses that extract the total value of a solution from their customers upfront—SaaS businesses generate revenue incrementally. With this “subscription” payment model—these businesses operate from a loss when they initially acquire a new customer. The key to their success is their ability to retain existing customers long enough to generate a profit and offset these initial losses. In SaaS, it isn’t uncommon for the time required to break-even and overcome initial acquisition and service costs to be a year or more!
As you can imagine—this need to retain a customer for a long period just to make a profit dramatically changes the dynamic between a company and its customers.
These differences forced SaaS organizations to approach customers and value generation differently than traditional business models.
As a result, the SaaS industry has been reimagining the customer journey and innovating new customer experience strategies to retain customers, generate greater profitability in the long-term, manage service costs, and grow their revenues and customer base.
The widespread success of these CX innovations and advantages have changed customer expectations and entire industries. And the best part is—these innovations can be adapted and employed by other traditional business types—helping them unlock sustainable growth.
This series, “CX Lessons from SaaS,” explores insights gleaned from the SaaS industry’s deployment of these new innovative approaches to growth and customer experience—as well as how these strategies apply to and benefit traditional/other businesses.
In this first article, let’s explore the relationship between customer churn rate and SaaS profitability—and how the SaaS industry can teach businesses the value of investing in and retaining customers.
How Customer Churn Rate Determines SaaS Profitability
As we outlined, customer churn rate is a critical metric for SaaS businesses. Without high customer retention, a SaaS business is unable to generate sufficient revenue to realize a profit.
But why does this occur?
SaaS business revenue generation differs significantly from traditional businesses.
With a traditional business model, customers buy solutions. Those customers pay the total cost (set by the organization) for the potential value—and they do this upfront.
While this works from a revenue generation standpoint—it doesn’t focus on customer needs. Instead, these models place the onus of achieving ROI squarely on the customer. They also create transactional relationships.
Once a prospect buys a solution and becomes a customer—the organization’s sales and marketing teams turn their focus back to filling the funnel with new customers. These teams are incentivized to essentially “forget about customers” and leave their service team counterparts to meet and fulfill all customer needs. In essence, once the business has generated profit, minimal investments are made in retaining, nurturing, and expanding that customers value.
In these arrangements, despite the highly profitable opportunities that reside within the customer base, it’s easy for a business and its customers to become disconnected.
With SaaS subscription models, businesses and customers share the risk and success of achieving ROI. Because revenue generation occurs over time, the SaaS business has a vested interest in ensuring that its products/services are not only adopted but fully integrated into their customer’s lives.
If customers cannot achieve their intended value, they can (and do) end the relationship to reduce further losses—leaving the SaaS company unable to recoup its acquisition and development costs.
As a result, customers have greater authority in a SaaS business model, which changes how they attract, engage, and support their customers. To understand just how much authority customers have in SaaS, let’s look at how customer churn directly affects profitability.
SaaS Profitability 101
Customer Churn Rate
Customer churn rate calculates how many customers cancel subscriptions or end their relationship with the business over a given period. This vital SaaS metric is the inverse of customer retention rate. Meaning if you retain 90% of your customers over a given period, your churn rate is 10% over that same time.
Customer Acquisition Costs (CAC)
CAC refers to the expense of finding, converting, and onboarding new customers. This cost is what determines the break-even point for new customers.
Average Recurring Cost of Service (ACS)
Average recurring costs of service are straightforward. It is the cost to the business to support, serve, and educate current customers.
The Break-Even Point
The break-even point is the length of time required to maintain a customer to pay the costs of acquiring them. The graph below depicts what a break-even point looks like with and without customer churn.
SaaS Profitability
Without diving into math, when customers are first acquired, SaaS businesses are operating at a loss. It isn’t until a customer is retained for a set period that the company generates a profit.
SaaS profitability occurs when:
- The average customer lifetime exceeds the break-even point.
- New customer acquisition is greater than churn.
- The current customer base pays for the cost of acquiring new customers.
The Levers That Influence SaaS Profitability
Subscription models provide a greater rate of return than traditional business models, provided the business can continuously demonstrate value and convince customers to keep paying their dues.
Because customers do not generate a profit until they pass the break-even point—a SaaS business cannot solely rely on acquiring new customers to grow.
Therefore, the factors that ultimately determine long-term profitability are the cost of service, acquisition cost, and customer churn rate.
Disclaimer: Yes, businesses need new customers to grow. We aren’t telling you not to add new customers if you work in SaaS. But suppose you only focus on acquisition and not your cost of service and customer retention rate. In that case, your business could theoretically continuously acquire new customers and never turn a profit due to high churn and high cost of service.
The graph below illustrates the effects of customer churn, cost-of-service, and acquisition on long-term profitability.
For SaaS businesses, churn is the antagonist to profitability. Unfortunately, though, the reality is some churn will always exist. The trick is to keep churn low enough to offset the cost of new growth.
Of course, the primary goal is, get out of the red. To do this, SaaS businesses must take greater care of their current customers to retain them as long as possible. While other business models may not be as dependent on keeping customers—there is still enormous value and numerous bottom-line growth opportunities sitting in their customer base. We just have to look at the lessons from SaaS.
Applicable Lessons of Customer Churn to Other Business Models
Clearly, the success of a SaaS business is tied to how they ensure value, maintain relationships, and ultimately encourage customers to retain their business agreements.
By relentlessly focusing on why customers leave and what keeps them coming back, SaaS businesses gain a deeper understanding of their customers and create experiences that reduce churn and increase lifetime value.
The key here is that SaaS organizations crafted customer-centric experiences to bolster their revenue generation model and create a competitive advantage. But these opportunities and benefits don’t just apply to SaaS companies.
Benefits of Lowering Customer Churn That Apply To All Businesses
If, for some reason, you needed more motivation to take care of customers and reduce churn—there has been considerable research spanning multiple industries about the value that resides in a company’s customer base.
Here are just a few highlights of why obsessing over customer churn is a valuable investment:
- Acquiring a new customer can cost five times more than retaining an existing customer (HBR).
- 80% of your company’s future revenue will come from just 20% of your existing customers. (Gartner Group)
- Improving your customer retention by just 5% can increase your company’s profitability from 25% to 95%. (Bain and Company)
- The success rate of selling to a customer you already have is 60–70%, while selling to a new customer is 5–20%. (Marketing Metrics)
- “Loyal customers are five times more likely to purchase again and four times more likely to refer a friend to the company.” (Qualtrics XM Institute)
By adopting a SaaS mindset and applying some of the same principles and approaches, non-subscription businesses can attract customers, cultivate lasting relationships, increase customer lifetime value, and spur growth.
The question is… Are you doing enough for your customers?
SaaS and Tech Taught Us That Customer Experience Matters
When it comes to reducing churn and tapping into the value of your customers, it all comes down to customer experience (CX).
The way you approach your customers and generate value throughout the customer journey affects their willingness to do business—and continue to do business—with your brand. To provide a compelling customer experience, you’ll need to adopt a holistic approach to CX that spans every customer interaction across all of your customer-facing teams (not just the service team.)
For any of you that are eagerly twirling your overly-sized, wonderfully-manicured mustaches over the profit opportunities of this SaaS-inspired, customer-first approach to revenue—know this…
Modern customers hold ALL of the authority in business relationships.
Savvy consumers, the internet, and a global economy have laid waste to old school thinking that customers can be retained against their will.
So unless you are a utility or service provider that enjoys a regional monopoly—or an oil Baron/oligarch who can engage in rent-seeking tactics—take care of your customers.
If you don’t provide an experience that customers want, the digital age has empowered customers to quickly and easily transition to a competitor that will.
Take a page out of SaaS’s playbook and adopt a healthy obsession with reducing customer churn and providing your customers with value to keep them engaged. Doing so will reveal opportunities to engage customers, remove friction, and generate additional value.
The Wrap Up
Unlike other business models where customers pay upfront for promised value—SaaS business simply cannot grow through new customer acquisition alone. Instead, profitable subscription businesses have aligned themselves with modern consumer behaviors. They seek to delight customers and reduce churn through shared success strategies and customer-centric experiences.
As a result, these businesses foster long-term customer relationships that lead to greater profitability than traditional business models. But it does take time.
Regardless of industry and model, when businesses invest in and empower their customers—they foster brand advocates, increase word of mouth, and unlock sustainable growth.
If you’re looking for ways to reduce customer churn, increase customer lifetime value, and grow your business—the SaaS industry provides a proven roadmap to the value of investing in your customers.
Stay tuned for additional topics on how the SaaS industry is changing CX and increasing the value of its customer base.
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