March 26, 2021
This blog is part our recurring series “Friday’s on Recur” featuring Co-Founder of ASG Jake Brodsky, covering what’s happening in the market and common Founder questions about growing, selling and leading a SaaS business.
Retention is an incredibly important business metric regardless of what type of business you run. Retention metrics measure a company’s ability to retain, or keep, a certain percentage of its customers, revenue or employees over a given period of time. These metrics are most typically measured on a year over year basis.
The areas I want to dive deeper into are revenue versus logo retention, as that has become a debate within the software landscape over the last few years. It’s worth mentioning that scoring high on these retention scores point to the company being strong, but the details of the composition matter.
To get some definitions out of the way. Revenue retention tracks how much revenue is retained year over year, and specifically doesn’t count revenue coming from new customers in the period. There are two ways to track revenue retention: Gross Revenue Retention (GRR) and Net Revenue Retention (NRR). Net includes upsells, downsells and lost revenue. Gross includes just lost.
So if a company has $1 million in revenue at the end of 2019, upsold $100,000 of revenue from existing customers, had downgrades of $50,000 from existing customers, and lost $150,000, their NRR would be 90% (1- (100,000 – 50,000 – 150,000) / 1,000,000). Meaning if that company added no new customers in 2020, they would be $900,000 of revenue in that year, or 90% NRR retained over the year.
Logo or customer retention (or churn), measures a company’s ability to retain customer count regardless of how much revenue that customer contributes. For example, if a company started 2019 with 100 customers, and finished the year with 120 customers, with 25 of those customers being net new to the product or service that year, the company’s customer retention would be 95% ((2020 Customer count – New Customers added in 2020) / 2019 Customer count).
So now that we have that out of the way, here’s my beef.
Customer retention used to matter, but now it’s a distraction of a metric! If you were put in a scenario where you owned a business that went from $1 million in revenue in 2019 to $1.2 million in revenue in 2020 without adding a single customer, you’re generally going to be happy with that. What if I told you that in that same period, you lost half your customers? That would hurt! But when you look at net revenue retention, you’re noticing that the growth in your business comes from growth within your customers. As they grow, their spend with you grows, leading your business to grow. That is the importance of having a pricing model that includes variables to account for this (seats, users, transactions, etc.).
In the scenario above, the company has 50% logo retention (bottom 10% of companies), but 120% net revenue retention (top 5% of companies). A way this can happen is when a company finds their perfect target customer and that customer segment is growing. At that point, the CEO can focus on “How do I retain these customers that keep leaving me?”, which isn’t wrong, it’s just a defensive strategy, OR they can focus on “How can I capture more of the growth I’m experiencing with my growing customers?”, an offensive strategy. We can choose to work on our weaknesses or double down on getting great at our strengths. In this case, the business was able to more than double its average revenue per customer, which is a tremendous strength. Leaning into figuring out the “how” behind that can be an extremely powerful tool.
Now I know what some of you may be thinking…if you keep losing half your customers every year, you won’t be left with any eventually. The reality is that new customers do get added to the fold, and your older cohorts tend to get better over time. In other words, if you lose 50% of customers you acquired within their first year, those that stay have obviously stayed for a reason. The next year’s logo retention for that cohort wouldn’t go to 100%, but it would be better than 50%.
The truth of the matter is, the industry you play in is a big factor in deciding whether to throw out tracking logo retention or not. Not all industries or pricing models allow your business to grow revenue year over year without adding any customers, and in that case, logo retention may still be top dog of the retention metrics. But in the case that it’s not, throwing caution to the wind and diving head first into solving for net revenue retention could just be the shift of mindset to take you to the next level.