Customer Retention Measurement: How to Do It & What to Consider


Photo by: Isaac Smith

Customers are the life-blood of any business, and organizations work hard to get them. But what about keeping them? Customer retention is a massive part of a SaaS business strategy and can often be the difference between a business that succeeds and one that fails.

Before we do a deep dive into customer retention measurement and strategies, let’s first establish what we mean when we say ‘customer retention.’



What is customer retention?

Customer retention is really about two things: 1) Your customers using the products or services that you have sold them, and 2) These customers seeing value from those products so they renew their subscription. In other words, customer retention comes down to the combination of adoption and value realization.



Why is it important?

It was Peter Drucker that so eloquently said, “The purpose of business is to create and keep a customer”. Far too often businesses put emphasis on the acquisition of new customers and neglect to prioritize or give proper resources to the efforts around supporting the retention of those acquired customers.

The importance of customer retention really comes down to the unit economics of a business. We’ve all heard the widely accepted stat that it’s about 4-6 times more expensive to acquire a new customer than it is to retain an existing one. It was Salesforce, one of the early adopters of the SaaS business model, that first realized how critical the retention and growth of existing accounts was in ensuring a healthy and profitable business. They realized early on that if a customer churned after being with them for only a year, they would have spent more to acquire that customer in sales and marketing resources than they earned in the one year of license revenue.

One of the great things about the shift to the SaaS model is that it doesn’t require the same lengthy contracts and large upfront investment from customers as on-premise software and hardware companies typically required. However, this also has made it easier for SaaS customers to pick up and move to a competitor or drop their subscription, since they aren’t locked into a lengthy contract. Knowing this, SaaS organizations began to double down on focusing on their customers and designating significant resources to retaining them, and the concept of Customer Success was born.

You’ll often hear the ‘leaky bucket’ analogy used to sum up the importance of customer retention. If sales is acquiring new customers but the revenue is flowing out of the business more quickly than it’s coming in, the company does not make up the money it spent winning that customer in the first place. It’s crucial for businesses that want profitable revenue growth and predictability (and let’s face it, who doesn’t?) to fix the leak in their bucket by prioritizing retention efforts and having a thoughtful customer retention strategy in place.

The other reason that customer retention is so important is because as a company matures, the majority of the business revenue ends up being owned by the Customer Success team. In many cases, there is more revenue owned by the Customer Success team than the Sales teams, and therefore the strategies and resources around helping customers use your product and see value from it, should be as important as the efforts around closed-won rates and quarterly sales targets.



Who owns customer retention?

Most times the retention metric is owned by Customer Success. In some cases CS teams will own every part of retention and renewal, other times there will be Account Management or Revenue teams that are more involved in or responsible for renewal and expansion metrics, with Customer Success still focusing on retention.



How do you measure customer retention?


Customer retention can be measured in a few different ways, and from a previous article we published about CS metrics featuring some of the brightest minds in Customer Success, it’s clear that it’s nuanced and varied in different organizations.

Here are the three main ways that customer retention measurement is typically done:

1. Gross Revenue Retention Rate (also referred to simply as ‘Revenue Retention Rate’):

This measurement looks at how much revenue was coming in compared to how much revenue was lost over a set period of time. You can look at Revenue Retention Rate for any given time period, but the most common time frames used to measure revenue retention are monthly and annually. Monthly Revenue Retention Rates will look at changes in Monthly Recurring Revenue (MRR) from month to month, and Annual Revenue Retention Rates will look at changes in Annual Recurring Revenue (ARR) from year to year. The rate is expressed as a percentage and never goes above 100. For example, in 2019, Business X brought in $20 M in revenue, but lost $5M of the revenue to existing customers not renewing. In this case revenue retention would be 75%.

Calculation:

Monthly Gross Revenue Retention Rate = (Starting MRR - Downsell - Churn) / Starting MRR

Annual Gross Revenue Retention Rate = (Starting ARR - Downsell - Churn) / Starting ARR

2. Customer Retention Rate (also referred to as Logo Retention Rate):

This measurement looks at the number of customers retained compared to a previous point in time and is expressed as a percentage. For example, in 2019 Business Y had 45 active customers, but in 2020 only 41 of these customers were still with them, meaning 4 customers churned in this time period. In this case, the Customer Retention Rate would be 91%.

To note: Measuring customer retention by this metric alone can leave a lot of blind spots. For instance, you may only have lost one customer but perhaps this customer is responsible for 30% of the total business revenue. Alternatively losing half of your customers may look shocking but if they are all on basic licensing packages that only account for a small portion of your business revenue, you may still be in good shape. It’s best to pair revenue retention and customer count together to get a true picture of churn and retention.

Calculation:

Customer Retention Rate = 1 - (Customers Churned in Period/Customers at Start of Period)

3. Net Revenue Retention Rate (also referred to as Net Dollar Retention Rate or Dollar Retention Rate):

This metric, looks at account growth as well as retention, and considers things like upgrades or additional licenses or products. So it’s very possible that a Net Revenue Retention Rate is higher than 100%. For example Business Z brought in $20M in revenue in 2019, and in 2020 total revenue was $25M. In this case Net Revenue Retention would be 125%. This metric will give insight into whether or not on average you’re expanding your customer base and that you’re not just effective at retaining but also growing the accounts.

Calculation:

Net Revenue Retention Rate = (Starting MRR + expansion - downsell - churn) / Starting MRR

These reports and data are mostly tracked in a company’s CRM, like Salesforce and Customer Success teams will either track and report on this data themselves, or if an organization has a Revenue Operations or Sales Operations team, this data may be owned and monitored by them. Regardless of the internal structure, it’s critical that Customer Success team members all have access and insight into the data so they can make informed decisions, pivot initiatives, or scale up their activities based on what the numbers and customer retention analytics are telling them.

What are the best customer retention strategies?

Figuring out where to put your resources to ensure the best customer retention rate can be difficult. There truly is no one-size-fits-all answer. For starters, you’ll need to understand the unit economics of your business.

Let’s look at this example: If it costs Marketing $1,000 to acquire a sales opportunity, and the close rate is 25%, your cost per customer acquisition is approximately $4,000. If that customer’s yearly licensing is $2000, they will not be a profitable customer for you until the end of their second year. While you should be very focused on retaining this customer for longer than two years, so that you see the upfront investment in acquiring them back, it also doesn’t make sense to invest $5000 in Customer Success resources to try to save the customer from churning. This is where customer retention strategy becomes a science and businesses that find themselves throwing money at customers to try to keep them, with little thought paid to their unit economics, will find themselves in hot water.

The approach you take to customer retention should have a holistic lens and should consider the path of your most successful customers. Once you’ve understood the journey of your most successful customers you can create a Customer Success framework to align your process and operations to drive the success of your total customer base in a way that’s both repeatable and scalable.

The bottom line is that customer retention is not a one time effort. It’s an ongoing practice and a commitment that should be made at every level of the organization.

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