The Importance of Customer Retention + 10 Ultra-effective Ways to Improve it
Wanna know the importance of customer retention? Just look at the numbers:
It’s 6-7 cheaper than acquiring new customers. Plus, repeat customers spend 33% more on average than new ones. Many SaaS companies generate up to 35% of their annual contract values from upsells, and 40% of SaaS growth comes from word of mouth referrals from existing customers.
Last but not least – just 5% uplift in retention leads to 25-95% greater profitability.
We see and hear these stats quoted again and again in blogs and at speaker events.
No wonder customer retention is such a big deal – but how can you improve retention when it depends on so many different variables? (As Andrew Michael explains in this video (5:05))
Well, that’s exactly what this blog is going to explain!
- Importance of Customer Retention: Why it Matters
- Importance of Customer Retention: Don’t Kid Yourself
- Importance of Customer Retention: What to Do About It
Importance of Customer Retention: Why it Matters
Like other subscription businesses, SaaS has one very distinctive feature:
The Lifetime Value (LTV) of a SaaS customer trickles in over a long period of time – and the longer that time is, the more the customer will pay and the higher that value is.
But, the Customer Acquisition Cost (CAC) is the same for a customer who stays on board for a week and doesn’t pay a cent and for one who sticks around for years.
And the CAC is a leading metric – it’s all paid upfront. This graph from David Skok shows why that’s a big problem.
Only when the green area exceeds the red area (LTV>CAC) are you potentially making any money on this customer
If they churn before that happens, you’ve lost money – and a customer you lose money on is not one that’s worth having.
The trouble is, those customers you threw good money into acquiring could churn at any time if you’re not careful about retaining them for long enough.
That’s the heart of the importance of customer retention.
This has some serious knock-on effects.
Because they only realize revenue from customers very gradually, new SaaS companies tend to rack up big losses and cash deficits.
This graph shows the cash position that results from the cost/revenue figures above. It takes 14 months to get to a cash-positive position!
A situation like that can be fatal to an unfunded or bootstrapping SaaS and it can seriously worry investors.
This is precisely why so many businesses love to be paid in advance – but for any “as a service” product, that can only be pushed so far.
Of course, we’re only looking at the unit economics here. There are loads of other costs you need to take account of as well as CAC – not least the monthly cost of servicing your customers.
You need to know your CAC and LTV figures precisely to know whether your business is financially viable.
It’s that simple. We’ll return to this subject in the next section “Importance of Customer Retention: Don’t Kid Yourself”.
But this is where the lag on customer retention as a metric creates such difficulties.
You can only know with certainty what it has been. And at that point, it’s too late to do anything about the customers you ended up losing money on.
Perhaps this is one of the reasons why SaaS companies have a tendency to prioritize new customer acquisition over retention?
- Acquisition costs are easier to measure, because they’re immediate and not staggered.
- Sales metrics are often easier and more direct to affect than retention metrics, so it can seem more worthwhile to keep refilling the bucket than the plug the leak.
- Growth is just plain sexier than retention, right!?
Well, here’s a weird fact.
Another aspect of the importance of customer retention is that it actually imposes a finite limit to growth.
For any given churn rate (churn being the inverse of retention for our purposes), there is a point at which you just can’t sell enough to replace it.
When that happens, your business stays stagnant or begins to shrink.
And that’s a bad position to be in, because as we all know, SaaS success depends on growth and the compounding effect of subscription revenue.
Remember, a 2% monthly churn rate means you need to replace around 22% of your revenue every year!
As Jason Lemkin explains:
- SaaS companies that turn over less than around $2 million per year have a really hard time bridging the profitability and cash gap.
- $2 million ARR is an inflection point at which the business becomes very resilient, unless churn spikes unexpectedly.
- At around $10 million ARR “some level of real success is almost inevitable”.
Just look at Salesforce:
This is why most SaaS founders are obsessed with growth.
But if it’s actually cheaper and more beneficial to retain existing customers than to acquire new ones… most SaaS companies are going about growth in completely the wrong way.
Importance of Customer Retention: Don’t Kid Yourself
The trouble is, these factors often combine in a toxic mix.
- Founders want to grow, and the quickest and most direct way to achieve that is to sell more.
- Getting the retention rate wrong can lead to marketing overspend – which can lead to irrecoverable losses
- As David Gurley argues in this classic article, the LTV model ends up being misused to rationalize marketing overspend
So it’s essential to keep your variables completely clean and never engage in wishful thinking.
Be totally honest about costs and revenues because the truth will out.
Here’s an example of honest reporting from Hubspot. By tackling revenue churn, they significantly increased the LTV of their customers to the business.
In these figures, for example, Hubspot treat the one-off cost of onboarding new customers as part of the acquisition cost rather than a running expense or part of the software margin.
It is also critically important to understand what these figures really mean.
In the context of the importance of customer retention, ask yourself these questions:
#1 What kind of retention am I really interested in?
User retention is not the same as revenue retention.
If you lost only 10% of your customers in a year – but those customers contributed 25% of your revenue, your situation is far worse than your user churn rate would suggest.
Most investors and SaaS companies accept that revenue churn is a more meaningful figure than user churn.
That’s because if your retention rates are good in the lower-revenue-per-user group, but dismal in the best-paying customer segment: your average user retention rate will misrepresent the impact your churn in the different user segments has on revenue.
Many companies try to fool themselves and others by including free triallists in their customer numbers as a means of downplaying user churn. The fact is, a free triallist represents zero present revenue!
#2 Is one number crowding out another?
One issue with revenue churn, however, is that it can conceal serious problems if it’s not analyzed properly.
For example, if the increasing value of one group of customers (upsellers) is compensating for the loss of other groups. Your user base could be dwindling to an ever-smaller core without your numbers making it obvious.
#3 Who is staying and who is going? And why?
Your company’s aggregate retention rate doesn’t tell you a whole lot by itself.
It’s a variable that needs to be tracked over time, so that trends can be plotted and correlated against the retention marketing action you’ve been taking to fight churn. That way, you can start to build up a picture of what works and what doesn’t.
You also need to segment your user base in line with the main personas, use cases and cohorts. This gives you the information you need to start experimenting with the other variables, like price.
Importance of Customer Retention: What to Do About It
So let’s now assume that you have a complete and honest picture of your CAC and other ongoing costs.
Your subscription price determines how many months or years you have to retain the average client to recoup the CAC. In the simplest terms:
LTV = Subscription price x Average customer duration
You can get a lot more technical than that though. David Gurley offers this as his idea of a simplified calculation!
Of course, it’s not enough just to cover the CAC and running costs. The money you make from customers has to cover fixed costs (such as office rent, coffee bill, travel expenses etc) and profit.
David Skok’s benchmarks are, for a successful, financially healthy SaaS:
- LTV should be at least x3 CAC
- Time needed to recoup CAC should be under 12 months
How do you get there?
Well, there are actions you can take that will affect the CAC:LTV ratio directly.
Direct Route #1 Put Prices Up
If your users pay more, you recoup their CAC quicker. Simple!
It’s not always easy, but it can be done. It’s easier if your users are seeing massive value in your service compared to what they are paying.
An alternative to putting prices up might be to increase the subscription period. If your customers can all cancel immediately, then you have very little certainty about your future revenue.
Plus, you’re in a daily battle to stave off churn.
If you can switch users over to annual contracts you have much greater certainty about incoming cash and more time to show value.
This is why so many businesses offer a discounted rate for annual billing or a longer notice period.
And of course, as we have already mentioned, getting payment in advance makes a huge difference to your company’s cash flow and solvency.
Direct Route #2 Upsell
A more subtle strategy than blanket price rises (which can always backfire and lead to increased churn) is to encourage users who are seeing the value to move up to higher pricing tiers where they can realize even more.
It costs 6-7 times more to acquire a new customer than to retain an existing one.
That’s from the oft-cited Bain and Co study we’ve already mentioned at the beginning. It makes painfully clear the importance of customer retention.
Combine that with the greater likelihood of your happiest users spending more with you (a 33% premium, in fact) and putting more effort into upselling makes a whole lot of sense.
Direct Route #3 Cut Your Marketing Costs
Easier said than done, you may say, but studying your retention rates can reveal a great deal.
Remember the Hubspot chart we showed you earlier? Hubspot halved their CAC for the small business segment by ditching direct sales in favour of reseller-only.
Once you understand your market segments, you can get to work on any or all of these factors.
In the rest of this blog, we’re going to look at ways of increasing LTV by keeping hold of paying customers for longer.
The importance of retention is clear to you, but it’s not something your customers particularly care about.
It’s an internal KPI.
You need to translate that into customer-facing metrics that users care about.
Why do customers stay?
Because they’re getting value from your service.
Source: Andrew Michael, Churn FM
As Andrew Michael’s graph shows, the more your solution costs relative to the value it provides, the greater the risk that a customer will churn.
If they’re getting too much value relative to cost, you should be upselling them as we talked about above.
The “sweet spot”, as Andrew puts it, is when they’re paying a lot and getting a lot of value as well.
But what is “value”?
You need to break this down into some quantifiable, behavioral metrics that correlate with better retention. Because if a user sticks with you, you must be doing something right and they must be getting some value.
Depending on what your service is, these metrics might include:
- Feature adoption
- Positive feedback and NPS scores
- Monthly log-ins
- Progress along the ideal customer journey
We’ve covered these metrics in a lot of previous blogs, as well as how to integrate them into a retention strategy.
So here are ten practical things you can do increase user value and retention:
#1 Find out what the customer is looking for
Different customers adopt your SaaS looking for different things. You need to segment them by use case and desired value as early as you possibly can so that you can support them along the shortest, most direct path to value:
- Segment by marketing campaign. A new user who responds to a landing page that focuses on the benefits of your tool for (eg) SEO keyword selection wants to learn how to use that part of your service before any other features.
- Ask the new user what they are looking for on arrival. Welcome screens and welcome emails (see Freshbooks’ example below) are great for this, and can be used to segment by interest, experience level, preferred use cases and more.
- Respond to in-app behavior and segment contextually. So when a user starts a task, allocate them to that customer journey and offer support accordingly.
- Be proactive in suggesting beneficial use cases. See how Notion does this with a list of integrations below.
#2 Minimum Viable Onboarding
Keep it short, keep it focused and keep it trained on the user’s priorities – not your desire to show off your service!
As this graph shows, slow onboarding leads to churn.
The goal of the initial onboarding is to create users who can realize their desired value. It needs to show them how to become a competent user – no more, no less.
#3 Help Users Solve Problems
Even the best onboarding can’t preempt every problem a user may encounter.
So, you need comprehensive help resources. This can include:
- FAQs and Document Library
- Email, phone and live chat support
- In-app tooltips and video tutorials
But be sure to make these genuinely useful. Help centers that don’t actually solve users’ problems do more harm than good!
#4 Build Relationships
What’s the biggest single reason why people stop using a product?
Compare that with just 9% who said it’s the product quality!
SaaS is not just about software. It’s about Service too – and nothing says good service like genuine, personalized care and attention.
That may not be feasible for you, but creating a sense of personal connection alongside the value your SaaS delivers makes a big difference. That can be as simple as putting faces to names, like Balsamiq does here.
#5 Celebrate Success
Sometimes users need to be reminded or even told when they’re doing things right! Look at how Asana celebrates crossing a task off the to-do list.
While this is how Loom reacts when you complete your first video (i.e. finish basic onboarding).
#6 Introduce New Features
Falling usage levels are a tell-tale warning sign of imminent churn. If you spot this happening, start pointing out other features and use cases to the disengaged user.
If they’re not logging in, use email to reach out.
The same approach can be used to push engaged users onward in their customer journeys, by increasing the value they can extract from your product.
#7 Add Retention Hooks
Wherever you can, design in features that make it hard to stop using your service.
This is particularly powerful with tools that have a social aspect or which enable collaboration between people. The more users there are, the better it gets.
In the past, many SaaS providers discouraged people from leaving by making it difficult to extract and reuse data and other assets associated with their tools.
Thankfully, most businesses have seen the sense in avoiding this kind of locking-in and now try to make users not want to leave rather than preventing them from leaving completely!
#8 Easy Cancellation Flow
In fact, many SaaS businesses actually make it easy for users to leave.
Why? Surely we don’t want to encourage churn when we’re talking about the importance of customer retention!?
In general, once a user has decided to quit, it’s already too late. They’re not getting the value or they’re annoyed with you. The best thing you can do with somebody like that is let them go gracefully.
Of course, you should remind them of why they signed up in the first place and what they will be losing. That will change a few minds!
But as a rule the goodwill generated by not being difficult could well be what tempts a churned user to return later on.
#9 Experiment with Marketing and Product
Sometimes it’s not the user’s fault. Sometimes it’s you!
Try different marketing campaigns – that will bring in users with different expectations, who may be better suited to your products.
A/B test different in-app experiences.
And try out new features and product packages.
Keep experimenting, segment and analyze the results until you find a set of combinations that deliver you massive LTV!
#10 Don’t Be Afraid to Say Goodbye to Bad Customers
This final point takes us back to the beginning of the blog and to Andrew Michael’s value matrix. Here it is again:
Source: Andrew Michael, Churn FM
If your resources and time are limited, put your efforts into retaining customers in the sweet spot – at the expense of those in the unlabelled quadrant if necessary.
If you have a segment of customers who are difficult, who don’t pay much or who don’t see a lot of value in your product – let them go!
Put your resources into identifying the most lucrative segments, retaining them and bringing in more people like them.
We’ve shown you the importance of customer retention.
And we’ve explained how to improve it as well.
Good luck! Please share any more tips you have below.