How we achieved a 5% churn rate in SMB SaaS

What is a good churn rate in the Small Business (SMB) space?

Most people know that SMBs tend to churn much higher than enterprise — one of the main reasons being that they go out of a business at a higher rate. Also because the products tend to be less complex, it can in theory be easier to move and adopt an alternative.

The general consensus is that 3% monthly churn or 35% annually is decent. But this means you need to signup 35% new customers every year just to stay flat! Or 70% growth in new customers to get a 35% growth rate. However public SMB SaaS companies such as Mindbody and Shopify get much better rates than this. And in our particular SMB vertical, hair and beauty, the best companies aim to be doing 1% monthly or 12% annually. At Phorest we’ve gone from 8% churn in 2013 to approximately 5% for the last 2 years.

If it is so much harder to achieve low churn in the SMB space, why bother building a business in it?

Loads of reasons. It is huge. There are more SMBs in the world than any other type of business. And within SMB there are enormous verticals such as the salon space we are in where there probably more than 4m salons worldwide.

Also it is easier to sign a customer up in that you go straight to the decision maker. And there is less legal paperwork etc.

Another benefit that we like is that having thousands of customers rather than a few elephants, means we are less at the beck and call of one customer. This is particularly good for product development, as they can focus on features and tools that are the best in what they do for the majority of our customers — rather than just what one customer wants. The latter tends to lead to very bloated products.

What is LTV and how does churn affect it?

LTV is the lifetime value of a client. There are two elements that make up LTV; your average revenue per client per year and the churn rate. The first one is probably obvious in that the higher revenue per year, the higher your lifetime value of a client will be.

The second one is not as clear but just as important. How many years a client stays with you in determined by the churn rate. For example if your churn rate is 100% then you get 1 year of LTV or 1 year multiplied by annual revenue per client to get your LTV. The lower the churn rate, the more years your clients stay with you. As of today our LTV in years is 14.5.

LTV is important because the higher it is, the more you can spend to acquire customers, and therefore the faster you can afford to grow. The cost of acquiring a customer is usually called CAC and should in our experience include all costs (salaries, adwords, onboarding etc) of getting a customer from when they first hear about you until they are live on your product. If your CAC is the same as your LTV well then clearly you don’t have a business. You are spending the same amount of money up front as you can possibly ever hope to make. So a very general rule is you need to have a 3:1 LTV to CAC ratio. Anything higher than that is good. But if it is too high then maybe you aren’t spending as much as you should on growth.

Who looks after Churn and LTV?

Churn and LTV usually fall into the remit of Customer Success in SaaS companies. In enterprise SaaS, that often looks like Account Management. Basically the normal account management of being the person who is responsible for on-boarding and training the customer, being their point of contact for issues, combined with the new customer success elements of ensuring the customer engages with and gets positive results from the product.

In the SMB world, this method of Customer Success doesn’t work because the annual value of one customer isn’t high enough to fund a team of account managers to look after a number of customers OR too many customers have to be grouped with each account manager which means the customer is less likely to succeed with the software.

So you have to create assembly lines in SMB. The way we have done that is to have 4 independent teams with a VP for each. The 4 teams are:

• Onboarding
• Support
• Training and Education
• Grow (Upselling)

Each of those teams has to do more than just their core role. What I mean that each team has a customer success filter to what they are doing; as in the Onboarding team doesn’t just want to get the customer live on the software, they also want to see how they can get them live in a situation where the customer is the most likely they can be to use all the features and benefits of the product — and in our case to see them growing their business.

What do you mean by assembly line?

Within each of those teams, when customers are dealing with them, they don’t have a continuous point of contact. We try to build our systems and customer journey in a way to allow anyone on a team to deal with any customer at any time. It is the only way to scale — particularly in the S side of SMB.

For specific areas of expertise , basically we go deep rather than broad. The Grow team in Phorest is a very good example of this. The Grow team’s job is to get each customer to grow their business by using all or as many of Phorest’s extra revenue generating features. Each feature has someone specialising in that area (and often a team with them) — almost managing it like a business unit. So rather than talk to an account manager who has a general feel for how a feature may grow your business, clients talk to experts each time. In this way there is a benefit to an assembly line process to the feeling of continuity they may feel from a dedicated account manager. And most importantly an expert is more likely to be able to show them how to grow or “succeed” with a feature than a generalist — and generates bigger results for clients as a result.

We started down this path very early on in the company’s journey and I would strongly recommend anyone in the SMB SaaS space do so too. The way to tackle each vertical will be different, there will be nuances and the quicker you start doing that, the quicker you will figure out how to make it work

Focusing too much on ACV in SMB SaaS can lead to less revenue per customer

Your revenue mix in SMB SaaS is a very important factor in building a high LTV. We learned early on that focusing too much on ACV or Annual Contract Value was a surefire way to limit your potential revenue per client. This may seem unintuitive to many people in SaaS who think you have focus on increasing the ACV — but that is more in the Enterprise space. In SMB, you will scare off customers and potential customers by offering large and long term contracts. The best way in our experience is to have your basic subscription contract but then offer more revenue generating features that are transactional in nature (payments is the big one here for the public SMB SaaS companies such as Shopify and Mindbody). This means customers aren’t contracted to pay and use but only pay as they use or as the feature generates value. We’ve found that that results in much higher usage, and revenue per customer. So much so that we created a new term to describe it ARV. Right now in Phorest 65% of our average revenue per customer per month is not contracted. Because most SaaS companies are not SMB, the non-contracted revenue is valued lower than the contracted but I think you will see that change as people understand how much stickier the transactional revenue is.

Focusing on Upselling actually leads to lower churn

Another surprising and unintuitive thing we discovered was that more we invested in the Grow team, the lower our churn rate went. This was despite our customers spending more money with us. We reckon the reason is this: The Grow team were getting our clients to use more of our product, therefore they were relying on it for more functions in their business. And because those functions were trying to increase their revenue — they were relying on it for more of their revenue — and thus churn went down.

This is another thing it is worth investing in early on — because anything you can do to reduce churn early in your business’s life cycle — the easier it will be in the future.

Some other things we’ve learnt

We haven’t invested that much in support queues or support automation. Believe it or not, the more support calls we get the higher our revenue grows. A lot of this is down to building a relationship between Phorest and our clients, and the more they talk to us, the more they trust us, and the more opportunities we have to pass them over to the Grow or Training teams.

Content marketing and events also play a big role in LTV and lowering churn. We have a team of 3 working full time on content — for blog, ebooks, podcasts etc. Obviously the first reason we started that years ago was to build thought leadership for top of the funnel and customer acquisition. But actually it is had just as big an impact in increasing product and feature engagement and thus increasing our average revenue per client. Salon owners listen to the podcast or read the blog and then want to talk to someone in the Grow team about turning on a feature.

Another interesting thing we learnt was that having hands on sales process reduced churn. We have done both field, telesales and freemium over the years but field sales has led to much lower churn, and higher ARV — sometimes 2–3x higher which more than pays for itself.

Conclusion

At the end of the day, every company in every industry will have a different experience with different challenges and opportunities. The key thing is not to just accept the SaaS cookie cutter best practices that you may read about, particularly when it comes to churn and LTV. Keep an open mind, and be willing to experiment with as many different solutions and ideas that you can. That leaves you with the best chance of achieving the lowest churn possible.

This is a transcript of a fireside chat with Tom Lyons at SaaStock in September 2017. I discussed the same topic with Alex Theuma on the SaaS Revolution podcast.