Measuring Renewals

Early in my career, I taught bank credit analysts-in-training how to read financial statements. During my course, they heard from me one constant refrain: "Read the notes, read the notes, read the notes." The notes to a company's financial statements often reveal critical insights behind the numbers.

The advice on how to read financial statements certainly applies to software-as-a-service (SaaS) companies, and especially to their reported customer renewal rates. SaaS companies may claim that they have renewal rates of 90% or 95%, but it's critical to look behind these numbers and understand how they're calculated.

Is a 90% renewal rate a good thing?

First, it's important to know what the company is really counting when it refers to "renewals."

• Are they referring to the number of customers, or to revenues?
• Are they counting only the customers whose contracts are up for renewal, or all customers?
  

Then, carefully examine how the renewal rate or attrition rate is calculated.

• Some companies compare the number of customers at the beginning of the period to the number of customers lost during the period. For example, if they start the year with 100 customers and lose 15 customers over the course of the year, they'd show a 15 % attrition rate or an 85% renewal rate: 15/100
• Other companies compare the number of customers at the beginning of the period plus the customers gained over that period to the number of customers lost during the period. By this alternative method of calculation, if they start the year with 100 customers, lose 15 of them over the year, but acquire 50 new customers over the year, they'd show 10 % attrition or a 90% renewal rate: 15/(100+50). Voila! An 85% renewal rate becomes 90%.
  

Finally, look carefully at the length of the subscription term.

• If the subscription term is one year, a 90% renewal rate means that the company loses 10% of its customers each year.
• If the subscription term is one month, a 90% renewal rate means that the company loses 10% of its customers each month. At that rate, it will lose its entire customer base in less than one year.

So to answer the question, "Is a 90% renewal rate a good thing," by reading the notes you may have equipped yourself to provide a definitive answer: Maybe.


Thanks to Tod Loofbourrow for his insights on this topic.