SaaS Renewals and the Multiplier Effect

In case you've forgotten the concept of the multiplier effect from Economics 101, it's commonly used to project the impact of a change in government spending or money supply on the growth of GDP.

If, for example, we know that the government spending multiplier is 5, and the government increases spending by $10 billion, we'd project that GDP would grow by $50 billion.

In a similar fashion, renewals have a multiplier impact on SaaS companies' revenues.

The higher the renewal multiplier - that is the more times a company can renew a customer and extend its revenue-generating life - the greater the revenue accruing to the company.

Lifetime Customer Revenue

To be more precise, what we're actually referring to here is "lifetime customer revenue."

Lifetime customer revenue = recurring revenue per period * term of customer lifetime

As an example, I'll calculate the average lifetime customer revenue for salesforce.com, estimating a 3-year customer life multiplier:

$985 million in FY 2009 annual subscription revenue/55,400 customers = $17,780 average annual revenue per customer

$17,780 average annual revenue per customer * 3 year customer lifetime = $53,340 lifetime customer revenue.

Changing the renewal multiplier to a 5-year customer life, yields a more favorable result:

$17,780 average annual revenue per customer * 5 year customer lifetime = $88,900 lifetime customer revenue.

To illustrate the dramatic impact of longer customer life on lifetime revenue, I've calculated the lifetime customer revenue at several publicly-held SaaS companies, using 5-year, 3-year and 1-year renewal multipliers. As expected, a higher renewal multiplier yields substantially higher revenue.

The relationship between the renewal multiplier, lifetime customer revenue and customer acquisition cost

This calculation becomes truly useful when comparing the lifetime customer revenue to the cost of acquiring a customer, i.e. sales & marketing expenses.

Average lifetime customer revenue/average customer acquisition cost

This formula reveals how much lifetime customer revenue is generated by $1 in customer acquisition costs. (I discussed this concept at greater length in the May 2009 newsletter and in an earlier post entitled "Marketing Spend: How Much is Enough?")

According to this illustration, when salesforce.com can extend the average customer lifetime to 5 years, the company generates $2.40 in lifetime customer revenue for every $1 spent on customer acquisition. At a 3-year lifetime, $1.44 of lifetime revenue is generated. And at a 1-year customer lifetime, only 48 cents of revenue is generated for every $1 spent on sales & marketing.

Don't lose customers you've already paid for

As you can surmise, spending more than $1 to acquire a customer that yields less than $1 in lifetime revenue is not a sustainable business model.

Extending the life of the customer's subscription is critical to success. It's bad business to lose customers you've already paid for.