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.
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 mutiplier:
$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 * 3 year customer lifetime = $53,340 lifetime customer revenue.
$17,780 average annual revenue per customer * 5 year customer lifetime = $88,900 lifetime customer 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.
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4 comments:
Peter,
Good analysis and illustration. I am curious as you took a look at the customer acquisition costs over the lifetime of the customer, did you take into account the 2nd year, 3rd year, etc. commissions that might be in play in some sales plans.
In other words, is the customer acquisition cost in your analysis, static or dynamic, because that would change the Lifetime Customer Revenue derived from keeping a customer on longer.
The basis of your argument still holds, I am just trying to see the magnitude whether its really $2.4 in the case of SalesForce.com for 5 years or lesser.
SK
Here's how I've calculated the average customer acquisition cost:
Sales & marketing expense for the most recent fiscal year/the number of new customers added during that year.
I am really trying to get at initial customer acquisition cost, but you're right that the sales & marketing costs would include commissions paid for renewals if sales compensation plans are structured in that way.
The customer acquisition costs could also include marketing expenses related to renewing existing customers, e.g. customer events.
You could argue, in fact, that it may be appropriate in some cases to allocate some portion of support costs to customer acquisition. If customers aren't well-supported, they won't renew.
With more information, you could certainly do more detailed analysis, applying the same concept, but including or excluding certain expenses. Unfortunately, there's a limit to the data commonly reported by public companies.
I've seen companies make the mistake of marketing and selling to their retained customers in the same manner that they market and sales force.
It shouldn't take any marketing to get existing customers to renew. You really shouldn't use the same sales force either. Sales compensation plans need to distinguish between hunters, outbound sales, and farmers, inbound sales.
The typical savings in terms of cost of sale for a retained customer is 60-90%.
In "Habit," the author makes the case that renewals should be automatic and not require customer awareness, as in zero cost of sale.
I agree that vendors should consider sales compensation plans that distinguish between selling to new accounts vs. existing customers.
I'm not precisely sure about the "60-90%" figure, but I agree that is should cost less to renew an existing customer than win a new one.
I would disagree strongly, however, with the idea that no marketing effort is required to secure renewals. Existing customers who are unaware of the value of continuing their subscription to a SaaS solution are very unlikely to automatically renew.
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