Exposing the myth of linear SaaS revenue growth (and how to achieve exponential growth for your SaaS)
“Exponential SaaS growth is impossible. All SaaS growth is linear.”
“It takes a long, long time to grow a SaaS and you must be prepared for a slow, steady climb to your MRR goal.”
Today is the day you’re going to learn that the above statements are totally incorrect.
Over the last few years, SaaS has become the de facto business model for solopreneurs and B2B entrepreneurs looking to create bootstrappable companies that can grow profitable over time — whether with or without funding.
The SaaS business model has been touted for its ability to standardize monthly recurring revenue, and there is general consensus on the capital role churn plays in the SaaS equation; where high churn will inevitably kill a SaaS company.
Why churn is important for SaaS
You can’t grow a SaaS business if the revenue you work hard to acquire leaks away a few short months after being acquired.
In venture-funded SaaS, there’s this idea that you’re going to spend a bunch of money on day 0 (cost of customer acquisition) knowing how long it should approximately take for you to break-even (and start becoming totally profitable on that customer).
But if your customer is churning (re: unsubscribing, leaving) before they’ve paid you back, you’re going to get into trouble.
Worse, if your customer churns soon after signing up, that’s an indicator that your product isn’t well positioned to answer a pain or that the wrong type of customers are signing up for your SaaS.
What churn causes to a SaaS business
The big headline is that churn is going to slow down your growth rate. When you calculate how much net revenue you make each month, you take your MRR and subtract it by the revenue lost to churn that month.
So if I start the month with 100 customers, acquire 50 customers during the month but lose 30, I end the month at 120 customers. But my churn rate is 30%! It means one third of my entire customer base left on that month.
Luckily, we’re acquiring more customers, but you can see how this would reduce your ability to grow faster.
Fine, so we want to reduce churn. That’s where this all leads us.
Conventionally dealing with churn
Generally, there’s this confusing idea that “churn is inevitable”. I think that’s fair to assume that up to 1% or two of your userbase might choose to walk away each month. Granted you are at least growing a little bit, that churn should be negligible. So churn itself is inevitable.
As a young startup, it is common to experience high churn. Your product is young, you’re still figuring out who your customer is, and there’s time ahead to be spent on honing in against those parameters. But the error comes once that honing in happens. People look at the churn, hunch their shoulders and say “well, churn is inevitable.”
Sure, every growth marketer looking at churn will decide to take action against it (usually in the form of customer success or by looking at how the product is used). But this comfortable thinking that having churn is going to be a reality moving forward seriously bothers me.
So here’s the higher resolution picture on this.
Negative churn is the real goal
Let’s take a hypothetical SaaS business.
Its business model is generic — it offers a free offering (in the form of a trial or other) which then has some conversion rate to a subscription.
The funnel looks something like this:
- Visitor hits the home page
- Choose to start a free trial (or free account)
- Eventually, some % of the free users end up converting to the paid subscription
- Some customers eventually churn.
Sounds about right? Let’s say the company is at $10K MRR right now and is adding $4K MRR every month from its organic efforts, Not bad!
We’ll take our earlier example, where the churn rate is 30%. As a reminder, this is calculated by looking at the total amount of revenue lost by the end of the month divided by the total number of active subscribers at the beginning of the month. At 30%, that means that for every 10 users you have at the start of the month, 3 will leave over the course of that month.
And this is the result.
“What the heck?”
If your business is growing linearly, that goes to say that every single month, it brings in $4,000 in new revenue, but you lose 30% of the users you have at the beginning of the month, the growth rate gets totally squished.
In fact, the revenue eventually caps out at around 13.5K MRR because of that churn. And from there, the only way to make the business grow again, is either by adding more revenue (which is hard) or by making your product and customer success effect work to reduce the number of people who choose to part ways with your software.
How do you solve churn?
Now this is an interesting question you’re going to get a lot of different answers to.
The first go-to answer, which is correct, is to focus on product. Is your product actually useful? Is it responding to the customers’ pain adequately, consistently and creating value for the customers such that the expense of your product is far and beyond under the return granted by its use?
The second response relates to the customer: “it’s not the right customer.” This can also be true, the idea of product/market fit kills thousands of startups a year. There is little sense in spending a year creating a product without ever interacting with your intended user.
But those are two large topics I’m expecting you already have some responsibility over.
So for the sake of the article, let’s assume your product is in fact quite good and that you’ve found the right market to offer it to. The market is accepting your product to solve their problem, but they are still churning. Then what?
Customer success is one of the super powers of SaaS. There’s little doubt now of the power of on-boarding. Ensuring your customers are actually successful in using your product to create value for themselves and their businesses is the cornerstone of low churn, and it insinuates good product/market fit.
Customer success usually revolves around the way people use your product and ensuring they take the actions required for them to perceive value from your software. Applications like Intercom.io make customer success highly sophisticated by automating the process of reaching out to your customers while they’re using your product with assets to help move them further down the path of success.
Customer Success is not a magic pill
Here’s where things get a little hazy.
As a marketer, your reliance on customer success grants you the comfort that low-hanging fruits are being picked: that we are tracking our users and how they use our product and helping them reach their goals ourselves with quality messaging support and knowledge banks for self-service.
But at the end of the day, we’re still comfortable at the idea that at least some churn will remain. Inevitably.
The truth is that customer success on its own is not enough to get past the ticking bomb that is churn. Some other force needs to be at work to help you pad that effort.
What is that force, you ask?
Customer Upgrades are the major 🔑
Beyond the fact that upgrades, also know as upsells and cross-sells, dramatically increase your lifetime value and increase your cost of acquisition ceiling, they do something far, far more powerful that that:
Revenue expansion counteracts the effects of churn.
Read that again, out loud.
Revenue expansion counteracts the effects of churn.
If users who subscribe to your service — that is, free users who become paying customers — have an additional path to sales, you’ll be able to grow LTV. Even better, if you can make sure that path relates to their success over time, you’ll ensure exponential revenue growth across your user base.
Here’s the way to look at this information:
As mentioned at the start of the article, most SaaS businesses offer this Pro subscription type of offering. Sometimes the offering is tiered into 2, 3 or more packages.
This represents a unidimensional way for the SaaS to achieve revenue; where the user subscribes, and then the SaaS bills the user relative to their plan every month thereafter (until churn). That’s where linear growth comes from.
Upgrades allow SaaS business models to become multidimensional, because while the customer is subscribing to a Pro account to gain access to additional value-added features, he is also being billed relative to the capacity of their account, where as the capacity grows (from being successful with the product), additional funds are billed.
You can intuitively get a picture of this with something like HubSpot.
HubSpot charges you, say, $500/mo to access the software’s full feature set. Included in this feature set is the ability to manage subscribers, send emails and so forth. A successful HubSpot user will see a growing number of emails sent or subscribers being added to the CRM.
Consequently, HubSpot created a second dimension to their billing by also billing users based on how contacts they have in their database. When you pass 2,000 contacts, you enter a new billing amount, and so on.
Exponential SaaS Revenue From Negative Churn
This second dimension which introduces the idea of revenue expansion is what causes exponential revenue growth to skyrocket, because your product is successful at making users successful, which causes your customer to be billed additionally while being totally OK with it because they’re getting the same relative value over time against that spend. If I’m OK with spending $1K in exchange for $5K, I’m also OK with spending $2K to make $10K. And so on.
Revenue expansion counteracts the effects of churn.
So if your customers are becoming more and more successful over time, it is reasonable to see that a SaaS that is growing linearly will start to see more and more of its revenue coming from upgrades, rather than from its regular trickle of new customers.
And the key is for the revenue coming in from expansions to match or overshadow the revenues lost from churn.
Now for the money question:
What happens when revenue expansion outpaces churn?
You get exponential growth:
Instead of flatlining at 13K, your SaaS is able to grow even faster because (1) its churn is gone and (2) you get an extra growth boost from the additional revenue coming from upgrades, whom in term shuts down the effects of your churn while padding the needed revenue to grow faster than linearly.
How to engineer negative churn
Reaching the point of negative churn is a multiple-step scenario. First and foremost, do the “just fix it” tasks. Get your product in order. Get your market in order. Get your customer success set up.
Then look at the churn rate and contemplate just how hard the negative pressure it is applying affects your SaaS.
Generally, you want to aim for 1%-2% monthly churn. That is really hard to do without upgrades. What will happen is you’ll see churn ranging from 5% to 20% across a variety of SaaS. Just to make it clear, If you’ve got a 5% monthly churn rate… that means that if you acquired 1,000 customers over the year, you’ll have lost the equivalent of 600 of those over that year, stifling the size of your business by over 2.5x – not good!
Once you reach a “stable” churn rate, start to engineer pricing changes that align with the way your customers use your product:
- Use value-based pricing for your core subscription offer (i.e. the Pro subscription tiers).
- Use capacity-based pricing for your upgrades (i.e. number of emails send)
You should end up with a multi-dimensional billing model which bills additionally based on users’ growth inside of your product, while capturing actual customers by provided value-added “pro” features.
Once you’ve reached the point of multidimensional pricing, the revenue generated from the expansion revenue will go to war against the revenue lost to churn. From there, you should aim to get to 1% or so. If you’re really gunning for exponential results though, you’ll continue to fight until the revenue you make from expansions outpaces the revenue lost to churn. Queue exponential growth. 🚀