7 Reason #4: Even the Money People Are in Love with Customer Success
Picture a board meeting ten years ago for a typical B2B company. What would be on the agenda? Probably a smorgasbord of financial results and sales metrics. From time to time, you might have seen sprinkled in a discussion on product roadmap as well. Customer Success? That would only be a topic if there were a big issue.
Fast forward to today. Private company CEOs now know that when it's time to raise a new round of funding, they have to make sure that they have a strong Customer Success strategy in place. And public company CEOs are increasingly realizing that research analysts and fund managers understand how Customer Success fits into the SaaS business model. Far from looking at CS teams as just another flashy business fad, investors consider them to be critical to ensuring that revenue recurs predictably. That predictability gives investors peace of mind, when so many of the other variables they're analyzing in a business can change in a heartbeat.
Of course, most investors are data people. They take confidence in the numbers above all else. And we may have a soft spot for client emotions, but we love math as much as anyone! So, to understand why investors value CS so highly, let's turn to an example of Customer Success math.
Investors Are Doing the Math
Allyson White is a principal at Insight Partners, a leading global venture capital and private equity firm that invests in high-growth tech companies and has over $20 billion of assets under management. White has become a thought leader on how investors and their portfolio companies should approach Customer Success.
On the Insight blog,5 White describes Sales as “the hare in the race to scale—new logos start the race and accelerate strongly out of the gate. But, retention is the tortoise, and, as we know from Aesop's fable, the tortoise wins the race.” To illustrate the impact of higher retention on enterprise valuation—the total worth of a company—Allyson describes a hypothetical company. She explains:
Fable Co is on track to achieve $20 million in Annual Recurring Revenue (ARR) in current year (i.e. Year 0):
$10 million is new customer ARR.
$10 million is existing customer ARR.
The company has a solid product and adoption with a 95% net dollar retention rate and 90% gross dollar retention rate.
Fable Co sells into a very large addressable market that is growing 10% annually.
Assume Fable Co's new logo business grows at the same market CAGR of 10% and net retention holds at 95%. The company will reach $77 million of ARR in 5 years (no small feat!).
However, if Fable Co can increase net retention by 5% from 95% to 100%, then ARR will hit $87 million.
Each 1% uplift in net retention yields an incremental ∼$2 million in Year 5 revenue. At 5× revenue exit multiples, this 5-point retention uplift equates to more than $50 million in incremental enterprise value, a number sure to make Fable Co's employee and VC shareholders smile. (See Figures 7.1 and 7.2.)
Bear in mind that the 100% retention business is $10 million larger and growing faster (34% CAGR vs. 31%), and as a result will command a higher revenue exit multiple. The incremental EV from an increase in revenue exit multiple (from 5× to 6×) is >$135 million.
The second Retention Impact scenario to consider is what Insight calls the Opportunity Cost of Churn (OCC). What additional sales and marketing investment is required to make up for the revenue lost to churn—or to use a common SaaS phrase, to offset the “holes in the leaky bucket”?
To calculate: the Opportunity Cost of Churn (OCC) = (Churned Dollars + Downsell Dollars) × the Customer Acquisition Cost (CAC).
Let's take the same $20 million Fable SaaS Co with 90% gross retention and assume customer acquisition cost (CAC) is 1. In other words, Fable Co gets $1 of first year ARR for every $1 it spends on sales and marketing acquisition. What is the impact?
In Year 0, Fable Co loses $2 million of starting ARR, which will cost $2 million to reacquire.
In Year 5, churn loss is $6.4 million, which will cost $6.4 million to reacquire.
Over the 5-year horizon, the Total OCC is ∼$21M. (See Figure 7.3)
To summarize: At a CAC of 1, each percentage point of retention equates to approximately 1% of margin.
Higher retention businesses can grow faster, grow more profitability, or most likely pursue a combination of both. . . . Companies need both the tortoise and the hare to win the race.
If we lost you in all that math, here's the bottom line: Investors like White know that even a 1 percentage point improvement in retention impacts enterprise valuation in three primary ways:
It preserves revenue.
It gives the company a higher valuation multiple of revenue.
It improves the profit margin.
Sounds good to us!
Now that we've gotten inside the brains of investors by doing the math that they're doing, let's dive deeper into the qualitative reasons why VCs look to CS metrics when they're evaluating investment opportunities.
Why VC Firms Love Customer Success
For a VC firm investing in early-stage companies, strong recurring revenue signals that the startup is a real business, delivering a product or service that people want. Poor retention can sometimes be an indicator that a company hasn't achieved product-market fit—in other words, their product isn't solving a customer problem. That can lead to a company going out of business or laying off much of its team to stem cash burn and buy enough time to develop a stronger product.
Alex Clayton, general partner at Meritech Capital and formerly at Spark Capital, echoed the gravity of this kind of existential problem in a post on Medium.com in January 2018: “Dollar retention is critical to the health of a SaaS company. . . . A SaaS company could be growing ARR over 100% each year, but if their annualized net dollar retention is less than 75%, there is likely a problem with the underlying business. . . . Poor net dollar retention will almost always catch up and slow a business's top line.”
Therefore, VC firms consider retention when assessing whether a business's growth is going to continue well into the future. Bessemer Venture Partners (BVP), a leading VC firm with over $6 billion under management, has adopted that approach. The BVP team are thought leaders on subscription growth, having written the 10 Laws of Cloud Computing and launched the BVP Nasdaq Emerging Cloud Index, an industry index designed to track the performance of public companies providing cloud software and services. So they know a lot about the impact of Customer Success on both private- and public-market valuations.
“We care so much about CS at an early stage because it's a good predictor of whether the company's growth will continue at a high pace, which is otherwise very hard to know but also super-important to figure out as an investor,” explains Byron Deeter, a partner at Bessemer Venture Partners.
If a company doesn't have strong retention and doesn't have the right CSM protocols in place, churn can be the death of an SaaS business. But if you have high retention, you can last for a very, very, very long time. And you get lots of opportunities to grow, to innovate on the product, to sell new product categories, and to sell in the new market.
We look at three top metrics before investing: growth, retention, and payback, or some measure of sales efficiency, and in my portfolio I'm particularly focused on retention. Because not only can it be as attractive as high customer growth, but if you have a positive net retention rate, you can sell even more to your existing customer base.
Tomasz Tunguz is also particularly interested in the potential of growing revenue from existing clients, not just retaining them. Tunguz, the managing director at Redpoint Ventures who appeared in Chapter 4, explains:
One of the main differences between enterprise companies and consumer companies is that enterprise customers tend to expand on an annual basis. Best-in-class B2B companies might grow by thirty or forty or fifty percent per year. So a cohort of new customers last year who spent $1m last year would spend $1.5m this year.
As a company grows and scales, the revenue managed by the CS team will outgrow new bookings by the sales team. Because of new sales and this compounding expansion, Customer Success becomes the single most important function of the go-to-market. CS manages the company's revenue base, which is laden with expansion potential.
VC firms see the value of Customer Success not merely as driving revenue growth, but also helping the company learn how to improve the product, aligned with our “Law #7” in Chapter 1. “I think the future of Customer Success is observations from the CSMs,” says Tunguz. “If there's a tight coupling between Product Managers and CSMs, the products can get better and better. The companies with the highest net dollar retention combine a terrific product with in-depth analysis of the customer base through the CS organization.” Deeter from BVP agrees on the value of CS-Product dialogue: “I think the best enduring companies are the ones who constantly get feedback from customers and act on that feedback through the entire life cycle of the company. Spend time talking to them, listen to them, and try to build a product that they want.”
Whether VCs are looking for evidence of product-market fit, the longevity of the business, client expansion potential, or a strong long-term product strategy, they believe that CS is a primary indicator of the health of a business.
Private equity (PE) firms may be different from VCs on many dimensions—in particular, you may see more mahogany in their offices!—but they're drinking the same champagne.
Why Private Equity ( PE ) Firms Love Customer Success
If you follow trends in finance, you know that PE firms have had an expanded role in the technology market. Up until the past decade, many PE firms were known for identifying companies with slower top-line growth, acquiring those companies with a combination of equity and debt, and then, once they became a controlling shareholder, they would trim operations in order to maximize cash flows, which allow them to pay down debt and increase equity value.
But increasingly, many of these same PE firms are more focused on the opportunity to drive top-line growth. Instead of just cutting operating costs at the firms they invest in, they are now getting involved in processes and technology to improve a company's recurring revenue. Recurring revenue means recurring cash, which makes it easier to pay interest on the debt, pay down the principal, and generate strong returns on equity. High retention rates were “made” for the PE model.
Consider the case of venture capital and private equity firm K1 Investment Management (K1). Neil Malik, founder and CEO of K1, sees Customer Success as core to the financial model—and mission—of K1. “K1 exclusively invests in enterprise software companies. We've invested in over 120 companies since the inception of the firm. Our mission is to help make people more productive, so they can accomplish more in less time. Our focus is realizing the value of technology through adoption. Customer Success measures that we look at include customer satisfaction, usage information, and ultimately these are reflected in client retention. We believe that growth combined with strong retention is one of the biggest drivers of valuation.”
Consequently, it's very common—almost standard—for PE firms to create ways to infuse CS best practices in their portfolios. Many PE firms have annual summits to bring together CS executives; many have operating partners internally who work with their companies on CS; and many want to ensure that their companies are implementing CS technology.
As an example, K1 invests heavily in Customer Success best practices in their portfolio. Malik explains,
We think about it as a multi-functional practice. K1 has a quarterly function-specific summit, including go-to-market, product and engineering, human capital and finance as well as a customer experience summit. All of these summits have components that focus on the customer experience. Our final summit of the year, customer experience, brings together professional services, support, and customer success professionals. They spend several days networking and learning from their peers across the portfolio. We bring in some renowned innovators as keynotes, including Nick Mehta from Gainsight and Chris Bates from Tableau, talking about their customer experience journeys. This enables our companies to learn from each other as well as from industry experts and luminaries.
The end result is that PE-backed companies are some of the most innovative, in terms of Customer Success. Malik shared two examples from the K1 portfolio.
Emburse is a large player in the global travel and expense space. They've produced onboarding videos that help clients in a one-to-many experience, in advance of a more traditional white-glove implementation kickoff. This improves the scalability of our portfolio company by allowing clients to work asynchronously and absorb content and basic building blocks at their own pace, after which we can provide our resources in more synchronous and live formats.
Similarly, we have a portfolio company called Clarizen in the project management arena. In lieu of cookiecutter business reviews with a templatized deck, Clarizen came up with measures like usage, support, customer business, and adoption goals and uses those to design the agenda for the QBR, focused on our mission of realizing the value of technology through adoption.
At the same time, some PE-backed companies are newer to the CS movement and new to deploying technology to improve operational efficiency. At a recent conference that we attended among chief financial officers at PE-backed companies, those CFOs were vocal in describing the limitations in older systems for managing customer relationships. In particular:
Modeling clients the way they experience you (by department, business unit, product, stakeholder), not just in the way you sell to/bill them.
Blending a variety of data (telemetry, usage, analytics, surveys, support, CRM, billing) to holistically measure the customer experience.
Analyzing this data in a scalable way to measure customer health in all dimensions.
Driving proactive human and digital outreach along the customer journey.
Nearly every firm had experience trying to cobble together CRM, BI, spreadsheets, and the like—and the scalability limitations therein.
At the same time, many PE-backed companies are trailblazing for their peers. This is valuable for PE firms' portfolios, since the managing directors tend to want to see examples of success before rolling out a specific operational change to another portfolio company. They especially do not want to reinvent the wheel. Their companies are so efficient that they don't build internal tools when third-party vendors are available. In fact, PE firms often guide portfolio companies to standardize on a common stack of third-party business systems.
Why Research Analysts Are Scrutinizing Customer Success
Even in the public markets, Customer Success is becoming a hot topic. As Alex Clayton stated in the same post mentioned above, “Net dollar retention has a huge impact on the long-term success of a business; the companies that get public usually have net dollar retention rates of well over 100%, and in some cases 150%+. It's unfortunately at times overlooked, but increasingly becoming one of the most core KPIs for any SaaS company.”
In nearly every SaaS research analyst report, retention is a topic of discussion. Analysts obviously cover the fundamentals of revenue growth, profit margins and the like. But they have shown a spotlight recently on retention metrics. Because most public companies only disclose Net Dollar Retention, churn is a bit more opaque to the stock market. But savvy analysts continue to dig in through primary research calls with end clients. As public investors understand Customer Success more, we expect it to be an increasingly hot topic on earnings calls.
Summary
Investors are now increasingly focused on CS metrics and strategy as indicators of a company's health. That's true when they're conducting due diligence on investment opportunities, and it's true when they're guiding their portfolio companies in the boardroom. As a result, the CS priority has reached the highest levels of the corporate structure.
That means that CEOs can't delegate CS—they have to own it. And they have to ensure that every function within their company makes meaningful changes from traditional models to adopt a customer-centric mindset.
In that vein, now that we've explored the why behind Customer Success—the four reasons behind the greater investment in CS—we'll move on to the how. Part II of this book is all about how to emulate the companies that have achieved great success for their clients. The question is, how can you bake CS into every single department of your company?
