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Why NRR (net revenue retention) is the one metric to rule them all for SaaS
This article was originally published on Forbes.com.
“Oh, by the way, what’s your customer retention?” asked the managing partner of a venture firm while we were in the final stages of their due diligence. It was the turn of the millennium, and I was raising a round for a B2B software company—one of four companies that I founded over the course of my 25-year career as a repeat entrepreneur. The partner’s firm had already issued me the term sheet a few weeks prior. It was clear that, barring any wildly outlandish figures, customer retention wasn’t a dealbreaker in their decision to invest. In fact, it was probably a throwaway question, one of many in the long list of standard diligence questions.
Cut to 2022, and the idea that a SaaS company could secure venture funding without investors digging deep into retention metrics seems comical, if not reckless. Net revenue retention (NRR) is taking center stage as the qualifying metric for determining the health of a SaaS business. You can demonstrate an amazing product, have an expert executive team and show a top-tier growth trajectory, but without reasonable NRR, you will summarily get disqualified from funding consideration.
According to Software Equity Group’s M&A figures, the valuation metrics of a SaaS company with high retention rates can be twice as much as a company with average rates. Higher retention signifies a more stable customer base and greater growth potential, and that’s what investors care about.
Even if you aren’t actively seeking outside capital, as NRR continues to take SaaS by storm, your investors and board will expect you to know it well and with nuance. You must be able to confidently speak about NRR, how it looks by different cohorts and the strategies you use to increase it.
Net revenue retention defined.
NRR is the cumulative total of your retained, contracted and expanded revenue over a period, typically a month or year. To calculate NRR, deduct your revenue churn (contract expirations, terminations and downgrades), add any expansion revenue and divide it by your renewable revenue. This number will likely be in the range of 70% to 130%. NRR offers the most clear-cut valuation of your customers’ success. As such, it is becoming the north-star metric of customer success functions and, increasingly, organizations as a whole.
With that said, if you track NRR in isolation, you can hide churn behind expansion. As a CEO or investor, you never want to be surprised, especially by churn. To make sure you’re not being misleading, monitor gross revenue retention (GRR) alongside NRR. GRR uses the same formula as NRR, except you omit expansion. Use NRR with care and tell the full story, not just the one you think investors want to hear.
How can you increase net revenue retention?
1. Create customer cohorts based on value.
Losing a high-value customer can have a significant impact on your NRR. Segmentation is the foundation of proactive service that can increase product adoption and customer retention. Create value-based customer segmentation to inform your customer success and support strategy. For example, when designing your onboarding journey, you might choose a high-touch model with one-on-one coaching for your high-value customers and rely more on a tech-touch for other lower-valued segments of your customer base.
2. Use behavioral data to surface expansion opportunities.
Customer expansion is a sustainable way to increase your NRR. Monitoring adoption trends and other behavioral intent data is key to identifying the right time to approach the right customers with the most relevant upsell or cross-sell offers. A health score can act as an effective indicator of a customer’s expansion likelihood. Scores weigh both quantitative and qualitative buying signals such as service utilization, product usage, engagement, satisfaction, support history and more. When paired with automation, you can trigger expansion outreach based on positive score changes. Without a proper health score, customer expansion can be fraught with risk. Asking unhappy and unsuccessful customers to invest more can increase their dissatisfaction and will make your company look unprofessional.
3. Shift renewal and expansion revenue responsibility to the customer success team.
Renewal and expansion directly correlate to the value a customer realizes throughout their tenure with your business. As the custodians of value attainment, the customer success team has the most insight into customer behavior. Therefore, it is best positioned to identify buying signals. To encourage the growth of post-sale revenue sources, add a variable component to your customer success compensation plan. Tying variables to renewals and expansion emphasizes the main goals of customer success.
4. Invest in customer success.
One need only look at the rise of NRR and its impact on valuation to see that undervaluing customer success comes at a heavy price. With just 15% of customer interactions adding value, according to Gartner’s research, the opportunity for companies to corner the market with smart customer success that reaches out at the right time with the right ask is ripe for the taking.
NRR matters to SaaS executives and investors. Customer success owns a large portion of that metric. As customers continue to expect more value from their products and services, companies need to invest more in the resources and tools to meet their demands. Customer success is business success.
Get a crash course on Customer Success metrics
Though NRR should be at the top of every CS leader’s list of metrics that matter, it doesn’t mean it’s the only one to know inside and outside. With so many SaaS metrics out there, and even more opinions on when and how to use them, it’s not always easy to discern whether you’ve got it right. Leading SaaS expert, Dave Kellogg, and ChurnZero CEO, You Mon Tsang, sat down to answer all the questions you want to know about SaaS metrics like ARR, NRR, GRR, LTV, and CAC and set the context for their usage. Get your crash course on Customer Success metrics.