Prepared by Matthew Duncan, Associate Consultant
In SaaS, there is often a great deal of importance placed on retention. There is good reason for this - in a subscription business, keeping customers around and getting them to purchase additional offerings is a key factor in increasing revenue. As a result, you’ll see many different recommendations on the internet. A common recommendation is to keep Net Revenue Retention above 100%, but the same guidance can mention that top performers are often above 110% or even 120%, year over year. These are excellent outcomes, of course, but it is important to take these numbers in context, as they don’t always tell the whole story.
Annual Net Revenue Retention: The percentage of subscription revenue from customers active at the beginning of the year which is retained at the end of the year. This number is lower when churn is high, and higher (potentially even above 100%) when upsell is high, especially when churn is also low.
Customers are more likely to upsell if they have purchased more recently.
Across the dozens of SaaS clients we’ve worked with at Pricing I/O, we’ve noticed that the customer lifecycle tends to follow similar trends across different segments. One of the most common is that, when measured from the date of first purchase, the key window for upsell and expansion is generally between 6 and 18 months after the initial purchase. Early on, expansion and upsell can be high, until a customer hits their “ceiling”. After that, we tend to notice that upsell slows down. It doesn’t necessarily have to stop entirely (and it shouldn’t, for high-performing SaaS companies!), but long term, high average year over year growth rates are not generally sustainable without new product releases or a focus on acquiring new first-time customers.
The chart above shows what NRR would look like for a hypothetical company with a consistent churn rate that primarily upsells within 2 years of initial purchase. For this example, new sales are assumed to happen at a constant rate. As we can see, the NRR is propped up early on by a younger average customer age -- more customers are in the high-upsell phase of their journey with the product. However, this decrease in NRR is not due to poor retention -- overall retention is the same across the entire time period. It is only a sign of increasing average customer age. Therefore, the easiest way for an otherwise high-performing older company to move the needle on NRR is not to improve retention or upsell. Instead, they should focus less on retention directly, and more on selling to first-time customers. The easiest customers to upsell are relatively new, so increasing the pool of these newer customers will have additional benefits in expansion. The first part of “Land and Expand”, after all, is “Land”.
NRR might be a low bar, while for companies with more established customers, the same 110% NRR could be nearly impossible to achieve. With constant pressure to increase metrics, it is important to understand the context behind numbers such as Net Revenue Retention. However, the specific targets will often differ depending on a company’s growth stage. A young company, with a large fraction of its customer base in the first two years of their subscription can expect much higher NRR numbers (and lower GRR numbers), simply because a greater fraction of its customers are in a high-upsell/high-churn period of their lifecycle. Meanwhile, an older company, even with the same customer lifecycle, will see these numbers trend in a less extreme direction.
In our experience, older customers are both less likely to expand and less likely to churn, so NRR generally trends closer to 100% for companies with long-term customers.
When setting targets for your business, it is important to consider the average age of your customers. For companies with many customers in the key 6-18 month upsell window, 110%. This shouldn’t be discouraging, but it does show the importance of considering the broader context when considering targets and KPIs.