Desk Notes is a new series of insights from our experience working actively with over 40 SaaS companies. You can find more of Dan's thoughts on tech through his Substack.
***
We had Vinny Puji from Left Lane Capital out to visit us a little while ago. He said something that got Britt and I chatting but in truth, in a world where growth is often king, we have had limited success swaying others to: “fix your product, then scale”.
I think there are two reasons I have struggled to convince founders of this:
- Founders are often misled into believing that businesses must always be growing;
- The impact of churn escalates with growth making it obvious when visualised over an extended period but less obvious in a short-term forecast.
Investors must wear some responsibility for this. The hungry markets of a bygone era focussed too much on top-line growth without paying enough attention to economics. This has all changed now and to the first point above I only say this; If you’re growing your top line but your underlying metrics - things like your Burn Multiple, LTV:CAC, Payback, Magic Number and other efficiency measures are underperforming - change your approach now. Understand and incorporate these into your reporting and thinking as a priority relative to growth. This article will focus on the second point.
There are two key identifiers when it comes to understanding whether you are ready to scale. These are: (1) churn; and (2) the costs of delivering your product (AKA customer success). This image represents much of the message that I unpack in this article:
Gross Churn Rates and Product
If you have a high churn rate alongside low post-sale costs, you might need to scale your CS team. While this may be valid, simply augmenting our customer success team may not address the underlying problem - most likely a product problem. The potential causes of churn are broad and may lie in inadequate partnerships and integrations, strong direct or adjacent competition, erroneous focus on a particular target segment, ineffective pricing and packaging or your product's inability to provide adequate value to customers. All of these challenges stem from a gap in product-market fit. In these cases, a CS focussed effort may prop up a business but will lead to high churn and dissatisfied customers. If you expand your GTM while these issues persist you will miss quotas and face layoffs. Whatever the case, you need to know what is causing the churn, fix your product reduce churn, then scale.
The below charts plot 2 business, both with 1,000 customers, each acquiring 60 new customers per month with a churn rate of 4%. The difference is that Business 2 stops acquiring customers completely for 5 months while it reduces churn from 4% to 1.5% and then continues to acquire 60 customers per month. The message here is simple; even if acquisition suffers while you focus on reducing churn, you will be a lot better off in the long run. Fix your churn, then scale.
Business 1 – steady acquisition of 60 customers per month with 4% churn
Business 2 – pauses all acquisition for 5 months, churn reducing from 4% to 1.5%
Business 1 and 2 - total customers number over 24 months
Post Sales Cost-To-Serve
If churn is low but the cost of delivery is high, you may be approaching CS incorrectly. For example, you may not be engaging with the right stakeholders or you might be putting significant effort into retaining small, cumbersome customers. Ultimately, if you find yourself needing an outsized CS investment, you should optimise the CS function first. Exploring methods to automate CS through product enhancements or in-app messaging is often the first step. If the product itself cannot sufficiently reduce costs, pursuing process improvements such as one-to-many tactics and building a team in a lower-cost geography should be considered before scaling. Again, you need to know what is causing the churn and reduce it before you scale.
Business 1 – 85% margin
Business 2 - 70% margin
Business 1 and 2 within 24 months
The bottom line of all of this is:
- If your churn is too high - you likely have a product problem and you won’t be able to continue to scale
- If your CS costs are too high - your reduced margins will make it even harder to scale.
There is a lot of content available on these benchmarks and I haven’t covered this here. If you’re not convinced yet, below you can see the impact of both business 1 and 2 shown above while both churn and COGS/CS are too high.
Fix your product, then scale.
Desk Notes is a new series of insights from our experience working actively with over 40 SaaS companies. You can find more of Dan's thoughts on tech through his Substack.
***
We had Vinny Puji from Left Lane Capital out to visit us a little while ago. He said something that got Britt and I chatting but in truth, in a world where growth is often king, we have had limited success swaying others to: “fix your product, then scale”.
I think there are two reasons I have struggled to convince founders of this:
- Founders are often misled into believing that businesses must always be growing;
- The impact of churn escalates with growth making it obvious when visualised over an extended period but less obvious in a short-term forecast.
Investors must wear some responsibility for this. The hungry markets of a bygone era focussed too much on top-line growth without paying enough attention to economics. This has all changed now and to the first point above I only say this; If you’re growing your top line but your underlying metrics - things like your Burn Multiple, LTV:CAC, Payback, Magic Number and other efficiency measures are underperforming - change your approach now. Understand and incorporate these into your reporting and thinking as a priority relative to growth. This article will focus on the second point.
There are two key identifiers when it comes to understanding whether you are ready to scale. These are: (1) churn; and (2) the costs of delivering your product (AKA customer success). This image represents much of the message that I unpack in this article:
Gross Churn Rates and Product
If you have a high churn rate alongside low post-sale costs, you might need to scale your CS team. While this may be valid, simply augmenting our customer success team may not address the underlying problem - most likely a product problem. The potential causes of churn are broad and may lie in inadequate partnerships and integrations, strong direct or adjacent competition, erroneous focus on a particular target segment, ineffective pricing and packaging or your product's inability to provide adequate value to customers. All of these challenges stem from a gap in product-market fit. In these cases, a CS focussed effort may prop up a business but will lead to high churn and dissatisfied customers. If you expand your GTM while these issues persist you will miss quotas and face layoffs. Whatever the case, you need to know what is causing the churn, fix your product reduce churn, then scale.
The below charts plot 2 business, both with 1,000 customers, each acquiring 60 new customers per month with a churn rate of 4%. The difference is that Business 2 stops acquiring customers completely for 5 months while it reduces churn from 4% to 1.5% and then continues to acquire 60 customers per month. The message here is simple; even if acquisition suffers while you focus on reducing churn, you will be a lot better off in the long run. Fix your churn, then scale.
Business 1 – steady acquisition of 60 customers per month with 4% churn
Business 2 – pauses all acquisition for 5 months, churn reducing from 4% to 1.5%
Business 1 and 2 - total customers number over 24 months
Post Sales Cost-To-Serve
If churn is low but the cost of delivery is high, you may be approaching CS incorrectly. For example, you may not be engaging with the right stakeholders or you might be putting significant effort into retaining small, cumbersome customers. Ultimately, if you find yourself needing an outsized CS investment, you should optimise the CS function first. Exploring methods to automate CS through product enhancements or in-app messaging is often the first step. If the product itself cannot sufficiently reduce costs, pursuing process improvements such as one-to-many tactics and building a team in a lower-cost geography should be considered before scaling. Again, you need to know what is causing the churn and reduce it before you scale.
Business 1 – 85% margin
Business 2 - 70% margin
Business 1 and 2 within 24 months
The bottom line of all of this is:
- If your churn is too high - you likely have a product problem and you won’t be able to continue to scale
- If your CS costs are too high - your reduced margins will make it even harder to scale.
There is a lot of content available on these benchmarks and I haven’t covered this here. If you’re not convinced yet, below you can see the impact of both business 1 and 2 shown above while both churn and COGS/CS are too high.
Fix your product, then scale.