If you lose $1 in revenue through churn – either because a customer cancels their subscription or decides to stay but pays you less because of discounts or downsells – you first need to replace that $1 before you can start to grow.
Now, you can acquire those churn-offsetting revenue dollars in two ways: by acquiring net new customers or by getting your existing customers to buy more or expand their relationship with you.
For the longest time, companies looked at acquiring new customers as the logical way to offset churn. But at some point, it would occur to them that this was a losing proposition for several reasons, ranging from a longer payback period for Customer Acquisition Cost (CAC) to the negative market sentiment created by so much churn.
So the logical next step in offsetting the revenue lost from churn was for vendors to look at getting their existing customers to buy more or to otherwise expand their relationship with them.
But as you’ll see, this doesn’t work, either.
Some people think that having churn – even a lot of churn – is okay as long as they’re making up for it by getting more from the customers that stay.
In fact, I’d say this is one of the biggest – yet least talked about – misconceptions around Customer Success: that you can “use” existing customers to offset whatever churn you have.
It’s time to address this directly so there are no more misconceptions…
Why Customers Churn
Customers that churn out – that cancel their subscription with you or don’t renew – do so for only two reasons (which I’ve documented in detail before):
- Something changes on their end (they go out of business, get acquired, etc.); or
- They don’t achieve their Desired Outcome
We can’t really do anything about (1) – though some products are so valuable that customers keep their relationship with the vendor going even when their business fails – so let’s focus on (2) here; they don’t achieve their Desired Outcome.
Customer Success is when your customers achieve their Desired Outcome through their interactions with your company.
If they don’t achieve their Desired Outcome through their interactions with your company, that could be attributed to the fact that they don’t have Success Potential (you acquired bad-fit customers), or they do have Success Potential, but you failed to unlock that potential and make the customer successful.
The good news is you can fix both of these reasons by acquiring only customers with Success Potential and then ensuring they achieve their Desired Outcome.
And doing that is the secret to achieving near-zero churn.
So where does Upsell – or any type of Expansion – figure into this?
Expansion is Part of the Customer’s Success
Historically, within Customer Success (yes, historically), it was said that Renewal and Expansion (upsell, cross-sell, etc.) happen because a customer is successful.
But looking at it that way (“oh, a customer’s been successful; let’s make them an offer”) is what allows for the error of applying “new business” sales or traditional Account Management tactics to renewals and expansion, even when that’s exactly the wrong approach.
On the other hand, if you understand what Customer Success is and realize that Expansion (and Renewal, too) is actually PART of the customer’s path toward success – and that churn happens when the customer is no longer on that path – it should be obvious that the conditions for churn are incongruent with those for expansion.
You can’t use upsells to offset churn because churn is caused by the very thing that prevents upsells from happening.
Let that wash over you for a minute. Meditate on it. Breathe it in. Retweet if you agree:
You can’t use upsells to offset churn because churn is caused by the very thing that prevents upsells from happening.
— Lincoln Murphy (@lincolnmurphy) December 24, 2016
This isn’t just a numbers game. In fact, it’s not a game at all.
Customer Success-driven Growth – seeing Customer Success as more than just making customers “happy” but as a true Growth Engine – is all about expansion (upsells, add-ons, land and expand, etc.), but in a way that absolutely requires a baseline focus on the customer’s success.
But…
The Math Says you Can; Reality says you Can’t
What about negative churn or, because I want that term to die, Net Revenue Retention (NRR)?
NRR is the Revenue that remains at the end of a timeframe, net of any upsells and churn.
If NRR is less than 100%, this means that revenue churn was higher than the revenue generated from upsells – because customers canceled, didn’t renew, or stayed but paid less for the privilege through discounts, downsells, etc. – and it means your company is shrinking.
10-3+1= 8 or NRR of 80% (that’s bad)
However, NRR of 100% does not mean your company is shrinking; it means you’re not growing. And if that status quo is due to expansion “offsetting” revenue churn just to break even, that’s likely a really bad sign.
10-3+1+1+1 = 10 or NRR of 100% (that’s actually not great)
If, however, NRR is greater than 100%, which means you’re making more from expansion than any revenue churn you might have, things are looking good.
10-3+1+1+1+1+1 = 12 or NRR of 120% (that’s pretty good)
Consider the following scenario… wait, before I go on, know that things like the cost to acquire customers (CAC) and the damage done through the negative sentiment created in the market by those customers that churned out (through negative public reviews, revealing how you failed them to your competitor, etc.), do not figure into the very simple math presented below.
Okay, consider the following very simple scenario:
You start the month with 10 customers, each paying $1000/year for $10k/ARR total.
One customer churns out and take $1000 with them.
Two customers threaten to churn, but you “save” them with 50% discounts on their $1000/year fee, which means you lose a total of $1000 for the two.
So your total revenue churn is $2000.
If this is all that happened, you’d now have only $8k/ARR and a shrinking business.
But you’re making sure your customers (well, except for those that represented 20% of your revenue, but whatever) are successful, and you have four customers that expand their relationship with you, adding a total of $7k in new ARR.
That new ARR of $7k offsets the $2k you lost, leaving you with net new revenue of $5k/ARR.
So it looks like this: $10k – $2k + $7k = $15k
The NRR for that timeframe is $15k, and since you started with $10k and ended with $15k, we would say you had NRR of 150%!
Yay, math!
But while that’s how it works from a math standpoint, how it works practically, in actual reality is… a very different story.
First, let’s explore…
Where Traditional Account Management Failed
Traditional Account Management failed because it treated customers like Accounts… literally like numbers.
Account Management was focused only on Renewal and Expansion from the company’s revenue perspective and honestly didn’t care if the customer was “successful,” only that they would take the latest offer being shoved down their throat.
In the past(and some today), Account Managers were given quotas for expansion and renewal and were incentivized to hit those numbers, or punished if they didn’t. Taking this mentality to the extreme is the Wells Fargo fraudulent account scandal of 2016, where quotas were so out of line with the success of the customers, and leadership put such an emphasis on incentives – and used these to drive action – that account managers opened accounts in customers’ names without their permission.
So Traditional Account Management no longer works, but Customer Success-driven Growth absolutely does. And while the function of Account Management – handling the process of upsell and renewal – is still required, it should sit within, roll-up to, or otherwise be governed and monitored by Customer Success Management.
As I said before – but really want you to understand – Renewal and Expansion are actually part of a customer’s success; in order for customers to achieve their ever-evolving Desired Outcome, they’ll need to stay past renewals (if you’re on a month-to-month agreement with customers, every month is a “renewal”) and will likely need to consume more of your core product, adjacent products, training, etc.
Which means this is all part of Customer Success Management; even if your organization decides to have dedicated Account Managers to handle Upsells, Cross-sells, and Renewals, those should roll-up under Customer Success Management.
Churn and Expansion Cannot Coexist
You can’t use upsells to offset churn because churn is caused by the very thing that prevents upsells from happening.
If you are acquiring customers without Success Potential and/or not doing what is necessary to ensure your customers that have Success Potential are unlocking such potential, then you are not creating the conditions necessary for expansion.
You’ve created – by choice or by accident – an environment and experience that are not congruent with the customer’s success; so how can you realistically expect enough customers to buy more or invite you into other parts of their company to offset the damage that’s being done by the customers you’ve failed?
I’m sure there are edge cases that have been able to do this – success in spite of what they do rather than because of it – but most of the time, without worrying about outliers, this is not going to work.
You simply cannot achieve the revenue expansion necessary to offset revenue churn – in a scalable, repeatable way – when you’re not working to ensure your customers are successful since expansion is PART of the customer’s success.
Which means if you’re working to ensure your customers are successful, your customers will expand because that’s part of their journey toward success; thus, you won’t have to worry about having to offset churn.
Focus on Offsetting Churn; Always Have Churn to Offset
If you’re focused on offsetting churn with expansion revenue, remember that you’ll always be trying to offset churn because you’ll always have churn.
The reality is, you don’t need to have churn… figure out how to get rid of churn (hint: by making sure your customers are successful), and churn won’t be a thing in your world.
When you don’t have churn, you don’t have to offset the lost revenue; all of your expansion revenue just adds to the top line and improves your margins. It’s true that it costs less to get revenue from existing customers than from net new customers, but this only works if you create the conditions for Customer Success.
And ultimately, this focus on the customer’s success directly increases the value of your company.
About Lincoln Murphy
