NDR Growth Tactics 4: Avoid Package Shrinkage
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talio.
Net Dollar Retention (NDR), or Net Revenue Retention (NRR) to use the more generic term, has become a priority for most SaaS businesses. The reasons are simple.
Customer Acquisition Costs (CAC) have already been covered so this is a very cost efficient form of growth
Buyers and investors want to be sure a solution delivers value; NDR growth is strong evidence of value
Positive NDR shows that the company has the ability to overcome the natural account churn that is part of any SaaS business
Ibbaka has a compelling framework for delivering NDR growth, one that is well supported in the Ibbaka Valio platform. We are sharing this framework in this series of eight posts.
NDR growth tactics 4: Avoid Package Shrinkage (This Post)
The six NDR factors are often shown using the NDR waterfall. This is a powerful tool to understand what levers are driving NDR and where actions should be focussed.
Avoiding package shrinkage as an NDR lever
The first negative lever we will look at is how to avoid in package shrinkage. This happens when a buyer scales back usage of your system. They don’t churn (the worst outcome, one that we will cover in ‘NDR growth tactics 6: Reduce Churn’) and they don’t downgrade to a cheaper package, but they do cut the number of users or reduce usage, resulting in lower revenues.
This can be the most difficult of the levers to pull to improve NDR. The reason is that the shrinkage is often the result of changes on the customer’s side that are beyond your control. So the first step is to understand what is causing in package shrinkage, what is within your control, and what is not.
Factors beyond your control
Business conditions at your customers leading to
Headcount reductions
Lower level of business activity
Mergers that reduce and concentrate your customer base
Business conditions at your customers’ customers driving their own business performance
Understand if these trends are
Cyclical - part of the normal business cycle, things will eventually get better on their own
Exceptional - the result of a hard to predict one off change in business conditions, many people see the recent Covid-19 pandemic as an example
Structural - part of a long-term change in the structure of the economy
Your pricing response will differ in each case.
Pricing for Cyclical Markets - design pricing that mutes the impact of the business cycle but does not try to eliminate it completely. This can be done by careful blending in of usage or outcome based pricing. Try to have a customer base that includes some counter cyclical industries (industries that do well when the economy as a whole is doing poorly).
Pricing Under Exceptional Circumstances - be proactive in responding, giving your customers relief, and offering special packages and solutions. Make sure these are framed and contracted as short term actions and make it clear that pricing will revert to normal as the exceptional circumstances pass.
Pricing for Structural Change - this is where business strategy drives pricing. One wants to be investing in growing customers and withdrawing from declining or sunset markets. Solutions and pricing should be designed to help customers make transitions that will help them thrive in the future. End of life cycle pricing is a microcosm of this. In this case prices are often designed to guide people onto newer, and more valuable solutions.
Note that ‘competitor’ actions are not included in the factors beyond your control. You are in an open, multimove game with your competitors. Given that they respond to your actions, as you respond to theirs, it does not help to think of them as being beyond your control.
Factors you can control
Declining value
New alternatives are available that offer the same or similar value at a lower cost
Value paths are broken (the user cannot get to an outcome of value) or disconnected (one cannot go from one value path to the next in your platform)
Input costs have gone up making the overall cost of your solution higher (it is the customer’s input costs that we are concerned with here)
Customers care about the total cost of your solution vs. the value it provides, that cost can include their internal costs, third-party costs, data costs, and so on
User experience (UX) challenges are impeding usage (and completion of value paths)
Changes in the ecology such that new integrations and data exchanges are required
Competitor actions that you are able to respond to
Value enhancers - competitors may have found new ways to deliver more value, add value paths, or connect previously disconnected value paths
Price competition - competitors may have reduced list prices or stepped up discounting and promotions
Partnering strategies - competitors may be tieing up the partners needed to deliver a whole product solution or to access markets
Declining value - It is critical to track value to customer (V2C) on a regular cadence, usually monthly, and to segment customers by trends in both V2C and Value Ratio (VR). VR is generally defined as V2C/LTV or Value to Customer / Lifetime Value of the Customer. Customers where V2C is declining or the VR is climbing (you are taking more and more of the value available) are at risk can be expected to shrink in package and eventually churn.
The first thing to diagnose is why V2C is declining. There are many possible reasons …
Customer economics and business model have changed, making your solution less relevant or less able to deliver value
Alternative solutions have changed the reference value (the next best competitive alternative) and customers are starting to solve the problem you solve in new ways
Value paths are broken, perhaps because of changes to customers business processes, and users are no longer completing them (just looking at usage data can disguise this problem for a time, usage can even go up as users desperately try to complete a path)
Value paths are disconnected - most value paths lead to a next step, and if it is too difficult to get to that next step value and use go down
When price is based on value, declining value is a pricing problem. Like most pricing problems, the solution will take cross functional collaboration, but pricing needs to lead the diagnosis and propose some of the treatments.
Input costs - Traditional manufacturing and resource industries are used to managing the impact of input costs on pricing. SaaS pricing leaders have a lot to learn from our peers in more conventional industries. Input costs can have a big impact on V2C and the overall competitive economics of your solution. This is one reason Ibbaka has added cost models to value and pricing models and look at the interactions between value, price and cost. See SaaS pricing is model driven.
Rising input costs may be making your solution more expensive even if you have lowered your own prices. So why not put this under ‘factors beyond your control’? Because you can control many input costs, or at least neutralize them, and design them into your pricing metrics. The key is to do this in a way that is customer centric. Too many companies only consider their own input costs and not their customers. So here is the challenge …
Which of your customer’s input costs impact the value of your solution?
Which of your customer’s input costs impact the total cost of your solution?
How can you reduce the importance/impact of input costs on the cost of your solution?
How can you flip increases in input costs so that they increase the value of your solution?
Input costs can be things like
People costs
Data costs
Processing costs
Integration and integration maintenance costs
Risk, insurance and liability costs
User experience (UX) - UX is seldom considered in pricing work but that is a serious oversight, especially for subscription or usage based offers. There is even an equation proposed by Majid Iqbal to connect price, value and experience.
Outcomes - Price/Experience = Net Value
This equation says ‘the better the experience, the higher the willingness to pay.’ There is a feedback loop (not shown here) between Net Value and Price.
The other impact of UX is on value paths.
Is it easy to find the beginning of each value path?
Are there any blocks that make it difficult to complete a value path?
On value path completion, is the value communicated to the user? Is the value communicated to other stakeholders (perhaps in a report)?
Is the next value path obvious?
Is the connection of completing a value path and value clear?
Ecology change - We have entered a paradigm shift in the B2B SaaS business. Pricing will be under a lot of pressure to respond to that shift. Part of this is driven by economic change, higher interest rates, higher cost of capital and a greater focus on profit and cashflow. More important is the transformation being forced by the adoption of AI. See Generative AI, SaaS innovation, value and pricing. The adoption of AI is changing partnering patterns. Partners that can provide the data that feeds AI models are now critical. At the same time, go-to-market partners are also changing, often in unexpected ways. Make sure you have the partners you need to lock in value for your customers and shut out competitors.
Value enabling partners (partners needed to complete specific value paths)
Value enhancing partners (partners that increase the value but are not strictly required)
Market access partners (partners that provide access to customers)
Market validation partners (partners that give you and your solution credibility)
One reason for in package shrinkage is changes to partnering. It is easy to miss these, especially when the ecology is changing as it is in 2023. Some of the changes to be aware of …
Buyers are consolidating SaaS solutions
Buyers are buying through partners like managed service providers and demand aggregators
Buyers are aware of the AI revolution and are looking for solutions
Buyers are more aware of the value of their data, including the data generated by using your solution, and want to monetize it
Buyers are also aware of data privacy and security, their legal obligations and liability, their risks
Changes in any of these five ecology variables can impact your Net Dollar Retention.
Competitor actions - You and your competitors are likely playing an open, many turned game. It could be zero sum (if you win they lose), positive sum (there are cases where everyone is better off if you win some and they win some), or negative sum (there are actions you can take that destroy value for all parties, even for customers).
There are very few situations where you want to respond to a competitor price move by matching their price. The ‘we will not be undersold’ tactic may work in retail, sometimes, but it almost never works in B2B SaaS where one needs to build relationships with customers who will stay with you and not switch at any time to the low cost provider. Encourage those buyers to go to your competitors.
What you do need to worry about is a competitor offering more value than you do. When this happens you will see contraction inside the package (but probably not downsell) and if no corrective action is taken the customer will eventually churn.
What can you do?
Address the first four issues first
Declining value
Input costs
User Experience
Ecology changes
Offer value enhancers (data, services, integrations) to top up the value
Change your pricing design to better align price with value
The latter will likely involve a move to hybrid pricing (use of two or more pricing metrics) or if you are already using hybrid pricing a rebalancing or possibly a swap of one pricing metric for another (one place to look for alternative pricing metrics is in the fences and functions that define your packages).
Download the NDR Report here
Read other posts on Net Dollar Retention
Pricing Diagnostics and Rapid Response (Master Class with PeakSpan)
Using Pricing to Optimize NDR (Master Class with PeakSpan)
NDR Growth Tactics 4: Avoid Package Shrinkage (this post)
Net Revenue Retention (NDR) impacts the value of your company