Net Revenue Retention impacts the value of your company
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
TechCrunch published an interesting article on November 8, 2022.
What’s the right NDR target for SaaS startups? And why pricing could be key to moving the NDR needle
The article is behind the TechCrunch paywall, it alone is a reason to subscribe! But here are some of the key points from the article and some further thoughts on how pricing and packaging strategy are central to growing NDR (Net Dollar Retention or more generally NRR for Net Revenue Retention).
Ibbaka has been publishing on this theme for some time Pricing for NDR and it is a critical theme as we go into 2023.
Key insights on pricing and NDR from TechCrunch
“Modern software companies are set up to sell more of their product to existing customers over time” the measure of this is NDR
NDR “helps investors understand just how much built-in growth momentum a company has”
“Investors, focused on more efficient growth than last year, are likely putting more emphasis on the metric” (the metric being NDR)
Techcrunch then dives deep into the OpenView Saas Benchmarks report to see how companies are doing on this key metric.
Some companies are achieving truly astonishing NDR numbers. Snowflake ‘s NDR is about 200%. Which as Tom Tunguz has indicated generates incredible growth in value.
From Tom Tunguz
NDR varies with the size of customers you are targeting (and Snowflake is an outlier)
Combining NDR with CAC gives deeper insights into the performance standards that investors will be holding companies to
OpenView’s recommendation:
That pricing, rather than expanding one’s product mix, is the lever founders should focus on to improve their NDR
How pricing and packaging can optimize NDR
The standard way of calculating NDR is as follows:
Net Dollar Retention =
(Recurring Revenue (RR) at Start of Period + Expansions + Upsells – Churn – Contractions)/
RR at Start of Period
These are the inputs into NDR and any pricing strategy meant to improve NDR needs to balance each of these variables.
Classic pricing talks about the Volume Optimizing Price, the Revenue Optimizing Price and the Gross Margin Operating Price. These are all different prices. Pricing optimization for NDR is more complex as it has to balance the impact of price on each of these variables and their interactions. Let’s start with a price increase.
A price increase will generally
Increase average contract value, hitting the ‘Expansions’ variable
Have some impact on churn, this is generally reasonably small up to the point where one hits a price wall, at which point the price will cause churn which can overcome the expansion
For companies with a usage based pricing component, a higher price can cause a reduction in usage, especially during a recession where business activity may be down
The impact of usage based pricing on NDR is going to be very important in 2023 and there is no one cookie cutter solution. There are a number of scenarios to consider. All of these depend on three things ….
How to balance a usage pricing metric with other pricing metrics
What percentage of revenue should come from usage vs. more stable metrics like number of users or a platform fee?
Historically the revenue growth optimizing balance has been trending upwards from about 20% usage based pricing contribution to about 30% usage based pricing contribution (Zuora and Ibbaka data) but will this trend hold in 2023?
How to balance price changes
Will increasing prices generate enough additional revenue to compensate for the increase in churn?
Will decreasing prices generate enough additional usage to compensate for lower prices
How to design pricing to optimize cross sell and upsell
Role of each package in framing price and value
Role of each package in cross sell and upsell
There will probably be no one size fits all answer to these questions. Different part of your customer base will respond in different ways so you need to look at your current customers and segment them for how you will increase NDR for each segment.
One of the critical concept in pricing is V2C or Value to Customer. This metric measures how much value you are providing to your customers. V2C must be higher than LTV (Lifetime Customer Value).
V2C > LTV
Usage based pricing is a good way to make sure the V2C/LTV ratio (the value ratio) stays in the target range as value and usage change.
Pricing and packaging for NDR is top of mind for many B2B SaaS companies at present, especially as the economy seems to be headed for a recession.
A word of caution here, any recession may be short lived and will not be the same in different countries and software categories.
As you prepare for a recession prepare for the world after a recession
Some companies will do themselves long-term damage as they try to optimize NDR during a recession. Make sure you are not one of these companies. Be careful to
Maintain the value ratio (V2C/LTV) for your customers
Do not reframe your pricing at a lower level (set a new anchor price)
Do not design pricing for a recession that will trap you when the economy emerges from a recession
NDR is a critical metric and it will remain so. B2B SaaS companies are valued on trends and not on point data. Investors, and your valuation, will be based on the trend and not just on NDR at some point during a session. Design and build for long term value.
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)
Net Revenue Retention (NDR) impacts the value of your company (this post)