Questions (and answers) from the PeakSpan Ibbaka webinar on Net Revenue Retention
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talio.
On October 4th, Ibbaka partnered with PeakSpan to give a webinar on Net Revenue Retention and discuss the results of the inaugural PeakSpan-Ibbaka Survey on Net Revenue Retention.
You can get the results of the survey here
The webinar was a conversation between Sanket Merchant, Srinivas Somayajula and Steven Forth. We had a wide-ranging discussion of NRR/NDR, what it means to an investor, and how to improve it from an operating perspective.
One interesting thing was the way the conversation about NRR become a conversation about value. The best way to drive NRR is to make sure you are delivering value to your customers. Solid NRR performance is in itself evidence that a company has product market fit and that the value delivered is being recognized by the customer.
The key takeaways from the webinar are …
Overall NRR performance is likely to decline slightly from 2022 to 2023
The SaaS industry is separating into a group of higher-performing companies and the rest (high performance being NRR > 120%)
The top-performing verticals are General AI and Data Management
The verticals struggling are HR and EdTech
Even in underperforming SaaS verticals there are companies delivering top performance
Having two pricing metrics is highly correlated with higher performance
The top performing companies have dedicated teams focussed on NDR performance
Companies with the Good Better Best or the Platform + Extensions packaging pattern are often outperforming
In the webinar, and the research that informed it, we used the Ibbaka NRR Waterfall to have a focused discussion of NRR benchmarks, strategy, and tactics.
There were many questions from the community during the webinar, and we did not get to all of them, so here are the questions and our answers.
Could these ranges could be slightly different by stage of the company? i.e. does early stage have a slightly lower or maybe slightly higher NRR?
Yes. There are some common patterns that we see.
Early on, NRR is often low, below 100%, as the company works on product market fit. As product market fit improves, and the company get better at selling to its ICP (Ideal Customer Profile) NRR will go up. Early-stage companies also tend to have simple package architectures that do not support upsell or a single pricing metric that does not allow for growth in package.
As companies mature and differentiate their product they generally address these shortcomings. NRR improves, generally going above 100%. For enterprise, best of class companies have NRR of more than 120%. This can be more difficult to achieve for companies selling to SMBs or individuals as the opportunities for in customer growth are more limited.
But eventually, the market becomes saturated. Companies have maximized their share of wallets, and new alternatives have begun to nibble at their market. At this point, NRR will trend down. It is still important to maintain NRR above 105%, preferably 110%.
Not even Snowflake will have an NRR above 130% forever.
Are you going to cover what comprises/drives NRR and to what degree?
NRR is determined by the six factors, three positive, three negative described above. There are different patterns possible. For example, here are three companies, all with NRR of 106% and churn of 7%.
See Pricing and NRR: The Six Factors to Manage.
Example one, high churn and high package growth, gets most of its lift from in-package growth of 15%. There are some companies, like Snowflake, that are able to exceed this for prolonged periods. Even with shrinkage at some customers, it has a net in package growth of 13%. Churn chews up 7% of this leaving NRR at 106%. This company may want to look at introducing a GBB architecture or finding opportunities for cross-sell.
Example two is more of a mixed bag with in-package growth (+10% -2% for net +8%) and upsell (+3% -2% for net +1%) both contributing. Balance is good, but this company should pick either package growth, upsell, or cross-sell and concentrate on tweaking packaging and pricing to get an improvement.
Example three is the inverse of example one. It has no growth in package (probably because it has no usage metric) and relies on upsell to drive NRR. In this case, the introduction of a usage metric could have a big impact on NRR performance.
To manage NRR you need to understand the underlying dynamics for your own company. Two companies with identical NRR may require very different strategies and tactics.
Does repricing (price increase) count as “growth?”
Absolutely yes. In a podcast with Mark Stiving, not yet released, he took me to task for not including price increase as a way to improve NRR.
In fact, price increases or decreases could increase NRR, depending on the market dynamics and the pricing design.
If revenue gained from a price increase will more than offset increased churn, decreased use, or down-sell, then that can be one way to increase NRR. If a price decrease leads to enough expansion in use, and you have a usage-based pricing metric, that could also lead to higher NRR.
It is always worth considering a price change and having a process in place to explore the impact of price changes. One should consider a price change at least every year, and in some markets as often as every quarter, or even every month.
In situations in which you see that a product might be at the top of the market for price but lower comparably for product value - which of these growth levers would you recommend the most for improving NRR?
If the value ratio is pushing the upper boundary, which is generally 30%, then the thing to do is to innovate to increase differentiation value. The value ratio is the percentage of differentiation value claimed back in price. For new, untested products, it can be as low as 5%, for mature products where the value is well documented and understood, 30% is generally an upper limit.
The NRR formula suggests that 1% of growth equals 1% of retention improvement, but looking at the LTV formula, a 1% of retention improvement is far more valuable than 1% of growth - could you please comment?
It is not quite that simple. One percent of NRR means one percent of total recurring revenue, and this is worth, in terms of equity, somewhere between 3X and 30X in value (probably close to 3X in the current market for companies with ho-hum growth rates or lower-than-average operating margins).
Customer Lifetime Value (LTV) does not map directly to equity value for most companies (perhaps it should) is a measure of the value of retention over multiple years, while NRR is calculated one year at a time, so one would expect the LTV calculation to be larger than an equivalent NRR calculation.
Would love to hear your thoughts on best practices for transitioning pricing models. Specifically from seat-based to usage-based or feature-based pricing for an early-stage company ($7k-$40k ACV).
This is a big topic in its own right, too big to address here.
A few thoughts though.
Change prices and pricing metrics when introducing new, valuable functionality and/or when repackaging.
Segment your customer base by value delivered, and value captured. Each segment will need a different approach.
Communicate early and often.
Be transparent, explain how you derived the new pricing.
Be fair, show that the new pricing is a fair distribution of value between the parties involved.
The below diagram shows how the current customer base can be segmented for price changes and migration to a new packaging and pricing model.
Do you count reactivations in NRR calculations?
Yes, if one has a way to deactivate and reactivate accounts then this is part of NRR. It becomes the seventh and eighth NRR factor.
Note that with the possibility of reactivations comes the possibility of deactivations. This is an important principle of NRR analysis. Look at the behaviors of the companies with positive performance on a metric separately from those with negative performance. Map the behaviors of each segment. Ask how they differ. Build separate prediction models for each segment and then apply them to all customers.
Segmentation and cohort analysis are the keys to improving NRR.
I think the commission structure for Sales can impact their NRR performance, no?
Yes. Again, this is a very big question. Some of the issues that come up are …
Who gets the renewal commission?
Who gets the upsell or cross-sell commission?
How are cancellations and contractions handheld?
Is the renewal commission different than the commission on the original sale?
We should have a masterclass on sales compensation and make sure it addresses the questions around commission structure for NRR.
Can you give a few more examples of a “Dedicated Team?”
Srinivas described a tiger team that he has convened at several companies he has worked at. This team, a dedicated team, is key to driving high NRR performance.
A tiger team is a group of highly capable people convened to address a critical issue. NRR is a critical issue for most companies.
The tiger team needs:
Clear goals and KPIs
A leader who is accountable
Resources
The ability to provide rewards, to itself and others
Data
Analytical tools
In smaller companies, this team is likely made up mostly of people who have other full-time jobs. Ideally, it should be the full-time job of the team leader, but even that can be hard to do on a small team. The other team members are drawn from all the different business functions that are concerned with NRR.
Product - who often control packaging and in some cases pricing
Marketing - who needs to bring the right leads to the company and who help set expectations around value
Sales - who should be closing the companies that will contribute to high NRR, and compensated for doing this
Implementation - who is responsible for fulfilling the original value promises
Customer Success - who support ongoing use and value delivery, and who are often responsible for NRR
Finance - who depend on strong NRR numbers to drive financial performance
Data Science - who can support the analysis needed for understanding and effective action
What comprises Community-led growth?
Community-led growth is one of six growth motions that Ibbaka tracks and supports through packaging and pricing design. Most companies have a lead motion and one (sometimes two) supporting motion.
Community-led growth happens when users and other stakeholders form a community and encourage others to join the community and adopt the solution. Open-source products and companies grow primarily through community-led growth. Microsoft has historically done a great job building and supporting a developer community. Today, Hugging Face is building, and monetizing, a community of people committed to building and using artificial intelligence.
Could you pick 2-3 insights or recommendations for companies that are not in pure SaaS but are growing their recurring revenue (vs transactional) and therefore should learn from SaaS?
The most important thing is to take Net Revenue Retention seriously.
Measure NRR
Have targets for each NRR factor
Have a leader accountable for NRR performance and give them a team
Architect the solution so that different NRR factors can be leveraged (if you cannot take advantage of at least one, preferably two, of the factors then NRR will necessarily be less than 100%)
Invest in customer success and make customer success accountable for delivering value
Any impact on freemium vs. free trial and NRR performance?
We did not explore this explicitly in the survey, but it is a very good question.
Freemium can draw users away from the paid tiers, but it can also build a community of users and data that provide value for paid users.
A good free trial program helps you screen out users who will not get value, and this can improve retention numbers. It also helps to set the right expectations as people enter the software and begin to use it.
One tactic that may help with upsell is the reverse trial. In a reverse trial, one starts by giving all the power (and value) of the top tier, and then lets the buyer select down.
Kyle Poyar provides a good guide to reverse trial on Growth unhinged.
Some conclusions
NRR does not manage itself, you need detailed metrics, prediction models, and a team that is accountable for performance
Understand your NRR factors - each company has its own unique dynamics, and you need to understand your own dynamics
Packaging and pricing design need to take NRR into account, supporting at least two positive levers and reducing the negative levers: churn, shrinkage in package, down-sell
The foundation of high NRR performance is value, if customers are getting value they will renew and expand, helping to grow NRR
Make NRR a pillar of your packaging and pricing as you develop your revenue growth plan for 2024