Which NRR factor are you prioritizing?

June 10, 2024 Steven Forth

Steven Forth is CEO of Ibbaka. See his Skill Profile on Ibbaka Talio.

In the current business environment, where buyers are cautious about adding new applications to their technology stacks, it has become ever more important to grow revenue from the current customer base. NRR (Net Revenue Retention or NDR for Net Dollar Retention) is a key metric for revenue and customer success and is being monitored closely by boards and investors.

Ibbaka and its partner PeakSpan began to research the drivers of NRR performance last year with the first survey to take an in-depth look at NRR performance. We published the results here and had a webinar to discuss what we found.

This survey is the only place to understand how NRR differs by

SaaS vertical
Growth motion
Packaging pattern
Organizational design

Top-level NRR numbers obscure as much as they reveal. To get actionable insights you need to get down into the weeds.

One mistake that people make in NRR management is to focus on macro numbers. Some companies only focus on the aggregate number. This is a mistake. One needs to breakdown NRR performance into the different factors that compose it.

The Six NRR Factors

Companies sometimes go beyond just the topline number to report churn/retention plus growth/shrinkage in revenue. They calculate NRR as Revenue from the Previous Period - Revenue Churn + Growth in Revenue from Current Customers. This is a step in the right direction but it is not granular enough to actually manage NRR. To do that you need to separate the positive factors from the negative factors and manage them both.

The PeakSpan-Ibbaka survey gets down to that level of detail and asks companies to rank each of the factors (in order) that are relevant to their business. Why do we do this?

Companies can have the same top-level number but very different dynamics, that require different tactics if the top-line number is going to improve.

Consider the three companies below. For each company, the net impact of growth/shrinkage in package is +3%, but the underlying dynamics are quite different.

Company 1 has an impressive 10% growth in package. But the net impact is dragged down by 7% shrinkage in package. It has a volatile business, with some customers growing use rapidly while others cut back The priority here is going to be to reduce shrinkage in package. Doing this will require a behavioral segmentation to determine (i) the difference between customers that grow in package and those that shrink in package and (ii) a sub-segmentation of customers that shrink in package to pinpoint the reasons for the shrinkage. This is the sort of analysis that Ibbaka’s NRR Predict software will provide.

Company 3 is in the opposite situation. It also has a net contribution of +3% from growth/shrinkage in package, but there is virtually no shrinkage and only 3% growth. This company needs to find ways to increase growth in package, even if it allows some shrinkage to creep in.

Company 2 is in the middle. Determining the NRR optimization strategy here will begin with a behavioral segmentation to determine (i) the difference between customers that grow in package and those that shrink in package and (ii) a sub-segmentation of customers that grow in package and (iii) shrink in package. There may be room for improvement in both factors, but any pricing actions will need to be tested to make sure that an increase in growth is not undermined by an even greater increase in shrinkage. Increasing growth in package to 9% is not a win if shrinkage grows to 7% leading the net contribution to shrink from 3% to 2%.

The lesson? The details hidden in the six NRR factors matter. Actions based on high-level numbers will likely be wrong.

We recently talked to a company that allowed churn to increase but made sure that the customers churning were those most likely to shrink in package. After a few cycles, they had built a much more reliable customer base that they could grow aggressively.

What about price changes?

A common question is what impact a price change will have on NRR. The only way to answer this question is to look at the impact of a price change on each factor and model different scenarios.

Churn: a price decrease will generally cause some churn, but it is often smaller than expected. On the other hand, a reduction in price seldom leads to an improvement in churn. Be careful about price decreases as a solution to churn. The questions to ask here
- What volume of sales can I afford to lose at the new price and maintain revenues?
- What volume of sales can I afford to lose at the new price and maintain profit?
  The answers to these questions can be surprising. Make sure to actually calculate the answer and not to guess. Ibbaka can provide you with a calculator to do this.
Growth in package: This factor requires some sort of scaling or usage metric. It is often more sensitive to price than many assume. Be careful with price increases for usage metrics as they can discourage use.
Shrinkage in package. The inverse of growth in package. In a lot of the data we have studied a price increase reduced usage but a price cut did not increase usage. Be careful here.
Upsell across packages: For companies with multiple packages, especially, especially those with tiered or Good Better Best (GBB) packaging, rebalancing the pricing of packages is often one of the most effective tactics. There is often room to increase the price differentiation between packages or to address the fences that guide buyers from one package to the next.
Downsell across packages: Our data shows that downsell is not a big challenge for most SaaS companies, and it primarily takes place in response to a price change. So as part of your package price and fence rebalancing think through what might lead to downsell and look for ways to discourage this.
Cross-sell: This is where bundling comes in. It is worth designing in bundle incentives. Microsoft is the master of this, see note below. Note that one goal of cross-selling is customer lock-in.

Rather than simply increasing prices, SaaS companies need to look at pricing as a system. Consider the impact of a price change on all six factors. Include an analysis of package performance and the roles of fences

Perplexity AI on Microsoft Bundling

See the whole chain on Perplexity.

Prompt: How does Microsoft approach pricing bundles of its software products? Is bundling meant to increase revenues or profit? What lessons can other companies learn from Microsoft's approach to bundling?

Answer: Microsoft's Approach to Pricing Bundles of Software Products

Microsoft employs a strategic approach to pricing bundles of its software products, leveraging bundling to enhance market share, increase revenues, and solidify its competitive position. The company's bundling strategy involves combining multiple software products into a single package, often at a discounted rate compared to purchasing each product individually. This approach is evident in several of Microsoft's offerings, such as the Microsoft Office Suite, which includes Word, Excel, PowerPoint, and other applications, and the Microsoft 365 plans, which bundle productivity tools with cloud services and security features.

Key Aspects of Microsoft's Bundling Strategy

Discounted Bundle Pricing: Microsoft often prices its bundles lower than the sum of the individual products, creating a high perceived value for customers. For example, the Microsoft Office Suite is offered at a lower price than buying each application separately.
Ease of Procurement: Bundling simplifies the purchasing process for customers, particularly in large organizations and government sectors, where ease of procurement is a significant factor.
Market Penetration and Dominance: By bundling less popular products with more popular ones, Microsoft has successfully increased the market share of its entire product suite. For instance, bundling Internet Explorer with Windows helped Microsoft gain a significant share in the web browser market.
Revenue Recognition and Allocation: In Dynamics 365, product bundles are represented by a parent item and multiple component items. The selling price is allocated proportionally to the individual components, ensuring accurate revenue recognition.
Flexibility in Pricing: Microsoft allows for variable product quantities within bundles, enabling customers to adjust the quantities of individual products while maintaining the overall bundle price.

Objectives of Bundling: Increasing Revenues and Profits

Microsoft's bundling strategy is primarily aimed at increasing revenues and profits through several mechanisms:

Higher Sales Volumes: Bundling encourages customers to purchase more products than they might have individually, thereby increasing sales volumes.
Customer Lock-In: Bundling creates a dependency on Microsoft's ecosystem, making it more challenging for customers to switch to competitors. This lock-in effect ensures a steady revenue stream from existing customers.
Cross-Selling Opportunities: Bundling allows Microsoft to introduce new products to customers who might not have considered them otherwise, thereby expanding its market reach and increasing overall sales.
Competitive Advantage: By offering comprehensive bundles, Microsoft can out-compete rivals who offer standalone products. This strategy has been particularly effective in the cybersecurity market, where bundled packages have helped Microsoft gain significant market share.

Lessons for Other Companies

Other companies can learn several valuable lessons from Microsoft's bundling strategy:

Create High Perceived Value: Offering bundles at a discounted rate compared to individual products can enhance the perceived value, encouraging customers to purchase the bundle.
Simplify the Buying Process: Bundling can simplify procurement, especially for large organizations, making it easier for customers to choose your products over competitors.
Leverage Cross-Selling: Use bundling to introduce customers to new or less popular products, thereby increasing overall sales and market penetration.
Ensure Flexibility: Allow customers to adjust quantities within bundles to meet their specific needs, which can enhance customer satisfaction and loyalty.
Focus on Long-Term Gains: While bundling can lead to immediate revenue increases, the long-term benefits of customer lock-in and market dominance are equally important. Companies should aim to create a comprehensive ecosystem that customers find difficult to leave.

By adopting these strategies, companies can effectively use bundling to boost their revenues, enhance customer loyalty, and gain a competitive edge in the market.