The Revenue Hit You Didn’t Know You Were Taking: Why LTV-based Segmentation Matters
Recurring revenue businesses are built on a foundation of account lifetime value (LTV), but when revenue stalls, aggressive pursuit of immediate net new bookings can hide the insidious long-term impact of churn. Rekener COO Greg Keshian describes how putting account LTV at the core of segmentation analysis helps companies avoid common segmentation traps and get back on the track to healthy long-term growth.
Why do so many recurring revenue businesses experience early explosive growth, only to hit a revenue plateau, whether at $10 million $50 million, or even $100 million? And why doesn’t throwing money at the problem have the desired impact on growth? We’ve seen it all before: an exciting new company with a promising product offering, an outstanding leadership team, great market visibility and a large number of early, happy accounts. At some point, however, the company appears to lose its footing, and subsequent investments to boost sales, marketing and customer success actually slow the company down instead of escalating its growth.
Typically, when a business appears to stall, its analysts pore over marketing and sales data to conduct segmentation analysis. Teams look for patterns that might identify the best opportunities for sustained and repeatable revenue. However, if analysts approach segmentation with a near-term revenue mindset, the results will be more of the same, potentially further diminishing the company’s future growth. When analyzing segmentation opportunities in a recurring revenue business, the primary goal must be to find segments with the highest potential account LTV.
Let’s start at the beginning. When a company is young, the leadership team has no historical data to use when creating models for future growth. Everything’s an experiment, so the team begins by allocating the majority of marketing and sales resources to land as many new accounts as possible, as quickly as possible. This approach helps the business prove its product-market fit and generates some cash flow.
Once its customer base grows a bit, the company shifts its focus from closing a high number of net new deals toward generating as much revenue as possible by maximizing new business bookings.
This is when things start getting real for the go-to-market team. A marketing team is hired and the sales team is expanded, each with its own department-specific goals in support of the mission to maximize revenue. For sales, that means a focus on net new bookings. For marketing, it’s about hitting targets for lead generation and qualification based on what sales needs for net new bookings.
For a while, this works. Lead volumes increase, bookings per quarter go up, and the company continues to add accounts. The leadership team is happy because revenue is growing and everything seems headed in the right direction. At some point, a renewals and/or customer success team is added to keep customer churn rates in check.
The Leaky Bucket
But little by little, every effort toward growth feels harder than it should. In preparing next quarter’s board slides, the leadership team realizes that the quarter-over-quarter revenue growth rate isn’t quite as stellar as it used to be. The next quarter is likely to be even worse. The quarter after that, worse still. But new bookings haven’t dropped. In fact, they might even be up from last quarter. What’s going on?
Churn is starting to become an issue. The company’s recurring revenue base has become large enough that the number of accounts cancelling or declining to renew is becoming comparable to the number of new accounts added.
Ignoring churn is like ignoring the leak in your revenue bucket. Adding more water isn’t the solution. Every month, the sales team pours in as much water as they can in the form of new bookings. But every month, some water leaks out in the form of churn. The fullness of the bucket represents the level of annual recurring revenue (ARR) the company is achieving. If water keeps leaking out at the same rate it’s coming in, the bucket won’t fill up and ARR will flatline.
The importance of managing retention in recurring revenue business models has been well-documented(1). After all, account lifetime value, or LTV — keeping and expanding the account over time — is what recurring revenue businesses are all about. But despite nearly universal visibility of this important metric, companies can easily fall into one of two traps once churn starts to drag down revenue growth.
Trap 1. Just add water.
In this trap, companies just pour water into the bucket faster. That means hiring more salespeople, adding to the marketing team, spending more money on marketing and advertising, maybe introducing a new channel strategy — basically doing anything and everything to bring in more bookings. Here’s what’s wrong with pouring more water in the bucket:
- This will stave off flatlining revenue for some time but not forever, because the bucket has holes in it.
- This approach has significant cost, possibly requiring another fundraising round to raise the capital needed for this increased sales and marketing investment, which will dilute ownership.
- The cost to acquire a customer (customer acquisition cost, or CAC) also goes way up, because the company is now likely pursuing less efficient channels in its effort to find net new business wherever it can.
- It’s not a permanent solution to the problem. While raising capital to scale a business isn’t a bad thing to do, raising capital to scale a business with unhealthy fundamentals is, especially if the funding doesn’t address the underlying churn problem.
Trap 2. Patch and pray.
In the second trap, companies find ways to patch the holes in the bucket. This means hiring more customer success people, trying to do a better job with onboarding new accounts, paying attention to every single renewal, and so forth. These are all worthwhile activities, of course. Even minor improvements to the retention rate at this point will help the company hang on to more cash and will lead to incremental improvement in ARR. For many companies, patching the leaky bucket results in incremental improvements in the renewal rate, but it doesn’t improve renewal rates enough to grow revenue significantly or permanently.
In order to stop the bucket from leaking for good, companies need to recognize the connection between new business and renewals. That’s because today’s new customers are the ones who will decide next month, or next quarter, or next year, whether to continue with your product or service or whether to cancel their subscription.
LTV-based Segmentation Is the Solution
What if the marketing team were able to generate demand among prospects who are not only likely to buy, but likely to renew? And what if the sales team were able to pursue only those prospects likely to renew? By deliberately aligning marketing and sales teams to prioritize efforts around high LTV accounts, recurring revenue businesses can move away from the days of trying to close every deal in sight. This shift is significant because it forces marketing and sales leaders to stop thinking about department-specific goals (MQLs and SQLs and new bookings) and go to market using an aligned approach that blurs the line between traditional marketing and sales. Instead of setting goals to “generate as many top-of-funnel leads as possible” or “land as many new accounts as possible” or “book as much new business as possible,” these aligned growth teams prioritize activity and allocate resources collaboratively, all in pursuit of a company-wide goal to keep filling the bucket higher and higher: “pursue, book and retain high lifetime value (LTV) accounts.”
Maximizing account LTV is a far more efficient way to grow revenue in the long term, because while it costs money to land new customers in every segment, the focus across the company shifts to maximizing future revenue from each account. By looking at customers by market segment, we can identify those segments containing accounts with higher lifetime value.
Let’s look at a fictional SaaS software company, QuiddlyBoop. Just a few years in business, QuiddlyBoop’s revenues are showing signs of slowing growth in spite of increased investments in all phases of the go-to-market effort. They’ve chosen to segment their business by company size: Small, Mid-Size, and Large. Note that the definition of “segment” varies — options include company size, revenue, industry, use-case, geography, and many more.
After getting data from her Sales Ops Analyst, Erina, the Director of Sales at QuiddlyBoop, concludes that the Mid-size segment shows the most promise. As illustrated in the table above, she’s captured the number of sales activities required to open a new business opportunity, the new business close rate, the average selling price (ASP) of new business deals in each segment, and the length of the sales cycle. Erina’s also calculated the expected value per opportunity by multiplying the ASP by the close rate.
Given the results of Erina’s segmentation analysis, she’s made a great case for focusing on the Mid-size segment. The yield would appear to be highest as this segment has the highest value per opportunity opened. Also, if Erina were to divide value per opportunity by the number of activities it takes to create each opportunity, the Mid-size segment still appears to be the most productive. Add to that the fact that the sales cycle is only two months long, and it’s clear that the Mid-size segment is very attractive.
The numbers continue to look promising for the Mid-size segment when Erina forecasts the future impact of a strategic shift for QuiddlyBoop. In this model, she calculates three trajectories for the business if 100% of available resources were allocated to each of the three segments.
As her chart below indicates, focusing on the Mid-size segment would produce the best result at $3.0M in bookings, followed by the Large segment at $2.7M and the Small segment at $2.4M. While the Small segment produces the lowest volume of bookings it would yield the highest number of new accounts, as it has the highest close rate, the shortest sales cycle and requires the fewest sales activities to generate a new opportunity.
Erina is confident she’s got the company’s strategic plan all figured out. Unfortunately, she’s actually missed something significant: she isn’t looking at account LTV. If she manages to persuade the company’s leadership team to shift marketing and sales resources to what appears to be the most lucrative segment, she’ll eventually come under fire when the company’s revenue stalls.
Part of the issue here is that Erina is the Director of Sales. Her target and incentive compensation are based on the volume of Net New Bookings produced by her team. It only makes sense, then, that she would optimize for that metric, but that’s not what will make for a successful business.
Strategic BizOps is Required
What QuiddlyBoop really needs is someone in a strategic business operations, or BizOps, role, responsible for analyzing and segmenting the entire business in a way that will set the company up for success. This Director of BizOps will examine the entire account lifecycle on a segment-by-segment basis so the company can optimize for account LTV. If QuiddlyBoop were to hire Dave, the Director of BizOps, here’s the segmentation approach Dave might take.
Informed by conversations with leaders from marketing, sales and customer success, Dave explores the data. When he looks at accounts after the first purchase, the story begins to emerge. In the table above, Dave notices QuiddlyBoop is opening 1.3 expansion opportunities in the Large segment for every new customer they land. More importantly, the value of each Large opportunity is an impressive $52k! This expansion stream would be easy to miss if the analysis pivoted on net new bookings, because the expansion revenue doesn’t appear until nearly a year after the first purchase. And since the company is already so focused on the Mid-Size segment, the quantity of these Large expansion deals is small enough that the sales team believes them to be hard to find.
Because Dave is focused on the entire business, not just net new bookings, he then explores the significant difference in renewal rate among the three segments. In particular, he sees lots of water leaking out of the Small and Mid-size buckets. This could be a function of the types of companies in that segment, or perhaps how well-suited QuiddlyBoop’s software products are to customer needs in each segment.
Armed with the data about the entire account lifecycle, Dave puts together an LTV-based segmentation model, below.
In addition to the expected value of a new business opportunity in each segment, Dave multiplies the number of expansion opportunities created per new customer landed by the expected value of those expansion opportunities to generate Value / New Biz Opportunity (including expansion). This represents anticipated revenue from both new business and expansion bookings for each opportunity. Then, Dave factors in the renewal rate and calculates account LTV to display the result in the final column using the LTV formula below:
LTV = Value per New Biz Opportunity Including Expansion / (1 – Renewal Rate)
When Dave looks at the company’s segments this way, the potential impact is immediate. The Large segment has an expected account lifetime value 44 times higher than the Mid-size segment due to a much higher rate of expansion, a much higher expansion value, and a much higher renewal rate.
Why Isn’t This Obvious?
Though the numbers in favor of the Large segment seem to jump off the page, there are many reasons why Erina, QuiddlyBoop’s Director of Sales, would have missed them:
- The net new landing close rate for the Large segment is much lower than the Mid-size segment, so her team isn’t focused here;
- The net new opportunity volume is lower in the Large segment; and
- The sales cycle is longer for net new and expansion deals in the Large segment. Erina’s current compensation plan is based on bookings in the near term, not revenue or LTV. Her job is to drive the sales team toward their targets.
Clearly, Erina needs a strategic partner in BizOps who can continually analyze the business and help her aim the sales team in the right direction.
For most companies, it isn’t easy to aggregate this information and share it in a way that’s actionable. Customer relationship management systems (CRMs) are great at tracking individual sales deals, but they don’t deliver a view of the entire account lifecycle, and don’t facilitate segmentation at the account level. In fact, plain old Microsoft Excel is better for this type of data manipulation. However, using Excel requires manual export and import of data from the various systems around the company that capture activity throughout the account lifecycle. And with that data changing in real time, it’s just too hard, too time-consuming and too error-prone.
There are two critical elements required to successfully conduct and track LTV-based segmentation analysis:
- A strategic BizOps leader focused on what’s best for the entire business, not just one department; and
- Account Lifecycle Management software to aggregate all of the company’s accounts, group them in real time using segments defined by that company, and pull in the marketing, sales and renewal information needed to calculate the key ratios that feed the account LTV equation.
Impact of LTV-based Segmentation
An LTV-based segmentation analysis changes everything. In Erina’s “net new”-oriented segmentation effort, she looked at the possible outcome of putting all the company’s resources behind each segment, then graphed that possible outcome on a chart showing Cumulative Net New Business Bookings over 1 year. In Dave’s LTV-based segmentation chart, we see Revenue Run Rate projected over 6 years, with each line representing QuiddlyBoop’s revenue if 100% of available marketing and sales resources were allocated to each of the three segments. The difference between the two charts is startling.
The Large segment ends up at a $33M run rate at the end of the 6 years, with a 65% Compound Annual Growth Rate (CAGR), and it’s still on a growth trajectory. Meanwhile, the Mid-size segment, which held so much promise in Erina’s one-year net new-oriented segmentation analysis, is actually flatlining at $9.2M in run rate at the end of 6 years with a comparatively low 24% CAGR over the same period. Keep in mind, this assumes that sales and marketing spend are at the same level in each scenario.
Here are the two charts side-by-side for easier comparison.
These diverging growth curves highlight the power of expansion and renewal revenue over time. The Large segment gets a boost at the 11-month mark when expansion begins. The Small and Mid-size segments start to flatline at 25 and 50 months, respectively, as their relatively higher churn rates start to catch up to new bookings.
Remember the two traps: “Just add water” and “Patch and pray.” When approaching flatlining revenue, a business leader might “just add water” by doubling down on sales and marketing investments to increase the inflow of water into the bucket, or “patch and pray” by investing heavily in customer success to stop the leaking. Both of those efforts will produce higher near-term revenue, but they won’t help the company maximize long-term efficiency and account LTV.
The leadership team at QuiddlyBoop made the wise decision to invest in a BizOps leader empowered to help the company grow smarter. And by leveraging Account Lifecycle Management software, the BizOps team can easily group accounts by segment such as company size, revenue, industry, use-case, geography and identify which growth activities contribute to win/expansion/renewal rates.
Now focused on building account LTV in its Large business segment, QuiddlyBoop is unlikely to fall into either of the two traps. When QuiddlyBoop increases its spending on sales and marketing, it will be adding more water into a bucket that no longer leaks. Its Sales Director Erina can focus all of her energy on making her team productive, knowing that Dave the BizOps Director will monitor results daily and position the company for maximum revenue growth. By aligning marketing and sales to pursue prospects most likely to buy, stay, and expand, the company’s investments in customer success are likely to improve the already healthy renewal rate of 86% — rather than just patching customer churn leaks. Now the company’s leadership is on track to help a healthy business reach its potential by focusing on a fundamental aspect of recurring revenue businesses: account LTV.
Rekener Account Control Center
Based on the extensive domain experience of the Rekener founding team, we’ve created Account Lifecycle Management software. The Rekener Account Control Center automates these functions and helps align the entire team — BizOps, marketing, sales, customer success and customer support — around driving account LTV. When everyone is focused on the same global metric versus individual local metrics, it’s amazing what you can achieve.
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(1) David Skok, “Unlocking the Path to Negative Churn,” For Entrepreneurs blog, undated, http://www.forentrepreneurs.com/why-churn-is-critical-in-saas/ and Amy Gallo, “The Value of Keeping the Right Customers,” Harvard Business Review blog, October 29, 2014, https://hbr.org/2014/10/the-value-of-keeping-the-right-customers
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Greg is COO and Co-Founder at Rekener. Greg’s career has been focused on using data to grow recurring revenue businesses. Before joining Rekener, he served as VP of Operations at ZeroTurnaround, where he built its strategy and operations practice, ran its customer success and renewals function, helped to grow and coach its high-velocity sales organization, and optimize its marketing efforts. Prior to that, he ran the BizOps and marketing functions for the AVOKE call center analytics business, a SaaS company within BBN Technologies. He got his start using data to improve sales and marketing efforts while at AppNeta.
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