The Meaning of Stickiness

In our last article we talked about what high renewal rates mean for your business, but how do you set your business up to achieve those renewal rates? As we said, it comes down to customer success with your product and stickiness in the face of market changes and competitive pressures.

Let’s talk about stickiness (a term everyone seems to talk about) – just what does it really mean? A quick definition is the nature of your customers to continue to use your products or services, to “stick” with you.

The traditional (and now outdated) approach to keeping your customers sticky was to sign them up to long-term contracts or be a black box in one of their main business processes. Such an attitude could not be further from the spirit of adding value and customer success.

As we look at the stickiness of businesses today, we focus on a few key areas that drive value and make a customer successful – which leads to them to renew, upgrade, and never leave.

What’s in a Renewal Rate?

One of the key value questions for any software or services business is the rate of customer renewal. Whether it is measured in dollars, customers, subscriptions, maintenance agreements, or some other metric, higher renewal rates usually indicate better products and stickier customers, and they directly translate to more predictable revenue and lower selling costs.

Typically, good services businesses have renewal rates of more than 80%, while more sticky software renewal rates hit 90% or more. But what is the difference between a company which has a 90% renewal rate vs. one with a 95% renewal rate? Both are clearly leaders among their peers, but, as just one example, the 95% renewal rate company can spend half what the other must spend on selling and still come out ahead.

In order to get to that conclusion, we need to look at renewals from the other angle – by considering attrition. While a 90% renewal rate is great, it means that attrition is 10%. So the company with a 95% renewal rate has only 5% attrition, meaning on average it loses half as many customers per year as its rival in this example.

Software, Software Everywhere

Across almost every industry in the U.S., businesses both large and small are highly dependent on software technology to support their operations. Whether they are manufacturing a product, managing a sales force, invoicing a customer, or paying employees, more often than not software plays a major role in getting the job done. With the increasing amount of software technology, including third-party applications, databases, operating systems, websites, and propriety applications, one of the key challenges that companies face is how to manage and maintain all of this software, in many cases mission-critical software, in a cost-effective manner. For software and technology providers themselves, the increasingly competitive marketplace is making it important to not only provide a lower total cost of ownership but also be fast and efficient in improving products and expanding feature sets.

Non-Newtonian Liquid(ity)

Many investors have found it challenging to generate yield in a “low for long” interest rate environment. Not surprisingly, this topic often comes up in our casual conversations with limited partners. As a service to our constituents we decided to not only explore what has been happening in the credit markets, but also provide some ideas on where they can find yield. These learnings also help Virgo and its portfolio companies plan for strategic initiatives in 2016, such as the level of debt available to help fund add-on acquisitions. In the spirit of holiday giving, we would like to share some of these findings with our Virgo View readers.

HIMSS14 Postmortem: From Shakedown to Shakeout

Like many of those in attendance, my post-HIMSS14 recovery weekend was spent on a variety of therapeutic activities such as spending time with family, attempting to work off one too many breakfast/lunch/happy hour/dinner/reverse happy hour meetings, and flipping through a stack of special edition publications picked up at the conference (thank you FedEx!). I also had time to reflect on some of the key conference takeaways that I wanted to discuss with my colleagues this week.

Nonprofit and Association Management Software

Associations are a relatively recession-resistant business, but as the professional labor force grows during economic recovery, professional and trade associations specifically need to be ready to engage potential new members who seek to advance their careers through membership. For national organizations, as opposed to state-level organizations, membership is voluntary, so these groups need sophisticated tools and technology, including social media, to continually attract and engage members, especially the younger generation of professionals, and fend off competition from for-profit entities who can also provide relevant content and experiences to members.

ERP Systems for the Manufacturing Sector

As the economy emerges from the recession, middle market manufacturing companies are growing and have built up demand for quality IT systems to give them the edge in being their sector’s low-cost providers and reducing delivery cycles. Established manufacturing-focused ERP software providers with proven solutions and strong customer support are well positioned to succeed in the next decade as the middle market manufacturing sector grows. Further, in the middle market, software providers with domain expertise in manufacturing have an edge on large vendors, such as SAP and Oracle, as their solutions are specialized for their customers’ niche processes, and they can better implement and respond to changes.

Private Equity in the Lower Middle Market

Glance at the front page of the Wall Street Journal on any given day, and there is a good chance the term “private equity” will be mentioned at least once. Whether in a discussion on federal tax policy or in an announcement of the latest multi-billion dollar buyout, it seems everyone is talking about private equity. Despite the term’s newfound ubiquity, it is important to avoid painting the entire industry with the same brush. In this article, we note some key differences between various types of private equity and discuss our views on the opportunities and challenges present in an often overlooked sector, the lower middle market.

Enterprise Profiling Services

It should come as no surprise that in our ever-modernizing and increasingly connected world, spending in the information technology (IT) industry is on the rise. The worldwide IT market will exceed $1.2 trillion in 2007 with an associated five year CAGR of over 6%1. Sales quotas for companies which serve this market are on the rise as well, increasing 10-15% over last year, while sales budgets are only projected to rise 9%2. As a result, technology sales personnel need to work smarter to hit their quotas, which in turn means maximizing their leads from both a quantity and quality perspective. Virgo Capital believes that Enterprise Profiling Services (EPS) provide a clear solution to these issues and that the sector as a whole represents a promising area for investment.

The Emergence of Nearshoring

Few business trends in recent memory have garnered the type of attention that outsourcing has. Driven by increasingly strong pressure to cut costs and focus on core competencies, companies are continuing to look to outside firms to handle non-core business functions such as collections, customer care, and human resources. In the 1990s, many companies in the U.S. began looking into offshoring, sending work over to places such as India and the Philippines. Recently, however, numerous issues have emerged with the offshore model, and executives are starting to look to nearshore providers for their business process outsourcing needs. At Virgo Capital, we believe the nearshoring model offers a unique value proposition when compared to domestic and offshore outsourcing providers, and that it represents an attractive opportunity for the right investors.

Professional Employer Organizations

Human resources management is one of the most substantial and promising areas in outsourcing today. One of our favorite models is the professional employer organization, or PEO. The value proposition PEOs provide enables clients to cost-effectively outsource the management of human resources, employee benefits, payroll, and workers’ compensation, allowing them to focus on core business functions. PEOs deliver these services by establishing and maintaining an employer relationship with the client employees and by contractually assuming certain employer rights, responsibilities, and risk. We believe that significant investment opportunities exist in this consolidating market given the fast growth and low overall market penetration.