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.
Another valuable metric derived from attrition rates is average lifetime. If you have a 90% renewal rate, or 10% attrition rate, of customers, your average customer life span is 10 years (calculated from 100% divided by 10% – a formula from the mathematics of infinite series, which you will have to take my word for). If you can improve your renewal rate to 95%, the average life span jumps to 20 years (or 100% divided by 5% attrition). Not an easy task, but what if you could get the renewal rate up to 97.5%? You get an average customer life span of 40 years! By getting closer and closer to a 100% renewal rate you get exponentially better average life spans of your customers, and this phenomenon translates directly to the value of a business.
On the flip side, it is important to realize what a low renewal rate means for the future. Say your annual renewal rate is 75%. Not too shabby right? Well, hold on a second. If you are a license-model software company, this means you lose ¼ if your maintenance stream each year, so you have to go out and sell hard to win back the lost customers and replace the lost maintenance revenue with license revenue to just be a flat business. If not, your maintenance stream drops to about one-fourth of its value in just five years.
So how do you improve or maintain high renewal rates? It comes down to customer success with your product and stickiness in the face of market changes and competitive pressures. We will touch on these points in future articles.