How to Improve SaaS Retention Rates [with Benchmarks and Averages]
- How to calculate, interpret and optimize the three most common SaaS retention rates
- Why SaaS retention rates are so important for the M&A process
When founders and managers successfully lead their SaaS company to high retention rates, they’re able to grow the company rapidly and/or profitably on the foundation of recurring revenue.
These positive outcomes resulting from high retention aren’t just good for business—founders looking to make an exit will find starting a conversation with potential acquirers and achieving premium valuations are both easier when the company shows a strong track record of retention.
As such, founders should be acutely aware of their retention metrics, regularly reviewing:
- The story their retention metrics are telling about the business
- How they can strengthen retention rates for better growth/profitability
We've advised 75+ SaaS companies through successful M&A and capital raise transactions, and in each case the conversation always circled back to retention. Based on our experience, here is how we calculate, interpet, and respond to the three ways to calculate retention (along with benchmarks and averages from previous transactions we’ve advised on).
- What Is Retention in SaaS and How Do You Calculate It?
- Logo Retention
- Benchmarks & Averages
- Common Issues & How to Improve
- Gross Revenue Retention
- Benchmarks & Averages
- Common Issues & How to Improve
- Net Revenue Retention
- Benchmarks & Averages
- Common Issues & How to Improve
- Interpreting Retention Metrics Together and Taking Action
- How to Improve Your Retention Rates [Action Items]
What Is Retention in SaaS and How Do You Calculate It?
The three primary ways to measure SaaS retention are as follows:
- Logo Retention, which measures how good your company is at retaining customers
- Gross Revenue Retention, which measures how good your company is at retaining revenue from existing customers
- Net Revenue Retention, which measures how good your company is at retaining and growing revenue from existing customers
Taken separately, these metrics provide an incomplete retention story. Your company may be great at keeping customers, but if those customers are continually downselling, you’re in bad shape. When taken together, these metrics give founders and interested buyers a sense of the health of the customer base and future success.
Below we cover each metric separately, then take a look at how together they tell a more complete retention story.
Logo retention describes how well your company retains customers. More specifically, this metric provides a snapshot of what percentage of the customers you had in x calendar month one year ago are still customers today.
For example, if you had y customers in month 1 of year 1, what percentage of those specific customers are still clients in month 1 of year 2? Calculate as follows:
Formula for Logo Retention Rate
Logo retention averages and benchmarks
Among the companies we’ve represented in the last 5 years, the median logo retention rate was 89%.
Logo retention rates have little elasticity and are more of a "checkbox" for buyers and investors. While higher rates can yield better outcomes, they are less correlated to market leading valuation multiples than gross and net retention. Many buyers and investors use this metric as a minimum qualification, not so much in determining how aggressive they can be on valuation.
Your benchmark for good logo retention will depend on the nature of your business (e.g. enterprise vs. SMB, target industry, and other factors), but in general:
- A software business targeting enterprise customers should see at least 90% logo retention to be considered best-in-class.
- A software business targeting SMBs that allows even the smallest customers to subscribe to its platform (such as through low entry-pricing options) should see at least 75% logo retention across the entire customer base to be considered best-in-class. The benchmark is lower for SMB SaaS because churn is more common as customers are often acquired or go out of business.
Common causes for low logo retention and how to address them
The most common reasons for low logo retention come about from failures in the following areas:
Implementation/adoption. Whether customers have a positive onboarding experience and derive value from the product right out of the gate will strongly affect whether they will renew at the end of their contract. To resolve this issue, make sure you have a strong and standardized onboarding process led by a dedicated customer success team.
Product-market fit. If a large segment of your customer base is churning at a high rate, then you may have an issue with targeting the wrong customers. To address this issue, you should:
- Understand your customer needs and create a product roadmap that meets the broader needs of the customer base.
- Evaluate your marketing and sales efforts to focus on customer segments who fit your solution(s). Often young companies will take revenue from anyone who’s buying. While understandable, this approach creates a system where non-target customers become a part of the business. Customers with non-core use cases create greater churn in the customer base as they shouldn’t have been customers from the get-go.
Organizational structure. For companies with nascent customer success/support programs, the transition from sales to support can be a bumpy one and can result in the eventual churn of great customers. Here are some best practices to follow:
- Create a dedicated customer success team, separate from the sales & support functions. This team should be the primary point of contact with the customer going forward, submitting tickets to the support team on behalf of the client.
- Have customer success representatives manage renewals, instead of the sales rep who hasn’t been part of the conversation for the duration of the contract.
- Create multiple touch points in a customer’s journey and monitor usage metrics closely as they can be early signs of customer trouble.
- Make sure your customer success and support teams are well staffed and not overwhelmed.
Incentive structure. Make sure your incentive structure (i.e. commissions) are going to the right individuals and communicate the right message. If the sales team is responsible for renewals but the commission for a renewal is lower than that of a new deal, renewals will fall through the cracks. One way to solve this issue is to move responsibility for renewals over to customer success, along with the commissions.
Gross Revenue Retention
While logo retention evaluates the count of customers retained from one year to the next, gross revenue retention (also called gross dollar retention) evaluates revenue retained for those customers from one year to the next.
For this metric, retention is understood in the strictest sense of the word—in other words, how much of last year’s contract value will be renewed (retained), ignoring upsells. Similarly, this metric looks at what percent of revenue was retained after churn and downsells.
Gross revenue retention is the most punitive of the retention metrics, as the rate takes a hit from any downsells without upsells to offset the drop. Gross revenue retention will never be greater than 100% and speaks to a company’s true ability to keep customers buying what they first signed up for. Buyers and investors use this metric to understand the downside scenario where they get no benefit of upsell and new customers.
To calculate gross revenue retention, use the following formula:
Formula for Gross Revenue Retention Rate
Gross revenue retention averages and benchmarks
Among the companies we’ve represented in the last 5 years, the median gross revenue retention rate was 88% with a long tail towards lower retention.
Many buyers use 80% gross retention as a rough cut-off to differentiate great, low-risk investment opportunities from not-as-great ones. A lower gross retention rate frequently signifies a higher risk business that must depend on new customer additions instead of retaining existing customers in order to reach bookings and revenue growth goals.
While 80% is the general benchmark, the end market will determine a good retention rate. In general, an enterprise SaaS should see >85% gross retention and an SMB >75%.
Common causes for low gross revenue retention and how to address them
The same issues that result in low logo retention will also cause low gross revenue retention. Gross revenue retention rate, however, can be harder to solve because high churn rates could be rooted in market dynamics or the business model.
In addition to the issues underpinning low retention rates (see above), consider the following when looking to strengthen gross revenue retention:#common-causes-for-low-logo-retention-and-how-to-address-them
Pricing. If too much of your revenue is variable, meaning internal customer dynamics will affect the volume of transactions, you’ll likely see higher volatility in the revenue you retain from period to period.
Product usage. If your market doesn’t consistently need your product due to seasonality or a one-time need, your gross retention rates could experience strong drops. One solution is to add products/features that fulfill more jobs to be done and make your product stickier.
Net Revenue Retention
Net revenue retention is similar to gross revenue retention, except that it does take into account upsells for existing customers. As such, this metric is the most generous of the retention metrics, because if upsells are large enough, they can offset some of the losses due to churn and downsells.
When managers and acquirers look at net revenue retention, they’re looking for the company’s ability to grow internally within its existing customer base through upsells. When upsells more than offset losses due to churn and downsells, the net revenue retention will be greater than 100%.
To calculate net revenue retention, use the following formula:
Formula for Net Revenue Retention
Note: Churned Revenue, Downsell, and Upsell are all in period FY2 M1
Net revenue retention averages and benchmarks
Among the companies we’ve represented in the last 5 years, the median net revenue retention rate was 108% with a long tail towards higher retention.
Of the retention metrics, net revenue retention is most directly correlated to high valuation multiples as it speaks to scalability and future growth. If you have the ability to grow inside your existing customer base, interested acquirers view future growth as more attainable since current customers are a captive audience.
Determining a strong, satisfactory, or poor net retention rate depends on many factors. That being said, in general, a company with a rate over 100% is considered world-class and is going to see high valuations. For companies with <100% net revenue retention, acquirers will take a harder look at gross and logo retention to get a better sense of the company’s ability to retain customers/revenue.
Common causes for low net revenue retention and how to address them
While also taking into account any of the previously mentioned issues affecting logo retention and gross revenue retention, some specific issues that can cause low net revenue retention are related to the company’s ability to upsell existing customers. Consider the following:
Products and pricing. If you only have one product, then you can’t easily upsell a customer on additional products/software seats. Some strategies to address this issue include the following:
- Create a "light" version of your product to close more customers at a lower price point then expand within those customers (often called a “land-and-expand” strategy)
- Build more paid products and features to upsell to customers
Organizational structure and incentives. Having a sales rep re-insert themselves into the relationship at the renewal time looking for an upsell is an awkward hand-off. Dedicated customer success reps are better equipped to communicate the value of an upsell within the context of the customers’ current product usage. Make sure your customer success reps have the right tools and resources to make the upsell. Ensure your customer success reps are properly incentivized to make the upsell.
Interpreting Retention Metrics Together and Taking Action
Considered together, the three retention metrics tell a more complete story about how well your company retains customers/revenue. Below are a few examples.
Note: In the below section, calling a retention rate high or low is relative to that metric’s benchmark, not to the other retention metrics. For example, your net retention rate will always be greater than (or equal to) your gross retention rate, but could still be considered low.
A high logo retention but low gross retention means you’re good at retaining customers but they tend to downsell their contracts. This situation is by far the worst outcome and is tough to talk around with acquirers. Some areas to investigate include:
- Implementation: Were customers fully onboarded into all paid features?
- Organizational structure: Are customers receiving the support they need to utilize the product to its fullest?
- Incentive structure: Are the right people being incentivized to renew customers at their full contract value?
- Product-market fit: Which products/features are customers most likely to downsell? Which ones are they holding onto?
A high or moderate net retention rate but low logo/gross retention rate means you’re doing well at generating upsells with some of your customers while others are dropping off. Though your upsells are offsetting churn and downsells, you should investigate further in the following areas:
- Product-market fit and target market. In which customer segment are you excelling in terms of upsells? Can you focus more on that segment in your marketing & sales efforts?
A high gross retention rate but a low net retention rate means you likely have a strong product-market fit with your existing customers, but also have:
- No opportunity for growth because of your pricing strategy or lack of add-on products/features
- An improperly trained, structured or incentivized team responsible for making upsells
- No product-market fit between your primary customer base and your add-on features
Under these circumstances, you should investigate the following areas:
- Products: What can you adjust on your product roadmap to create new upsell opportunities?
- Pricing: Can you make a "light" version of the product to close more deals at a lower price point then expand?
- Organizational structure and incentives: Is the customer success team responsible for making the upsell, or is sales getting mixed up in the process?
How to Improve Your SaaS Retention Metrics [Action Items]
To help improve retention rates in general, here are several actions items you can take, as discussed in the above sections:
- Create a three-tier structure for managing relationships with customers, split between sales, customer success, and support.
- After a deal closes, hand off all renewal and upsell responsibilities (and the associated commissions) to the customer success manager.
- Ensure your customer success team has enough bandwidth and resources to meet the needs of their customers and pitch renewals/upsells.
- Standardize and optimize your initial implementation process to ensure all users are properly onboarded and deriving value from all paid features.
- Investigate product-market fit for both your most retentive and least retentive customer segments. Identify weak points in your product that if improved could make it stickier.
- Build out more products to grow within your strongest customer segment and/or become stickier with your weakest segments.
- Consider building a "light" version of your product and employing a land-and-expand strategy.
Building a SaaS Company Positioned for Exit
The above are powerful strategies for improving your SaaS company’s retention rate, but of course circumstances will be different from company to company. The retention rates and corresponding mitigation strategies of a high-touch, high-cost, highly integrated enterprise SaaS company will be different from an SMB SaaS acquiring customers at all price points. Neither model is better than the other, but they should be treated differently.
To learn more about what retention strategies you should be employing at your business, reach out to our advisors to set up a call.