What’s your margin contribution for your company and your customers?
We are in the midst, or perhaps just the beginning of a sea change in B2B SaaS. Markets and investors are spooked and as a result are more and more focused on profitable growth, not growth at all costs. The cost of capital is no longer close to zero, as has been the case for the past 10-15 years. With the cost of capital now around 10% (convertible dept probably at 12%) funds for growth are increasingly expensive. Raising capital to cover your burn rate and extend your runway (how long before you run out of cash) is now both very expensive and increasingly challenging. Cash, or lack of it, is the one sure thing to put you out of business. That means budgets for anything are increasingly scrutinised against their contribution to profitable growth and existing budgets are pored over with a fine tooth combed to identify costs that can be trimmed. CEOs, CFOs and investors are now reassessing what was, until very recently considered important but nice to haves and becoming laser focused on must haves.
CS is no exception. I have not found any figures specific to CS but Forrester are predicting 20% of customer experience programs will be cut next year. Private Equity are adopting a benchmark for CS spend at 6% of revenue; a big difference from the 12-15% often quoted by the CS community.
The changing macro-economic environment reinforces the need for CS leaders to focus on two dialogues. They are not new but not enough CS leaders are really literate in them. That has to change and quickly.
The internal dialogue
The question CS Leaders have to answer internally is “What is CS’ margin contribution?”
In the past, justifying CS investment was easy. Once a delivery model was agreed, headcount and other resources grew in line with customer count. Too many CS leaders relied on the assumption that investment in building a CS department was an essential part of a SaaS business. Well now, that assumption, along with other operating norms across the business will be questioned. I have spoken to CEOs who are asking about the impact on churn and growth (NRR) of not having a CS department. ‘Accepted wisdom’ is no longer accepted at face value. The cost of capital, its impact on cash runway and the focus on profitability has changed that.
If your CS operation is not generating margin, you are a cost centre. And even if you are margin positive, the pressures on the business will lead to requests for more. CS has some great arguments in its favour: the lower acquisition costs for renewal and upsell revenue; the impact of NRR on valuations; the contribution of referrals (secondary revenue) and the need to deliver on promises made in the sales motion are just a few. But even if you are doing all this, if you are costing the business more than you are earning, you will deservedly come under scrutiny. For this reason, growing NRR is no longer the game. Growing profitable NRR is. I believe CS leaders will be we be better served by measuring NRR efficiency the cost to deliver each % point of NRR) and CLTV:CAC ratio.
How do you address this? The model CS P&L. P&Ls are simple: Income – Cost = Margin. I built one for my own B2B SaaS company and helped several others do this as part of my coaching work. Note: this is a pro forma P&L; it’s a tool to help understand the financial impact of CS, however you choose to define the scope of that capability.
Let’s break it down.
- Recurring subscription revenue
- Recurring services revenue
- One-off revenie
- TOTAL REVENUE
Cost of revenue (Can be included in costs for a simplified model)
- PS costs
- People (See headings below)
- Support (if part of the CS organisation)
- TOTAL Cost of Revenue
- CS Gross Margin
- Staffing costs (CS, PS, Implementation, CS Ops)
- Employer Taxes
- Training & development
- Customer marketing
- Content production
- Distribution costs
- Facility costs (space, core equipment ….)
- Margin contribution = Gross margin – costs
- Margin % = Margin contribution/Total revenue
So what does this mean. There are some pretty clear implications.
The CS P&L will help you focus on profitable retention and growth. If you can’t track the data above, you have a problem. You are not in control of your business. Use your CFO to help you fix it.
If you do not directly own a number, you are a cost centre! On your head be it when the company starts looking to preserve cash.
The biggest cost element is always people. If the business is looking for meaningful savings to preserve and extend the runway, they will look here first, Productivity – how you can do more with the same or less is key. For me, productivity is about how we can deliver the same, or preferably better value for customers with the same or less resources. There is no trade-off: meaningful productivity requires both.
New products and features and how these are packaged and priced can change the top line but it usually takes time, which you might not have.
To repeat myself, this is not a ‘for real’ P&L but a very powerful tool for understanding and agreeing the financial expectation from customer success. It is richer than a budget, which tend to focus only on spend as it includes both income and costs.
I always run two, linked versions. The first is used to model how CS currently operates and how you want it to operate. This s your planning tool used during budgeting and periodic CS business reviews – typically quarterly. It’s a great tool for asking questions: “What’s the revenue potential of increased retention or upsell?” “What productivity improvement will we get from greater automation?” The real power comes from the discussion about how these changes can be made, generating a shared perspective on how actions can be implemented.
The second is the actuals, used to track performance and drive discussions around the progress of the changes to achieve or improve positive margin contribution.
The customer dialogue
Your customers are operating in the same challenging environment and probably having the same discussions: how can we maximise our cash runway and improve our profitability. Cost cutting is always quicker and easier than revenue growth so the larger the pressure on runway, the more this is likely to happen.
Your products and services are on the list of potential cost savings. How safe are you? I think that depends on two categories of factors:
There is always cost and risk associated with change. Incumbents benefit from this. Costs of change include training, adoption, integration and process change. Never underestimate the hassle factor in sustaining the status quo. We tend to prefer the easy over the best. Whilst real, these are all negative: reasons not to change but not meaningful reasons to stay. The greater the pressure on your customers’ costs the more these factors fade.
Positive reasons for change are primarily twofold.
The first, and I believe the most critical and influential is the recognition of the measurable value customers achieve from using your products and services. This operates on two levels: the measurable value achieved by the key roles you serve and how these benefits aggregate to achieve a measurable business impact, Not all will be financial. The important point is that they must be identifiable and of real importance to the individuals and the business.
Not all elements of value will be a direct result of your product. If you are on your game, you will be providing help, data and guidance on the broader issues of improving the domain of business you work in. This position of trusted advisor amplifies the value your product delivers. Beware; though this broader value is important, its impact wanes in the absence of measurable value attributable to using your product.
Rebalancing the see-saw
The financial situation has shifted the balance, increasing the focus and importance on the measurable value you deliver. If you cannot reliably and repeatedly prove, to the satisfaction of the key roles you serve (which will increasingly include your customer’s CFO) you are on the “potential savings” list.
I have been doing, advocating for and helping companies identify and report the measurable value they deliver for many years. Still, only a small number of CS leaders include measurable customer value as one of their KPIs. Do you? The tiny number that do is frankly staggering and a blight on the discipline. It’s a bit like a sprinter who doesn’t measure their times, relying instead on relevant but indirect measures like stride length, knee lift and arm cadence. They all contribute to performance but do not measure performance of what matters most – who wins. Too many in CS are happy to stick what they can measure – adoption, relationship strength customer health rather than what they must measure: what measurable value are customers achieving.
Let’s be clear, if you cannot show measurable value to your customer’s decision makers (which will increasingly include the CFO) and key users you will be in trouble. Key users are important because, if they can show they are achieving measurable value in the context of their role, they will advocate for you and you may well need all the help you can get.
The privilege of leadership
If you are not able to answer or not actively working on these two questions you are failing the people you lead. They rely on you to make their case for continued employment; to guide them on how to focus on the right things. When conditions change, it is the leaders job to lead, to adapt working practices and focus to what the changed situations demand.
Having lead a B2B SaaS company through previous financial crises, I can tell you it will be tough but one thing is sure. Thinking it won’t happen to you and your team is just sticking your head in the sand. It is abrogating your responsibility as a leader. I also learned one other thing. Hard times amplify what you should have been doing all the time.