The Economics of Customer Success Part One
When listening in on conversations about Customer Success you will often hear a wide variety of perspectives and opinions on exactly what it is, when it began, and why it is important. In a nascent profession such as Customer Success, this diversity of perspectives shouldn’t come as a huge surprise, as a matter of fact, it is probably a good thing, We are, after all, an evolving profession. What follows is yet another opinion, one that isn’t intended to answer all of these questions, but rather provide some insight from a financial perspective. One that hopefully contributes to the ongoing dialogue.
What is Customer Success? – The Financial Perspective
This breadth of perspectives results from, at least in part, the fact that many people feel they have been working in Customer Success for decades, while others believe the field has only been around for a little more than ten years. One answer to this dilemma is to consider that both of these perspectives are true and that what we have seen is a major evolution in Customers Success. I hate the whole “2.0” thing, but for lack of a better description, I think what we have seen is the emergence of Customer Success 2.0. I’m not sure of the exact date, but I believe that one of the inflection points that at the very least influenced the “evolution” of Customer Success, can be traced back to an event in the spring of 2005. It happened about a year after Salesforce’s IPO in June of 2004. In 2005 their valuation was ~$500M… today it is over $100 B. Clearly a great run, but what does this have to do with Customer Success? The answer is that Customer Success was a huge contributor to this, and I’m not the only one. In an Inc. article written by Matt Given titled, The One Word That Saved Salesforce From Certain Doom, he declared that the one word was churn. Matt’s point was that “Churn” was a wake-up call… and that Customer Success was the answer that enabled Salesforce to be what it is today.
This wake-up call came at an SFDC executive offsite. In the spring of 2005, a person named David “Doomsday” Dempsey announced that Salesforce’s churn was ~ 8% a month. That’s a little more than 63% churn in a year! This revelation was the trigger for a series of events that followed which are extremely relevant to Customer Success. As the story goes Salesforce embraced and responded to the challenge, making the commitment to turn this around by focusing the company on making their customers successful. This event and the focus on churn that followed was a milestone in the evolution of Customer Success and had a huge impact, not only to Salesforce but in many ways to all SaaS companies. The event, however, is not the whole store, but rather a contributing factor to what we call today, Customer Success. As for the momentum that has carried the profession forward, we must consider the role of investors, of VCs, and the leverage they have across our industry. Think about it, we all talk about the fact that investors are often the driving force behind the creation of Customer Success organizations. As for the reason, in part, it can be attributed to their pursuit of exponential growth and the associated mind-boggling returns… The sort of event that VCs live for, one like another Salesforce!
Based on this perspective, an argument could be made that the Customer Success team is the most important organization in a well-run company. A perspective that, as you know, is not shared by everyone. We can point the finger for this in a lot of different directions, but in large part I believe it is because we haven’t lived up to our potential. Clearly there are other factors, but the one that is most easily addressed by us, the one under our control, is us. As in most things, the way to live up to your potential, to be recognized as a force impacting the future of the company, is to earn it. So how does the Customer Success team you want to build or be part of “earn it”? By not only getting a “seat at the table” but making sure you also have a “voice at the table”, and this influence is a function of the language you speak. At “the table” the language of influence is numbers, financial numbers. The great thing is that the language of financials is not always as well understood by others at the table, as you might believe. This can be to your advantage but it depends on your ability to achieve some level of fluency in the language of financials. Of course, this is the CFO’s native language, but this, in reality, is to your advantage as well. As it stands today (and for the foreseeable future) the CFO’s voice will be heard and acted upon. This is one more reason to learn the language, the CFO in many ways can be your greatest advocate, and in reality, because of the value Customer Success brings, you should be their greatest asset. To understand where the financial conversation should begin, we’ll go back to Salesforce and take a look at some very important numbers, numbers that are foundational to understand how Customer Success as a profession is evolving.
To understand where to initially focus, take a look at the figure to the right. It shows Salesforce’s Customer Acquisition Cost (CAC) ratio relative to its market capitalization. At first glance, it makes absolutely no sense, they were burning through a ton of cash to acquire customers and their stock price was growing exponentially… so what gives? The answer is tied to customer success. In 2007 when customer success at Salesforce was about 2 years old, it had begun to show solid results relative to churn. This enabled Salesforce to get extremely aggressive in the amount they spent to acquire new customers. In 2007 the spent $1.39 for $1.00 of new revenue, and that ratio continued to go up. Through the financial crisis of 2008 Marc never wavered, spending approximately $1.71 for $1.00 of new customer revenue, and as the economy began to show some life, this number soared to over $2.50.
As you have probably guessed, their aggressive acquisition of new customers was enabled by their newfound ability to keep them, and this drove their Customer Lifetime Value (LTV) up, while also driving the cost of their revenue down. Bottom line (or in reality top line), the amount of money they were willing (and able) to spend to acquire new customers was the direct result of Customer Success!
So fast forward to 2019…
Was Salesforce’s aggressive spending an anomaly, was it just a function of a different time and place? Actually, it was not… To get a sense for CAC ratios for SaaS companies today, take a look at the Pacific Crest Securities 2017 Private SaaS Company Survey results to the left. You’ll see that the median CAC ratio is $1.15 for the ~200 SaaS companies surveyed. This number is up 2% from the previous years so high CAC ratios are not receiving a lot of downward pressure. Of course, there are companies with a CAC ratio <$1.00, but with the median at $1.15 and the 25th percentile at $1.65 spending more than a dollar for a dollar of revenue is clearly not the exception. So who is right? Will the companies spending more than $3.00 become icons of the industry, or are the companies that spend <$0.25 better off? If you ask the question only in the context of CAC ratios, you will often hear it said that SaaS companies should have a CAC ratio of $1.00 but does that mean we can declare the $1/$1 companies the winners? Are they the companies with the brightest future? The answer of course is… It depends. To gain better insight we need to look at another, you guessed it, financial ratio. It considers both LTV and CAC, namely the LTV to CAC ratio or LTV:CAC. Although there is no magic number that guarantees success, having an LTV:CAC ratio that is about 3, is a much better indicator of a healthy company than CAC alone. Using this ratio also provides insight as you move away from a ratio of 3. The assumptions regarding a deviation from 3 are fairly intuitive. If your LTV:CAC ratio is around 1, you’re burning capital. This can be a sign that your product is really hard to sell (not a good thing) or your customers don’t hang around for long (not a good thing either). Regardless of how you get to this number if your LTV:CAC ratio is ~1 you’re burning way too much capital and getting more may be really challenging. On the other hand, when you see an LTV:CAC ratio of 5, you’re probably loosing out on a growth opportunity. Clearly, the ideal situation would be one where your LTV is so healthy that you can afford to spend more aggressively to grow your customer base and your business. Although these ratios are obviously not the only numbers that matter, having a high LTV is clearly extremely important to your company. Since this is a fact, and because Customer Success drives LTV, your CS organization and its potential to impact the company’s financials, makes Customer Success extremely important too.