Calculating Your Customer Retention Budget With This One Simple Trick
How much should you be spending on your customer retention and expansion program? It is a basic and important question for any organization with subscription-based revenue. The output is simple but the generation of the inputs for the calculation can be more art than science. As is often the case in business, the accuracy of your assumptions and predictive variables are what make a decision good, bad or disastrous. Let’s discuss!
One Simple Trick!
(S × ▲N) ÷ (R - 1) = B
Simple is relative, let’s start there. The above formula is not attempting to prove the existence of dark matter, it is just a few numbers you can probably pull or estimate yourself.
S represents your Subscription Net Income
For those who aren’t in the know, SNI is calculated by removing costs of goods, operating expenses, and taxes from the total revenue generated from subscription contracts over a set period of time.
N serves as the estimated change to your Net Retention Rate brought on by additional investment in that area. More on this later.
R stands for the desired ROI (Return On Investment) for your retention spend.
B is your Budget to spend on customer retention
As an example, let’s say your annual SNI is $1 million. You want to see how much you can spend to increase your NRR from 2% to 4% while achieving an ROI of 20%. That looks like the below:
($1,000,000(.1-.08))(.2+1)= $16,666.67
Of course, you can use this formula in the reverse as well. If you have a set budget and want to see how much you need to improve your NRR to justify the spend, that would look like:
B × (R+1) ÷ S = ▲N
I have created a spreadsheet with these formulae embedded if you’d like to download it and try it out yourself: TCR-Customer Retention Budget Calculator
Calculating an Assumed Improvement to NRR
As I laid out in my opening statements, the difficulty does not lie in the calculation, but rather in the estimation of a reasonable expectation of NRR improvement per dollar spent. There is no magic bullet for this. I would argue that there aren’t even any standard guidelines. We can, however, make some reasonable assumptions to narrow the target area.
Assumption #1: Spending too little on customer retention/expansion will not affect NRR. A simple thought experiment can prove this. Assume you had a budget of $10 to improve a company’s NRR. Would you be able to do so? No, of course not. How about with $50? $1,000? You get the picture. There is a minimum amount in a budget to have any effect at all.
Assumption #2: Spending just enough money to improve your NRR by the smallest measure possible will not allow the investment to achieve a positive ROI. In other words, if you are just barely increasing NRR, you will be spending more money than the increase to NRR will generate.
Assumption #3: The law of diminishing returns will reduce the per-dollar-spent increase to NRR to the point where additional spending will no longer be profitable. Again, we can use a thought experiment in the extreme to prove this point. If, for example, your budget for retention and expansion is equal to revenue, that is clearly and obviously too much to spend for a viable business, all other factors being equal.
All of which to say that a customer retention and expansion budget would hypothetically look like the graph below, when compared to the benefit in NRR.
Final Thoughts
Subscription revenue is never passive, no matter how it looks from the outside. There are innumerable factors that contribute to your NRR and only some of them can be improved with time, attention and money. Navigating decisions on spend, human resource allocation, tech stack, and process development is difficult to do well without experience and expertise. Tower Customer Retention is here to provide both. Watch this space for more analysis, and head to our website for more resources, information and the ability to request a free consultation. We’re here to help.