Subscription Businesses: Should You Focus on Acquisition or Churn
February 5, 2021 by: Trevor Murphy
Grow Revenue and Reduce Churn
For all subscription businesses, there are two constants: battling acquisition costs and battling churn. Your success or failure with these falls above the gross margin line, and so they scale with your business and constitute among the most important places to put your time, money, and effort to grow a successful business.
Growing your customer subscription base is not something anyone needs to be encouraged to do – it’s directly tied to revenue, which is the metric that rules them all, and where we all instinctively focus. This is why when there’s a suggestion to put effort into churn reduction, it’s hard to allocate that time or money away from acquisition, even if you agree churn is important. That response is appropriate in some, but not in all cases.
Acquisition Cost and Lifetime Value
Consider a business in a steady state. You’ve plateaued. Let’s say you have $1M in MRR (monthly recurring revenue), about 10% monthly churn, and an LTV/CAC (lifetime value divided by the cost of acquisition) ratio of about 4. With customers sticking around for about 12 months, it’s taking you 4 months to recoup your acquisition cost. That means that if you throw a new dollar into your sales and marketing efforts, it’s going to take about three months to get it back.
Moreover, and this is even more true now (early 2021), acquisition costs are rising, and you’re spending additional time and effort on optimizing your flow just to maintain that 3x.
Reduce Involuntary Churn
So you turn to your churn. What would it mean if you were to reduce your churn? You might currently practice some outbound dialing and/or automated credit card recovery using your billing system’s decline recovery system. This has brought your net churn to 10%. That means you need $100k in new MRR to replace what’s falling out the bottom each month.
At this point, your Customer Service team is experienced and able to replace your customer cancellation with saved sales or expansion revenue on the existing client base. The 10% churn that remains is primarily involuntary, caused by credit card declines. And on this, you’ve already done your best.
The Lifetime Value (LTV) of Involuntary Churn
What if you were able to recover 40% of that $100k using a third party? That would be $40k per month in additional revenue with about $10k in fees paid to the decline salvage company, which leaves you $30k in net new revenue. That would effectively yield an LTV/CAC ratio of 4 – that looks a lot like the economics of customer acquisition in approximately the same ratios. There is one key difference.
When you acquire a new customer, it takes you 4 months to cover your CAC and then another 9 months to get all your LTV. With decline salvage, you start getting your LTV on day 0 since the CAC is a quarter rather than three times the amount of the bill. If that were how your customer acquisition worked, you wouldn’t pause for a second to put all your effort into an initiative with those kinds of returns.
In the chart below, we describe two scenarios:
In the first, you pay your $30 CAC and then wait 12 months to get it all back for your 4x LTV/CAC. This is how you are acquiring presently. In the second scenario, you put your effort into decline salvage for one month and recover 30% of your declines. You then take the cash from the recovered revenue and use it to finance a much larger marketing spend in the second month. The model follows the flow for the next 10 months.
In the acquisition scenario, you end up with $120 more in revenue and $90 in contribution margin. In the second scenario, you end up with $560 more in revenue and $410 in contribution margin. You’re now leveraging a gross inefficiency of your business model above the gross margin line. Once you have your decline salvage squared away and running smoothly, you can revert to your previous pattern of growing revenue. Because any money saved above the gross margin line can be converted to CAC dollars almost immediately, it is almost always better to make those efforts first.
Does this pique your interest? We want to help you understand how reducing involuntary churn benefits your business. Contact our team to discover how we can help your business with payment recovery (i.e. decline salvage).