Customer Segmentation, Why It Matters

Written by
Ross Andrewsarrow icon

Customer Segmentation, Why It Matters

Written by
Ross Andrews

Customer segmentation is a vital, yet often overlooked way for startups to better understand their growth. Startups typically don't have the best economics early or as they scale, which is fine if you have the right information in place to help find operating leverage as you scale so that you can turn on profitability and drive sustainable growth. Today we have an example to show you how this works.

We have the pleasure of a SaaS Founder graciously sharing their data with us to make this demonstration possible. The company will remain anonymous and we have roughly 4x'd all their metrics so while this breakdown is real (and one we actually conducted with the founder), the actual numbers are not representational of their business. Let's get into it.

Here is a breakdown of the revenue and economics of their entire business with their customers segments (we focus on industry segmentation since that was what we found to me most operationally relevant for the business):

Let's start all the way over on the right hand "Total" column. This is the equivalent of the entire business, all of the revenue and customers blended together which is how founders report their metrics the majority of the time (and I don't blame them, I'll explain why in a second). From the "blended" metrics we can see this company doing about $1.7M in MRR (~$20M in ARR). Overall it is a decently strong company with a 75.6% overall retention margin, but if we break apart their revenue, we can find that it is not all created equally.

For this company, industry segmentation was the most telling. At first, we can see that the majority of their monthly revenue (52%) is concentrated in one of their customer segments, Technology, and Software companies. Those customers actually have an “average” retention margin (75%, the same as the company average). But when you look at the Net Revenue Retention and the Cost Per Recurring Retention Profit Dollar (CRRPD is a metric that measures the $ efficiency of SaaS companies, it is equal to the amount fo money they need to spend to generate $1 of retention profit) these metrics are easily the strongest of any cohort that the company has. On a per-dollar basis, the revenue is actually profitable month over month.

Now, if you look across the bottom row, you can see that across the other customer segments, only one other (Real Estate, 11% of MRR) is barely profitable on a dollar basis, unfortunately the revenue retention isn't great. What is interesting here is the Education and Manufacturing segments. If you look at the economics and revenue both these customer segments show promise for sustainable growth. First, Real Estate has above average retention margins and on a per dollar basis is almost break-even, month over month. Manufacturing is also and interesting segment, strong retention margins and net revenue retention. Their CRRPD ($1.59) isn't as strong as Real Estate, but with strong revenue retention and healthy margins means that there is potential to drive stronger unit-economics.

So why does this all matter you might be asking? Well, let’s say your the founder of this company and you want to raise capital to help fund growth. Traditionally, you went to VCs and sold them equity on growth and anticipated growth. But if we take the breakdown above, what if we used the really health and strong revenue stream from the Technology segment, to borrow against? You can take a revenue-based loan, cashflow advance, or other debt-based vehicles against that healthy revenue and then using that working capital to help drive growth.

If you acquire more Technology customers, you will continue to build that health revenue and increase your borrowing capability. You can also use the working capital that you borrow to invest in strategic initiatives to improve the economics and retention of the Real Estate or Manufacturing segments. If you only report blended, company-level metrics, these operational insights and the ability to borrow non-equity capital won’t present themselves.

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