Last week we added Gross Margins to our ever growing SaaSy Math resource page. Gross Margin is a widely used and reported metric, but to truly understand take home profits in the SaaS/Subscription business model we need to take our analysis to the next degree, Retention Margin. Because the subscription business model means customers can (more) freely come and go, subscription startups are in a constant battle to retain these customers (Think Jon Snow in the Battle of the Bastards). Retention margin is the percentage of revenue left after your CORS (gross margins) plus subtracting out your cost to retain a customer (Customer Service, Success, and Marketing) are taken off of your top-line revenue. We will also examine what retention margins analysis across customer segments can help us understand about our customer base.
Retention margin is important to understand across customer segments similar to CAC because it could reveal customer segments that are “leaky buckets”, or simply, they cost more to keep as a customer than is worth the revenue they generate. Similar to our LTV:CAC ratio, you want to try and understand your retention revenue (customer revenue x retention margin) CAC payback period to make sure that what appear to be high paying customers aren’t costing you so much to retain that they actually could put the business in the red. Below is an example of how retention margins can impact your revenue analysis:
As you can see in the above area the the customer with the shorter CAC payback period changes when you factor retention margins into your analysis. While Customer A has higher MRR and on top-line revenue looks to have a more attractive CAC payback, what if they submit a bunch more service tickets and spend a lot more time with your customer success and service team which comes at a cost to you? With an 18% lower retention margin, Customer A actually takes longer to payback its CAC than Customer B despite Customer B’s lower MRR number. While a lower CAC payback doesn’t always mean a better customer segment, this is an example of how incorporating retention margins can change the picture of your customer analysis and can provide more context as to how different customer segments are behaving.
Calculating retention margin is similar to CAC, just looking at Customer Success, Service and Marketing cost (instead of sales and marketing) over a given time period and finding the average number of customers you had each month for that same time period. The formula you want to use is as follows:
Retention Margin = Top-line Revenue / (Gross Revenue (Revenue - CORS) - Service Cost - Success Cost - Marketing Cost)
To find these costs, similar to CAC, you can take financial data to calculate the cost of payroll and other expenses for your Success and Service teams as well as customer marketing spend and plug them into the formula above. You should already have your Gross Margins calculated, if not you can refer to our SaaSy Math resource to find that formula. One way to help find problematic customer segments is to analyze the Gross-Retention Gap, or the difference between Gross Margins and Retention Margins for each customer segment. When you look at these gaps you can look to see if their is a segment that has a gross margin similar to other segments with a huge gross-retention gap resulting in a low retention margin. This is the result of higher service and success costs typically meaning that this customer segments submits high numbers of service tickets and might be struggling to use your product or service and you might not have product-market fit with this particular group. Segments with a high gross-retention gap might be worth an additional product usage breakdown to understand what is going on.
With retention margins you can more accurately understand your profitability as well as find the segments of customer that may be negatively impacting your business. We hope that this can be used as a resource to help you find your retention margins and if you have any questions on how to find your retention margins feel free to reach out to us on the contact page and we would be happy to help. This article was meant to start the conversation around retention margins and we ill be adding all of the formula’s and definitions to our SaaSy Math page for future access and use if you want to use them as a resource.