How to Reduce Customer Churn in Cloud Computing By Ed Powers, Principal, Service Excellence Partners Executive Summary Cloud computing (SaaS, PaaS, IaaS, Managed Service Provider) firms often suffer significant customer turnover. Churn rates of 1% to 2% per month are common, some as high as 10%. Defecting customers cost millions of dollars in lost revenue. While 100% customer retention is not practical or even desirable, top service organizations in other industries enjoy a much lower monthly churn of 0.3% to 0.6%, which creates more referrals, increases sales, and lowers customer acquisition costs. Cloud computing firms operating at this level of performance could increase profitability per customer six fold. Decreasing customer churn isn’t about forming new departments, implementing loyalty incentives, or buying trendy technologies. It requires decisions and actions in many areas, including planning, finance, development, marketing, sales, operations, and customer care. This paper describes a customer loyalty model and a strategic approach to addressing customer churn. Cloud computing firms adapting practices from top-performing service organizations will retain more customers, boost revenue, and create a sustainable competitive advantage. Cloud computing firms operating at this level of performance could increase profitability per customer six fold. The Churn Problem Surprisingly, there is no standard calculation for customer churn. People use different measurement windows, include or exclude customers that join or leave during the period, separate the data by type of churn (voluntary or involuntary), use recurring revenue instead of subscriber numbers, prefer weighted factors, or choose denominators with either the beginning, ending, or average customer count over the term. For purposes of this paper, simplicity is preferred. We will therefore define: This definition excludes any customers added during the year. For example, a SaaS company has 1,000 customers on January 1, and of these, 200 canceled their subscriptions as of December 31, making the annual churn 20% (200/1,000). The average monthly churn is then roughly 1.7% (20%/12). Once again, companies may favor other calculations for other purposes, but gross, relative performance is sufficient for the analysis that follows. Churn has a significant impact on revenue and profitability. Customer Lifetime Value (CLTV) 1 can be defined accordingly: © 2012 Service Excellence Partners Page 1 CLTV = Average Lifetime of a Customer X (MRR − Monthly Cost to Serve) Where: MRR = Monthly Recurring Revenue Company profitability is closely tied to per-customer profitability when sales and marketing costs are included: Customer profitability = CLTV − CAC or Customer Acquisition Costs. Obviously, if CLTV is equal to or less than CAC, the company has a problem. The Average Lifetime of a Customer is equal to 1/Churn, so cutting churn rate in half doubles CLTV and per-customer profitability. Recognizing this leads to a powerful conclusion: even small reductions in churn can make a big difference. That said, not all churn is bad. Some customers buy a product or service even though it is a poor fit for their needs. Some consume a disproportionate share of support resources and are too costly to serve. Some demand unrealistic performance, are abusive or difficult, or conduct illegal activities. Consequently, a small churn percentage will always be present. A 2% average monthly churn means that a cloud computing company retains 76% of customers annually. In the insurance industry, the top five firms have 93% to 95% 2 annual customer retention. Private Escapes, a leader in luxury travel, had a retention 3 rate of 96%, and PeopleNet, a hosted time and attendance tracking software developer 4 for the staffing industry, reports 98%. For many, an improvement opportunity exists. If the company referenced above reached these levels of customer loyalty, it would increase per-customer profitability by a factor of six. And that does not include additional revenue and lower CAC from the 25% to 40% of new sales referred by delighted 5 customers. Causes of Churn Poor customer service is a major factor that leads to churn in any industry. Reasons for customer churn vary by market and company. For example, AT&T’s wireless business experienced an average churn of 1.39% during its fourth quarter 6 2011 which they attributed to iPhone challenges, network performance, and 7 customer service problems. In the banking industry, significant churn lately has been due to the widespread introduction of new consumer fees. Chase Bank estimated that 15% of its customers would no longer qualify for free checking and stated that, “Based on current attrition rates, we expect 50% to 60% of these 8 customers to leave Chase within the next year.” Customer churn in the SaaS business can be due to many factors. Sometimes customer defection is caused by offerings lacking basic customer value or inadequate differentiation, coupled with the relative ease and low cost of changing subscribers. In other cases, poor system reliability is the culprit. Some cloud companies haven’t embraced the fact that because of recurring revenue models, theirs is a service business, not a product business. Customer expectations are much different when it comes to services compared with products. Generally, poor 9 customer service is a major factor that leads to churn in any industry, and at least one influential venture capitalist asserts it is the primary cause in the SaaS 10 business. © 2012 Service Excellence Partners Page 2 A Service Loyalty Model Service Excellence Partners studied customer loyalty in many different industries. We 11 found that customer churn is attributed to shortcomings in delivering certain benefit types: Implicit. The customer learns the service is missing a basic feature or lacks performance they normally take for granted. For example, a cell phone service that drops calls, an insurance claim denial, or a cold cup of gourmet coffee. When obvious expectations go unmet, customers have the greatest dissatisfaction and are most likely to churn. Explicit. The customer realizes a specific promise made in the sales process regarding features, performance, or cost is not being kept. For example, an outsourcer falls short on service level agreements, an appliance repair bill is much higher than quoted, or a new restaurant doesn’t live up to its hype. The customer may not return if the issue is severe and the dissatisfaction high enough. If a competitor promises comparable benefits, and changing providers is simple and cheap, potential for churn grows. Experiential. The customer discovers a mediocre ongoing relationship with the supplier. For example, an unhelpful agent at a call center, a salesperson who only reaches out when selling something, or a painter who tracks mud into the house. Even though the service meets specifications, customers churn when they feel ignored, devalued, or treated unfairly by the company or its employees. Companies must address all three benefit types in a holistic manner to achieve high loyalty. Many cloud companies have created Customer Success Management functions assigned to reduce churn. Delivering a positive customer onboarding experience, maintaining periodic contact, facilitating renewals and upselling are good steps. However, many CSM activities treat symptoms, not underlying causes. Creating loyal customers, like improving enterprise quality, requires leadership from the top and often a change in the way the company operates. All functions—development, marketing, sales, and service—contribute to customer loyalty. There are no shortcuts to excellence. Meeting implicit customer expectations requires little explanation. In the cloud business, customers expect companies to deliver computing capabilities reliably and securely, regardless of the technical challenges. When customers have problems, they assume they will receive a minimum level customer service and support. Companies can solve many problems in system reliability or service just by doing simple things. Companies can also apply common process improvement techniques to systematically improve operations. 12 Meeting explicit benefits means living up to the product’s “value proposition.” A wellcrafted value proposition explicitly defines target customers, benefits, and costs. Many start-ups arrive at their value propositions through experimentation, but in the end superior value propositions emerge from good market segmentation, competitive analysis, and product definition. When the company deploys, communicates, and manages its value proposition through processes, metrics, technologies, staffing, and partnerships, it increases market distinction and gives customers few reasons to look elsewhere. Value propositions are therefore strategic, not tactical, constructs which affect every area of the business. Customer churn is attributed to shortcomings in delivering certain benefit types. © 2012 Service Excellence Partners Page 3 Customer satisfaction comes from fulfilling implicit and explicit benefits. Earning customer loyalty, on the other hand, takes a commitment to greater experiential benefits. It’s the human touch that makes the difference. Many companies understand this, improving in customer interfaces, account management, and onboarding of new customers. Leading service organizations focus on creating three important “moments:” Earning customer loyalty takes a commitment to greater experiential benefits. Moments of Connection. Building warm customer relationships from the outset and deepening them over time though a series of well-designed, impactful, personal interactions. Moments of “WOW.” Surprising and delighting customers by helping them discover unexpected features and benefits, and experiencing acts of kindness that leave positive and lasting impressions. Moments of Truth. Rising to the occasion when the chips are down and responding to very serious customer issues with quick, professional, and fair problem resolution. Over time, these moments create deep trust and emotional attachment which are the true causes of high customer loyalty. Experiential benefits are critical to rising above mere satisfaction. People who consistently receive implicit and explicit benefits and have superior customer experiences become raving fans. Implementing the Service Loyalty Model It sounds simple, but companies must start by analyzing why their customers leave. While many firms capture customer satisfaction and churn rate, few do a good job of collecting the information that really matters. At a minimum, companies should survey customers who cancel their services or interview former customers to ask them why they left. Analysts should then stratify data according to opportunities for improving implicit, explicit, and experiential benefits. Next, companies should address the upstream deficiencies that cause customer defections. The table below shows what improvement techniques we recommend, depending on the problem type. For example, cloud computing companies typically do a good job of developing and implementing technology. But sometimes they need to better manage strategic partnerships to raise service reliability in the computing ecosystem. While most companies market and provide their services effectively, others can struggle to create a competitive advantage and consistently deliver it. Refining the value proposition with marketing, product and service enhancements can help. Perhaps the greatest opportunity for cloud computing is improving experiential benefits. Most SaaS companies seek to minimize customer interactions in order to scale profitably. That can be a serious mistake. Believing “the product is the service” limits potential to raise customer retention because the human touch is overlooked. A better strategy is to deliver excellent experiences through a mix of efficient electronic and non-electronic means. It begins with Customer Success Management functions that onboard customers effectively and promote product usage. Companies that build on this foundation and include three moments—moments of connection, moments of “WOW,” and moments of truth—ensure maximum loyalty. Smart process designs ensure underlying drivers in customer loyalty are addressed and costs are minimized. © 2012 Service Excellence Partners Page 4 Customer Churn Reduction Strategies Customer Benefits Implicit Explicit Experiential Areas of Focus Improvement Approaches Cloud Ecosystem System Monitoring and Response Enterprise Metrics Failure Mode and Effects Analysis Technology Chain Management Business Plan Contracts Customer Support Development Marketing and Sales Satisfaction Measurement SLA Management Enterprise Metrics Lean Six Sigma Agile Development Process Management Planning and Review Value Delivery System Design Value Propositions Customer Success/Relationship Management Employee Hiring, Development, and Retention Loyalty Measurement Service Recovery Customer Experience Design Enterprise Metrics Leadership Process Performance Management Implementing process changes to enhance the customer experience can deliver immediate gains. However, far greater results occur when the organization develops new habits, making process improvement an ongoing activity. Strategic management systems provide the discipline to make new habits stick and ensure customer retention is maximized. Summary Better results come from better strategies and better processes. Cloud computing companies can significantly reduce churn by studying causes and implementing new approaches. By adapting best practices and making improvement habitual, cloud computing firms can retain more customers, generate more sales, and dramatically improve profitability. About Service Excellence Partners Led by Principal Ed Powers, Service Excellence Partners provides a unique mix of high technology, high service, and high performance for cloud computing companies. Ed has fourteen years of high technology experience in sales, marketing, quality, and operations with Hewlett-Packard and Sorcia, an ASP. He also has deep expertise in service delivery, having improved the performance of a high-touch luxury travel company to that of a recognized industry leader. Finally, Ed is an expert in strategic management systems and process improvement, with Lean Six Sigma and Baldrige National Performance Excellence credentials. Service Excellence Partners’ virtual network of 25+ year veterans specialize in IT, telephony, BPO, and computer software and hardware support businesses. © 2012 Service Excellence Partners Page 5 Notes SaaS consultant Dave Key’s adaptation of David Skok, “SaaS Metrics – A Guide to Measuring and Improving What Matters,” (Venturefizz blog: Feb 19, 2010): http://venturefizz.com/blog/saas-metrics-%E2%80%93-guide-measuringand-improving-what-matters. 2. Lynn Thomas, Customer Loyalty and Retention Primer, (self-published, 2000). 3. Private Escapes’ customer retention rates, 2004-2007. 4. PeopleNet website: http://www.peoplenet.com/why-choose-peoplenet/. 5. Private Escapes’ percentage of total sales closed from customer referrals, 2006-2007. 6. AT&T Q4 2011 results: http://www.att.com/gen/press-room?pid=22304&cdvn=news&newsarticleid=33762. 7. Victor Godinez, “AT&T Scores Lowest of Big Four Wireless Carriers in Customer Satisfaction,” (DallasNews.com, May 17, 2011): http://www.dallasnews.com/business/technology/headlines/20110517-att-scores-lowest-among-big-fourwireless-carriers-in-customer-satisfaction-report.ece. 8. “Retail Banking Industry Report: The Real Reasons Why Bank Customers Churn,” (Attensity Corporation, 2011). 9. K. Douglas Hoffman and John E.G. Bateson, Services Marketing: Concepts, Strategies and Cases, (South-Western Cengage Learning, 2011), pp. 398. 10. Skok, “SaaS Metrics – A Guide to Measuring and Improving What Matters.” 11. Adapted from Noriaki Kano, Nobuhiku Seraku, Fumio Takahashi, Shinichi Tsuji (April 1984). "Attractive Quality and Must-Be Quality" (in Japanese). Journal of the Japanese Society for Quality Control 14 (2): 39–48. ISSN 0386-8230. http://ci.nii.ac.jp/Detail/detail.do?LOCALID=ART0003570680&lang=en. 12. Michael Lanning and L. Phillips, “Building Market-Focused Organizations,” (Gemini Consulting White Paper, 1992). 1. © 2012 Service Excellence Partners Page 6
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