I think for many sales-aggressive enterprise SaaS startups, a fair amount of churn actually happens at inception. For example, back in 2013, shortly after I joined Host Analytics, I discovered that there were a number of deals that sales had signed with customers that our professional services (PS) team had flat out refused to implement. (Huh?) Sales being sales, they found partners willing to do the implementations and simply rode over the objections of our quite qualified PS team.
When I asked our generally sales-supportive PS team why they refused to do these implementations, they said, “because there was a 0% chance that the customer could be successful.” And they, of course, were right. 100% of those customers failed in implementation and 100% of them churned.
I call this “inception churn,” because it’s churn that’s effectively built-in from inception — the customer is sent, along with a partner, on a doomed journey to solve a problem that the system was never designed to solve. Sales may be in optimistic denial. Pre-sales consulting knows deep down that there’s a problem, but doesn’t want to admit it — after all, they usually work in the Sales team. Professional services can see the upcoming trainwreck but doesn’t know how to stop it so they are either forced to try and catch the falling anvil or, better yet, duck out and a let partner — particularly a new one who doesn’t know any better — try to do so themselves.
In startups that are largely driven by short-term, sales-oriented metrics, there will always be the temptation to take a high-risk deal today, live to fight another day, and hope that someone can make it work before it renews. This problem is compounded when customers sign two- or three-year deals [1] because the eventual day of reckoning is pushed into the distant future, perhaps beyond the mean survival expectation of the chief revenue officer (CRO) [2].
Quality startups simply cannot allow these deals to happen:
- They burn money because you don’t earn back your CAC. If your customer acquisition cost ratio is 1.5 and your gross margins are 75%, it takes you two years simply to breakeven on the cost of sale. When a 100-unit customer fails to renew after one year, you spent 175 units [3], receive 100 units, and thus have lost 75 units on the transaction — not even looking at G&A costs.
- They burn money in professional services. Let’s say your PS can’t refuse to the implementation. You take a 100-unit customer, sell them 75 units of PS to do the implementation, probably spend 150 units of PS trying to get the doomed project to succeed, eventually fail, and lose another 75 units in PS. (And that’s only if they actually pay you for the first 75.) So on a 100-unit sale, you are now down 150 to 225 units.
- They destroy your reputation in the market. SaaS startup markets are small. Even if the eventual TAM is large, the early market is small in the sense that you are probably selling to a close-knit group of professionals, all in the same geography, all doing the same job. They read the same blogs. They talk to the same analysts and consultants. They meet each other at periodic conferences and cocktail parties. You burn one of these people and they’re going to tell their friends — either via these old-school methods over drinks or via more modern methods such as social media platforms (e.g., Twitter) or software review sites (e.g., G2).
- They burn out your professional services and customer success teams. Your PS consultants get burned out trying to make the system do something they know it wasn’t designed to do. Your customer success managers (CSMs) get tired of being handed customers who are DOA (dead on arrival) where there’s virtually zero chance of avoiding churn.
- They wreck your SaaS metrics and put future financings in danger. These deals drive up your churn rate, reduce your expansion rate, and reduce your customer lifetime value. If you mix enough of them into an otherwise-healthy SaaS business, it starts looking sick real fast.
So what can we do about all this? Clearly, some sort of check-and-balance is needed, but what?
- Pay salespeople on the renewal, so they care if the customer is successful? Maybe this could work, but most companies want to keep salespeople focused on new sales.
- Pay the CRO on renewal, so he/she keeps an honest eye on sales and sales management? This might help, but again, if a CRO is missing new sales targets, he/she is probably in a lot more trouble than missing renewals — especially if he/she can pin the renewal failures on the product, professional services, or partners.
- Separate the CRO and CCO (Chief Customer Officer) jobs as two independent direct reports to the CEO. I am a big believer in this because now you have a powerful, independent voice representing customer success and renewals outside of the sales team. This is a great structure, but it only tells you about the problems after, sometimes quarters or years after, they occur. You need a process that tells you about them before they occur.
The Prospective Customer Success Review Committee
Detecting and stopping inception churn is hard, because there is so much pressure on new sales in startups and I’m proposing to literally create the normally fictitious “sales prevention team” — which is how sales sometimes refers to corporate in general, making corporate the butt of many jokes. More precisely, however, I’m saying to create the bad sales prevention team.
To do so, I’m taking an idea from Japanese manufacturing, the Andon Cord, and attaching a committee to it [4]. The Andon Cord is a cord that runs the length of an assembly line that gives the power to anyone working along the line to stop it in order to address problems. If you see a car where the dashboard is not properly installed, rather than letting it just move down the line, you can pull the cord, stop the line, and get the problem fixed upstream, rather than hoping QA finds it later or shipping a defective product to a customer.
To prevent inception churn, we need two things:
- A group of people who can look holistically at a high-risk deal and decide if it’s worth taking. I call that group the Prospective Customer Success Review Committee (the PCSRC). It should have high-level members from sales, presales, professional services, customer success, and finance.
- And a means of flagging a deal for review by that committee — that’s the Andon Cord idea. You need to let everyone who works on deals know that there is a mechanism (e.g., an email list, a field in SFDC) by which they can flag a deal for PCSRC review. Your typical flaggers will be in either pre-sales or post-sales consulting.
I know there are lots of potential problems with this. The committee might fail to do its job and yield to pressure to always say yes. Worse, sales can start to punish those who flag deals such that suspect deals are never flagged and/or that people feel they need an anonymous way to flag them [5]. But these are manageable problems in a healthy culture.
Moreover, simply calling the group together to talk about high-risk deals has two, potentially non-obvious, benefits:
- In some cases, lower risk alternatives can be proposed and presented back to the customer, to get the deal more into the known success envelope.
- In other cases, sales will simply stop working on bad deals early, knowing that they’ll likely end up in the PCSRC. In many ways, I think this the actual success metric — the number of deals that we not only didn’t sign, but where we stopped work early, because we knew the customer had little to no chance of success.
I don’t claim to have either fully deployed or been 100% successful with this concept. I do know we made great strides in reducing inception churn at Host and I think this was part of it. But I’m also happy to hear your ideas on either approaching the problem from scratch and/or improving on the basic framework I’ve started here.
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Notes
[1] Especially if they are prepaid.
[2] If CROs last on average only 19 to 26 months, then how much does a potentially struggling CRO actually care about a high-risk deal that’s going to renew in 24 months?
[3] 150 units in S&M to acquire them and 25 units in cost of goods sold to support their operations.
[4] I can’t claim to have gotten this idea working at more than 30-40% at Host. For example, I’m pretty sure you could find people at the company who didn’t know about the PCSR committee or the Andon Cord idea; i.e., we never got it fully ingrained. However, we did have success in reducing inception churn and I’m a believer that success in such matters is subtle. We shouldn’t measure success by how many deals we reject at the meeting, but instead by how much we reduce inception churn by not signing deals that we never should have been signed.
[5] Anonymous can work if it needs to. But I hope in your company it wouldn’t be required.
