How to Reduce Customer Churn in Cloud Computing Executive Summary

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)
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can be defined accordingly:
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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%
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annual customer retention. Private Escapes, a leader in luxury travel, had a retention
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rate of 96%, and PeopleNet, a hosted time and attendance tracking software developer
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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
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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
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2011 which they attributed to iPhone challenges, network performance, and
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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
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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
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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
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business.
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A Service Loyalty Model
Service Excellence Partners studied customer loyalty in many different industries. We
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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.
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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.
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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.
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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
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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.
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