There are many great business models out there but for me you can’t beat an annuity type business. Finding a customer once and having them pay you every month or year seems like the only business worth being in. I see many small business owners delighted with getting a big deal, just to have to start again next month from zero. Not very fun. Annuity businesses however pose their own set of challenges,especially in the “scale-up” stage and of all these challenges, customer churn is probably the most pervasive.
Churn is the slow killer or “enemy of scale” of any recurring revenue based business and unfortunately it is unavoidable. At one stage or other, a percentage of your customers will:
- Move to a competitor
- Close their business
- Not value your product any more
Churn is slightly painful in the early years of a business, but potentially debilitating as a business matures. As a business owner, it can feel like you are on a customer treadmill, welcoming new customers just as quickly as you are waving farewell to old ones.
We approached churn, how I think most other companies approach it, by investing heavily in marketing and sales . The logic being, if you can keep feeding the business with more and more customers, churn becomes less and less significant.
The problem with this approach however, is that you can never outrun the effect of churn. You can delay the impact but never outrun it. This is why:
Most sales and marketing activities are independent of your current customer base whereas churn is a function of it. Let me explain:
Let’s say you have a customer base of 1000 customers who pay you a set amount each month. Now let’s assume that your current customer generation tactics (sales reps, online and offline marketing) bring in 30 new customers every month. You calculate that you have a churn rate of around 3% per month (i.e. you are losing +- 30 customers per month) which means your business is stagnating and not growing at all (30 customers are added each month and 30 customers are leaving you each month).
Most companies at this point (like we did) then turn to sales to increase their net numbers. Let’s assume that after much hard work the company figures out how to bring in 60 new customers per month, instead of at the current rate of 30. It seems like the problem is now fixed and the company starts to grow again. The problem with this approach is that your churn catches up to you again as your customer base continues to grow. In this example the growth ceases to exist when the customer base reaches 2000, as the 3% churn rate again equates to the 60 new customers added each month.
This cycle repeats again and again, until the company is no longer able to figure out how to keep adding additional customers each month. This typically happens far quicker than one can imagine as coming up with new sales approaches consistently becomes a near impossible task and eventually stagnation inevitably sets in.
So what is the solution? The ONLY solution to combat the nasty effects of churn is investing in a sales engine which too is a function of the number of customers in your customer base — Enter, negative churn. Negative Churn is an increase in revenue which occurs when the change in revenue within an installed base of customers is net positive from one period to the next ; or in English — Negative churn is the opposite of churn. i.e. Each month your CURRENT customers generate more revenue than they did the month before either by buying extra goods or services or by referring new customers to your business.
There are a number of ways to get your current customers to refer new ones but from my experience the best way (and most long lasting way) is to invest in product.
Investing in product means making sure your customers don’t only enjoy using your product but they can’t live without it. The successful outcome of investing in product is the creation of a remarkable product. i.e. a product worthy of remark — A product good enough that it makes customers go out of their way and tell their friends.
Striving for a remarkable product might seem airy fairy but it is the only way to truly grow over the long term AND it is 100% measurable. You will know you have achieved a sufficiently remarkable product when your customers referral rate equals or is greater than your products churn rate. So in the example above, an ideal minimum acquisition rate is achieved when you are adding 3% or more new customers purely from customer referrals. The side-benefit of investing in a remarkable product of course is that your churn rate is likely to go down in the process as well.
So the goal, once you reach critical mass in your business is to go through a paradigm shift and no longer separate product design and marketing but rather embrace the fact that the best form of marketing is actually product-design.
There are many examples of companies that have grown exponentially at the beginning by great marketing alone but almost no cases of companies who have continued this trajectory without having an amazing product.