So far, the only startups I’ve lost money investing in had one thing in common: they had high churn in the early days
Some fought through it
But a lot never do
— Jason ✨Be Kind✨ Lemkin (@jasonlk) November 22, 2022
So in theory, SMB SaaS is better than enterprise, at least 9 times out of 10:
- Deals close much faster
- Customers don’t expect as much in terms of security, compliance, etc.
- Customers often can deploy on their own
- There is often just 1 stakeholder to sell to
- Often can avoid procurement, RFPs, and so many other headaches
- Customers don’t expect you to build a feature before they buy
- Don’t need as much sales experience on sales team
- Often will buy without even talking to anyone
- Often easier to get started here with less capital and/or if bootstrapped
- Often easier to break in as a new vendor if differentiation is super crisp and clear
- SMBs often force you to build a better product, as they lack a deployment and IT team
- Etc. etc. etc.
And importantly, there are just so, so many SMBs. 30,000,000+ of them. Or maybe it’s 15,000,000. Different counts are out there, but however many it is — it’s a lot.
But beyond all the other Pros and Cons of SMB vs enterprise, there’s one looming issue with SMB SaaS:
Endemic churn. The type of churn you almost can’t do anything about. Why?
- SMBs go out of business, and quickly. Enterprises take decades to go under.
- SMBs pay monthly, and often scrutinize every expense
- SMB owners often literally pay out of their own pocket, or feel that way
- SMBs don’t really budget for much, so if the business goes down, software purchases often go down very quickly too
Net net, most true SMB SaaS products often churn on the order of 3% per month almost no matter what you do. Almost. And we’ll get to that in a moment.
Now that makes things hard enough as you scale, but even worse, in SaaS, churn is often masked by high growth when you have early product-market fit. For example, if you are growing 13% a month in the early days, and churn is 3% a month … you’re still growing 10% a month. That can look mighty impressive. And it is.
But then what happens when you merely double new bookings, which is hard enough as it is — and churn remains 3% a month? Well, all of a sudden, you’re adding 6% a month (doubling) but losing 3% … and your growth is cut in half to 50%.
I see this again and again with fast-growing SaaS companies selling to SMBs and they know it, but they don’t change or evolve enough, or fast enough, and get caught in a Churn Trap once growth slows from top-tier rates.
Ok, so what’s to do here? A few thoughts — and then let’s look at some case studies from Bill.com, Shopify, Smartsheet, and more.
- Be honest about your churn and report it monthly and honestly. If you hide it or bury it in overall MRR growth numbers, it won’t get addressed. It will burn you somewhere between $5m-$20m ARR if you are growing quickly. Because at some point, growth slows to 100% year-over-year even at the best SaaS companies. And then 3% a month churn cuts your growth in half.
- Be relentless about building features that increase retention. Even modest impacts to churn for SMBs can have a huge impact on your business. What features are so valuable that customers don’t just buy — but they stay? I don’t see enough SaaS SMB companies relentlessly talking about the impact of new features on retention. And measuring it.
- Get better at onboarding. A lot of churn lurks in poor onboarding. This gets addressed in the enterprise with high levels of staffing. But it rarely gets enough attention with SMBs.
- Most SMB SaaS leaders end up as “SML” leaders — customers Small, Medium, and Large. At least, don’t run from slightly bigger customers if you start to get some demand.
- Be very careful about your CAC and other spend metrics if your NRR is less than 100%. They need to be at the low end of normal. You can burn a ton of cash following the playbook used by folks with 110%, 120%, 140% NRR.
- Learn the true churn rate for your competition — and challenge the team to beat it. No matter what, you can do better than the direct competition. Find out. Go ask.
So, in the end, you have to find a way with SMBs to at least drive to 100% NRR, and ideally, higher. The best have found a way. Even if it was often much higher in the earlier days.
A few things the best in SMB SaaS have done well to get NRR up above 100%, and churn down:
#2. Smartsheet, Zendesk, Shopify, and More Went Slowly Upmarket. Even just a bit can help a lot with NRR. Today, Zendesk’s big push is $1m deals. But it didn’t start that way. It started very SMB. But even going a bit upmarket can drive NRR well above 100%. Asana has about 100% NRR from SMBs (still impressive), but this grows to 140% for its $5k+ customers. And Shopify gets about 25% of its revenue now from its bigger customers on “Shopify Plus”, which helps drive their NRR to 100% and their unit economics up.
#3. Digital Ocean went from 100% NRR to 116% NRR from SMBs in just 2 years by focusing on customers that could pay just a bit more ($50/month) — but got a lot more value. This isn’t going enterprise. It’s just focusing on SMBs that value the product the most.
#4. Maybe don’t even charge some SMBs at all, like Zoom did. Zoom’s SMB growth finally slowed, but not until $3.5 billion in ARR. It had insane SMB NRR of 130%+ until then (although it’s come way down after $4B ARR — now they are seeing the “standard” 3% churn in their smallest customers). Part of the key was making the Free version so good, they didn’t have to deal with churn from users who wouldn’t really benefit from the Paid version. See also, Slack.
#5. For so many, going multi-product is key. It was for HubSpot, to drive from 75% to 110% NRR. We had a deep dive at 2022 Annual with co-founders Brian Halligan and Dharmesh Shah; watch it below — it was excellent. They noted all the way until $25m+ ARR, their NRR actually was pretty bad, around 75%. To get it to 100% and then 110%, then really had to go multi-product. And a smidge upmarket, with bigger SMBs as the core.
And finally … Mailchimp ignored it. At least partially. They chose to live with the higher churn that comes with being 100% SMB-focused. And with Mailchimp being the most successful founder exit ever in SaaS, it’s one example of this working. Being bootstrapped, CEO Ben Chestnut mostly just focused on top-line growth and profits. But as part of living with high inherent SMB churn, they did lose a lot of customers once those customers added a VP of Marketing and went upmarket. More in our great deep dive here:
Most important of all is recognizing high churn is an existential challenge for SMB SaaS. One you have to address early, strategically, and with a true plan. Almost none of the SaaS playbook really works if your NRR is less than 100%. Hide from SMB churn, and it will bite you. Almost no matter what else you do right.
— Jason ✨Be Kind✨ Lemkin (@jasonlk) January 30, 2023