As I prepared the S-1 analysis for ServiceNow, the third largest public SaaS company in the world, I came across a section in their latest annual report called Key Factors Affecting Our Performance in which the company describes the two ways they evaluate churn. One is common, but another is unusual. Below I’ve quoted their definitions.
Upsell rate. To grow our business it is important for us to generate additional sales from existing customers, which we refer to as our upsell rate. We calculate our upsell rate as the annualized contract value, or ACV, of upsells, net of losses during the period, divided by our total ACV signed during the period. The upsell rate was 36%, 31% and 30% for the years ended December 31, 2014, 2013 and 2012, respectively. Our upsells are primarily derived by an increase in the number of seat licenses purchased by our customers and are also derived from the addition of other subscription services.
Renewal rate. We calculate our renewal rate by subtracting our attrition rate from 100%. Our attrition rate for a period is equal to the ACV from lost customers, divided by the total ACV from all customers that renewed during the period and from all lost customers… Our renewal rate was 97%, 96% and 97% for the years ended December 31, 2014, 2013 and 2012, respectively.
The Upsell rate is the calculation of the dollar retention or negative net churn figure, and is commonly used by SaaS startups. While it’s a great metric, using upsell rate alone to judge the health of the business can lead to false conclusions.
For example, if one massive customer buys more seats, the upsell rate will look great, at better than 100%. But if the company is losing 10% of the rest of its customer base each month, the startup is in trouble.
So, in addition to dollar retention, startups will often calculate unit retention, as a way of seeing past the effects of large customers on dollar retention. But the unit figure has some problems, particularly if a startup has a very diverse customer base with lots of smaller customers, who will churn at very high rates, and depress the unit retention.
ServiceNow’s renewal rate is a great replacement for unit renewal. It’s a metric of revenue retention that doesn’t allow large customer upsells to mask customer churn, and it conveys the health of the broad base of the business.
As described above, to calculate renewal rate, use this formula:
Renewal_Rate = 100% - Lost_ACV/(Lost_ACV + Total_Renewed_ACV)
where ACV is annual contract value.
Consider adding renewal rate to your SaaS startup’s key metrics. It’s another terrific diagnostic tool to understand the health of your customer base.