SaaS Net Retention Rate Myths - One Size Doesn’t Fit All

March 22, 2019

A benchmark floating around the SaaS blogging community is that SaaS net retention rates have to be over 100% - or your company isn’t valuable.  In fact, according to this school of thought, your net retention rate should be way over 100%, at least 125% or more.  Some investors are even associating net retention rates with company valuations, regardless of model.

This can have the unintended effect of impacting Go-to-market strategies in order to meet investor expectations for isolated benchmarks, regardless of product and market.

Examples like Veeva Systems, the enterprise cloud provider for life sciences companies like Pfizer, which had 187% net retention at IPO, or Box at 103% among others, validate the thesis that valuable SaaS companies are valuable because of high net retention rates. These high growth unicorns stand out, not because their net retention rates are so high, but because their business models are based on an extreme version of Land & Expand in the enterprise space.  Whether thru usage-based pricing which is appropriate for their product/market fit, or adding additional functionality and services, these companies grow by upselling and expanding with existing, typically very large, customers.  These vendors, by business model definition, HAVE to have high net dollar retention rates.  And the fact that they have IPO’ed means that they are top tier performers.

Sometimes a benchmark like a net retention rate of 125% or more takes on a life of its own regardless of the fact that it doesn’t apply to all SaaS vendors.

Plenty of top tier, successful SaaS companies have been successful with lower net retention rates, especially if they are selling in the SMB space.  If your model is high volume, low average contract values (ACV), transactional, and your ACV doesn’t increase a lot, then a good net retention rate is in the 90 percent range.

SMB customers, by the nature of the market, are going to have higher churn rates than enterprise customers.  Small companies are riskier and go out of business, or get acquired and merged (all of which affects churn rates) more frequently than large enterprises.  And price points in the SMB space are more restricted, depending on where you start your pricing, there may not be a lot of room to expand.  SMB customers are less likely to commit to a product if they think the pricing is going to increase dramatically if they become dependent on it.

The value of the SMB market is that the SMB total addressable market (TAM) is vastly larger than the enterprise market and sales investment is focused on a low touch, transactional operation, rather than expensive sales and customer success people who can sell and retain million dollar customers.

In 2014 at the time of IPO, Hubspot had only gotten their net retention rate up to 90%, which by today’s standards doesn’t sound very good, but was an improvement over the previous year.

Hubspot built an extremely valuable business which continues to grow.  Their customer growth rate was strong leading up to and continuing through the IPO, which gave them the basis for future expansion of sales into their customer base, but more importantly, they continued to grow the customer base.

Benchmarks vary by business model, by stage of growth and cannot be looked at in isolation.  Companies selling into the SMB space by definition of the business model have lower logo and net revenue retention rates. Benchmarks need to be looked at in the context of the business model and compared to peers with similar operations, and compared to best in class for that business model, not all SaaS.  And one metric taken in isolation doesn’t tell the story