Five Ways to Improve Net Revenue Retention in the Subscription Economy

Welcome to the subscription economy.

From early subscription-model adopters like Salesforce, to two-sided marketplaces like DoorDash, to auto rental players like Hertz, the subscription model is showing its staying power.?An increasing number of businesses are exploring the path from traditional purchase-based models to ones based on the recurring revenue of subscriptions.

In the current highly uncertain environment, the promise of a reliable revenue stream is hard to pass up. BCG research shows brand preference is waning as consumers increasingly prioritize convenience, price, and values. Consumers also have less interest in owning physical products and are increasingly comfortable with the flourishing sharing economy, beyond mainstays such as software and digital services. These evolving consumer preferences are coming to bear when inflation is causing rapidly rising input costs and leaving a corrosive effect on company profits, particularly those with poor pricing practices. The shift to subscription-based offerings was inevitable, but the pace of adoption has accelerated.

The secondary benefits of subscription models are also enticing: loyal customers, a predictable top line, simpler inventory management, lower retention spend, higher customer lifetime value (CLV), among others. But deploying the model can be tricky because subscriptions fundamentally change how a business functions. New revenue streams, new organizational roles, new processes, and new metrics redefine go-to-market operations for incumbent firms and challengers alike.

Net Revenue Retention: The Key Success Indicator

The benefits of subscription models all contribute to the core objective of any firm: growth. One of the most powerful metrics of growth from subscription models is net revenue retention (NRR). NRR measures a firm’s ability to retain—and expand—its existing base of customers. Subscription businesses see increasing NRR as the most immediate and least costly path to growth compared with net new customer acquisition or M&A. While most firms still view annual recurring revenue as their holy grail metric, higher NRR has proven to be a major driver of shareholder value for subscription businesses as it identifies revenue growth over time and from which customer segments.

Rather than rely on increasing their customer base, subscription companies can boost existing customer relationships through cross-sells, upsells, and add-ons, while reducing attrition—or churn: customers who downgrade or end their relationships entirely. NRR becomes a powerful metric as it measures each of these key metrics to inform subscription performance.

Zuora : The Proof is in the Data

In a BCG report published in partnership with Zuora’s Subscribed Institute , we analyzed data on the subscription economy, finding several opportunities and roadblocks as firms build and improve their NRR strategies:

Higher ARR typically means higher NRR

Firms that sell across a customer’s enterprise, and thus have a higher average revenue per account (ARPA), tend to achieve both higher annual recurring revenue (ARR) and higher NRR. But understanding which firms are truly ‘enterprise focused’ is tricky as NRR benchmarks vary considerably depending on company profile and stage of growth.

Enterprise focus makes for stickier customers

The correlation between ARPA and NRR isn’t always clear, though. Enterprise companies tend to have “stickier” customers and more room for growth, so the correlation makes sense in that sector. But the correlation held regardless of company size or “label.” Low ARPA players can still have good NRR performance, even if it’s not as significant a bump as enterprise companies.

Multi-year contracts don’t materially improve NRR

Many subscription businesses provide significantly lower fees for multi-year contracts. The implicit assumption is that when a customer signs on for three years instead of one, retention will be a lot better. But it turns out that’s not true: our insights showed there is no material improvement in retaining and growing your customer base when you have a multi-year contract. Annual subscriptions actually deliver better NRR than either monthly and multi-year subscriptions.?Discounts in the latter reduce future revenue more than these improve retention or upsell.

Pay-as-you-go options perform better than fixed subscription pricing

Companies that offer consumption-based pricing models (otherwise known as pay-as-you-go, or PAYG pricing) did better than those without them —in some cases by 10 or 20 points. Consumption based-model companies with $10-$50 million in ARR had a churn rate of only 8%, while those with fixed subscription pricing had double that churn. The latter model usually involves access pricing as a set fee per term that does not fluctuate based on usage.

Five Steps to Improving NRR

With these insights, a clear path to improving NRR becomes clear. Here are five steps companies should take to achieve higher net revenue retention:

1.????Set expectations for NRR based on maturity, industry, end-customer type, and markets served.

Every business is different, so understanding where you fit will inform what you can expect.

2.????Activate volume growth drivers and upsell levers.

Customer engagement is a critical factor in converting small customers into heavy users. It usually translates to upsells and cross-sells, resulting in topline revenue and bottom-line profit growth.

3.????Multi-year contract discounts are often not worth it; annual contracts with auto-renew can be better

But if you find the comfort of multi-year contracts too hard to pass up, keep the discounts below 10%.

4.????PAYG can yield dividends when combined with subscription for the right customer profile

Consumption-based models can yield higher growth within the base—but it’s not as easy as flipping a switch. You’ll want to make sure you match to client needs and your business processes.

5.????Automate your processes to support customer acquisition, retention, and growth

Clear, real-time data is a requirement to track NRR.?As you scale, make sure to put in place effective, automated retention systems where feasible.

Closing Thoughts

Retaining customers is the pathway to your subscription business growth, and a higher NRR is the lighthouse indicating you’re on the right path. Keeping your sights on increasing NRR helps the relevant pieces to fall into place, setting you up for profitable growth in the near term and for years to come.?

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About the Authors

John Pineda is a Partner & Director based in BCG's San Francisco office. Samir Virani is a Consultant based in San Francisco.