We need to escape Net Revenue Retention’s reality distortion field
Investors and suitors see NRR as a golden metric that links customer success with revenue outcomes. Off the record, many operators have a different view.
Most of us are familiar with Goodhart’s Law, which tells us that:
“When a measure becomes a target, it ceases to be a good measure.”
In this way, I believe that many popular enterprise SaaS metrics have lost their efficacy over time. But there is one that I want to talk about today because it has become particularly egregious — Net Revenue Retention (NRR).
For anybody who requires a refresher,
NRR measures a company’s ability to retain revenue
It is the company’s starting recurring revenue, plus/minus any recurring revenue gained/lost by the existing customer base during the financial period, divided by the starting recurring revenue.
So at 100% NRR, a company can confidently state that its customer base is paying the same amount to the company at the end of the financial period as at the beginning. Useful!
So what’s the problem?
Investors, bankers, and suitors are addicted to this metric.
I believe this is the case for two reasons:
First, a shared view exists that NRR is an effective way to link customer success with revenue outcomes, and thus is a useful way to measure the health of the whole business in one snapshot.
Here’s what WallStretPrep has to say about it:
“… the higher the NRR, the more secure a company’s outlook appears, as it implies that the customer base must be receiving enough value from the provider to remain.”
And Stripe:
“A high NRR indicates that a company is not just successfully retaining customers and growing revenue through upsells and expansions, but delivering an experience and products that their customers love.”
The second reason the addiction persists is that NRR is a metric that’s easy for leadership to effect change around quickly, which makes it a convenient point of leverage for raising new funding, going through M&A, and much more.
As a result, the enterprise SaaS community has become so obsessed with NRR as a golden metric that it typically a) holds customer success teams directly accountable to it and b) underemphasizes metrics that are more directly indicative of customer satisfaction.
But does higher NRR in fact mean happier customers? Or better account longevity?
Ask 100 different enterprise SaaS operators and you will get 100 diverse answers to this question. But off the record, enough of these answers will boil down to a “no” to make one squirm.
Read between the lines and what’s happening becomes clear: Company leaders and their investors are surrounding each other in a reality distortion field. It’s easier and more lucrative in the short-term to expand an existing account than it is to preemptively save the entire account in the future. So they prioritize expansion revenue at the expense of customer satisfaction, and call it all a win because NRR hovers at or above 100% in the short-term.
But why is the notion of expansion revenue as an antidote flawed?
Generating expansion revenue requires resources
Whether it’s a land and expand play, pushing newly minted functionality as an upsell, or both, a huge concerted effort is required between the GTM, product, and engineering organizations to strategically expand revenue on existing accounts. As a result, far more resources are needed in each of these orgs than if the expansion were more organic.
Because nobody wants to increase operating expenses, new heads aren’t hired; existing heads are simply shuffled around projects.
What suffers? Innovation tracks that help successfully land new logos grind to a halt.
What’s the eventual outcome? ‘Bad fit’ customers are brought on to compensate for poor logo growth, and those bad fits are even tougher accounts to retain and expand against. The negative feedback loop continues.
Expansion revenue often becomes hostile to customers
Have you ever gone through a painful process to resolve an issue with your telecom company — just for them to have the gall to try to sell you an upgraded package at the end?
If so, this is personal.
Who suffers? Just because a company is able to expand the monetary value of its accounts over a relatively short period of time does not mean its customer base is happy or will remain loyal over longer periods of time.
What’s the eventual outcome? NPS goes down, churn goes up, and expansion revenue becomes even more important as time goes on. The negative feedback loop continues.
Averages are skewed by extremes
It's all too common to see a game played where a small minority of key enterprise accounts go through a massive expansion while the rest of the customer base loses value. NRR shows up at or better than 100%, which is fantastic, but the real story is that a handful of CSMs or AEs have had a great month.
Who suffers? Customers.
What’s the eventual outcome? Need we repeat ourselves?
The solution is in plain sight. But so difficult to accept.
More traditional customer success metrics should be utilized to understand the long-term health of the customer base!
I’m not here to teach you about those other metrics, though. You already know what they are. I’m here to talk about why those metrics are often deprioritized despite their importance:
Our shared addiction with NRR.
Like many addictions, there is a reason NRR is so enticing in the short-term. NRR provides a quick fix to a problem, and negative consequences are deferred to the long-term — usually for future leaders or investors to clean up.
It’s time to get back to building startups for the long haul.