SAAS companies love annual billing!
But how do monthly subscriptions compare to annual subscriptions?
Let the data speak for itself. Among the Forbes Cloud 100 with public pricing, 68% offer annual plans with a prepay. To get the commitment and cash, they typically discount their product by 20-30%.
To be fair, at first glance the logic is quite sound. In return for predictable revenue upfront, I will give you a discount.
This seems like an ideal arrangement for you and for the customer. If customers pay upfront for one, two, or even three years, retention rates will improve, CAC payback will improve, and cash flow will increase, right?
Unfortunately, as with most things, as we look under the hood this logic is deeply flawed.
Unless a refund or early termination occurs, you are likely to retain an annual customer for at least one year. You can count on this. However, do subscription based businesses with an annual bill plan have better retention than those with monthly plans?
The simple answer is no.
When it comes to gross dollar retention (GDR), there is not much difference regardless of how long the contract is (or how much it is). The median GDR of companies with all of their revenue on monthly/quarterly contracts is 90%, while the median GDR of companies with all of their revenue on annual or multi-year contracts is 85%. Overall, companies that use monthly contracts retain their revenue better than those that use annual contracts.
The case for annual contracts is flawed even if gross dollar retention is equal-because of the 20-30% discount, you need to see a big jump in retention to justify the discount.
It is also possible to recoup most or all of the costs of acquiring that customer by pushing them to annual plans. As a result, if you make your CAC payback for 12 months, you can be certain you won't lose money on that customer.
Again, companies with all of their customers on monthly contracts exhibit better metrics than those with annual contracts. And the metrics certainly don’t improve as you move across the spectrum.
Customers on an annual plan are likely to exhibit better metrics than customers on a monthly plan, if you already offer them. It's not that annual plans are good for retaining customers, but rather that your more loyal customers will opt for those plans, stay on your software for longer, and ultimately do better. Meanwhile, customers who are less confident in your product will choose monthly plans and likely churn more quickly. By thinking that annual plans will improve your metrics, you may be led down the wrong path by this self-selecting bias.
It has always been and will always be cash that reigns supreme. Moreover, rising Days of Sales Outstanding (DSOs) can be a nightmare that brings your business to a halt. If you’re not sold on this annual payment fallacy, you may want to at least consider reducing your discount or deemphasizing it in your go-to market strategy. Here are a few things to consider before you launch quarterly incentives for annual pre-pay contracts.
Working to have your sales team execute an annual commitment can lead to increasing levels of scrutiny and procurement involvement. Particularly in situations where you don’t have a robust free trial or freemium motion, this can lead to hesitation for buyers and allow time for fear, uncertainty, and doubt to creep in.
Pro tip: Let customers into your product and allow them to get to value before you start asking for an annual commitment. Not only will this allow you to decrease the threshold required to get this commitment (e.g. going from a 20% discount to a 5-10% discount), it also may increase the size of the overall contract as they discover new use cases.
It is common for larger customers to prefer annual plans because they simplify budgeting and invoicing. However, these customers may also be willing to pay more for your product.
Offering an annual discount to customers who are seeing the greatest value in your product is a surefire way to lose money. Those who would purchase annual plans at a discount are also more willing to pay.
You should evaluate your discounting structure for annual plans to ensure you're not over discounting. In recent surveys, it was found that diminishing returns exist above 10% (for example, 30% of customers would accept a 10% discount, and only 33% of customers would accept a 20% discount). In order to get an annual plan, you can lower your discount or use other levers.
Providing value to customers is a must for companies with monthly plans. You have probably seen a support ticket or feature request from a big customer get escalated to your leadership team because "this customer is up for renewal in three months." Inherently, building the right habits around retaining customers in the long run is a result of creating the right habits of always providing value to customers across R&D and customer-facing teams.
A pro tip: Build your customer-facing teams to focus on customer value consistently, not just in the three to six months before renewal. Churn issues don't go away in the last three months of a contract. It is possible to ensure that contract structures don't prevent you from building the right retention motion by linking OKRs and/or employee compensation to product usage metrics.