In the previous Blog we talked about the concept of “Golden circle of technology” helps tech — startups to ideate and build their Go-to Market strategy (GTM) as per the need of industry and consumers.
In this blog we will be focusing upon one diagnostic tool that helps keep in check the growth of these Software as a Service(SaaS) subscription products while they are at scale!
This diagnostic tool is called “Cohort Analysis”
But why is there a need for one anyway?
Having sole focus on topline numbers does not give you understanding of the on ground reality.
- Is the sudden increase of users hiding the weakness of the product?
- If you stop marketing, will the users still sign up and use the product?
- What are the expectations of users who are using the product?
Most important part is to define the cohort. It can be daily/weekly/monthly depending upon the type of subscription and user activity.
For eg –
- A movie booking app would need weekly cohort segmentation
- For grocery delivery apps monthly segmentation makes more sense.
This segmentation helps understand two main elements:
- Customer lifetime value ( Revenue per user till the time they stop using the subscription)
- Churn rate ( % of users not renewing the subscription)
So, what is “Cohort Analysis”?
Term “Cohort” means “Group of people who share similar characteristics over a certain period of time.”
And for SAAS subscription product it means “ Tracking specific groups of users’ activity on daily, weekly & monthly basis after acquiring them to understand whether the growth is resilient enough or not.”
Lets understand through an illustration
We will take monthly subscription and monthly segmentation as parameters for the example.
- Monthly subscription rate: INR 100
- Customer Acquisition Cost: INR 200
- Gross Margin: 70%
There are essentially 4 steps to understand Churn rate & Customer lifetime value of the subscription users.
- Customer retention %
- Net revenue/Cohort
- Cumulative lifetime revenue/cohort
- Customer lifetime “Revenue”/cohort
Figure 1 (Month on month subscription purchase by customers)
How to read this sheet: 40 customers had bought subscriptions in the month of January .Going ahead , 2 of them did not renew and hence only 38 subscribers continued in the next month from the January cohort. and Similarly at the end of year, 30 subscribers remained out of the initial 40, meaning in total 10 subscribers customers were lost throughout the year from January cohort.
If we plot the percentage graph, it would give us the retention rate at month-on-month level.
( Figure 2: Percentage of the cohort renewing subscription)
If we plot a stacked line graph we can get a trend of cohorts on a Month-on-Month basis.
( Figure 3)
We can clearly see that there is a sudden dip in renewal rate on the 5th month of the subscription!
Now whether it is good or bad depends upon a variety of factors such as competition, seasonality trends of the sector etc.
It’s important to know the initiatives the company took w.r.t to the trends, changes observed in retention rate.
This gives the understanding of churn rate and retention rate w.r.t to the customer purchases of subscription.
Now lets see the customer lifetime value based on the above data.
First we have to calculate the lifetime value (LTV) :
Formula: Average sales price* Number of transactions*Retention time period.
Followed by which we can calculate the Customer lifetime value:
Formula: LTV*Gross Margin
Average sales price in our case is the subscription cost* number of customers buying it.
Since we have mentioned that subscription cost is INR 100/month we will multiply this with the cohort numbers mentioned in figure 1.
(Figure 4 — Revenue per cohort, refer figure 1 for reference)
Next step is to see the cumulative lifetime revenue achieved per cohort of the month in the entire year.
For eg: In January 40 customers purchased subscription hence 40*100=4000
In the next month out of 40, 38 renewed the subscription hence 38*100=3800
So the cumulative revenue for the January cohort in the next month will be 4000+3800= 7800
(Figure 5: Cumulative revenue per cohort, refer figure 3 for reference)
Hence now we can get the “lifetime revenue” of the customer by
Cumulative revenue / Total number of subscription purchase
(Figure 6: Lifetime revenue/cohort, refer figure 1 and 5 for the reference)
Now we can get the customer lifetime value (CLTV) by:
Lifetime revenue of cohort (Figure 5) * Gross margin (70%)
(Figure 7: Lifetime revenue of the cohort* Gross margin = CLTV)
What does CLTV in figure 7 tell us?
It tells us that in this hypothetical example the SAAS company needs 3 months to recover its customer acquisition cost (INR 200 as mentioned at the starting of example)
Cohort analysis helps in revenue predictions of a SAAS company but more importantly it is also an indicator on what is the actual number of users who use the product.
If done correctly, it helps to understand “Why” the customer uses the product.
So what if the retention rate declines or it is less?
Well consider this as an opportunity to improve the features of the product!!
Author
Dr. Archit Shah
