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Optimizing Recurring Service Revenue: Eight Questions CFOs Should Ask

By July 14, 2007Article

Are you paying enough attention to an often-overlooked major profitability driver? Service revenue – from maintenance, support, and subscription contracts – contributes significantly to the bottom line. However, CFOs often assume that service revenue is like the weather: there’s not much they can do to influence it. And like the weather, if it’s good, why bother?
But seemingly high renewal rates can mask serious problems – not to mention opportunities to increase service revenue performance. Customers who don’t renew may do so because they’re unhappy and are about to bolt to the competition. Others may not renew until months after their contracts expire. Or very low rates in a few regions could go unnoticed within an overall high rate – meaning you’re leaving revenue on the table and customers underserved.
ServiceSource routinely helps customers increase renewal rates, on average, by over 15 percentage points and, in some cases, over 40 percentage points. We begin by asking a few straightforward questions that get to the heart of overall renewal rates. After answering these questions, you may be satisfied with your organization’s service revenue performance. Or you may identify portions of the renewal process that are ripe for transformation by reviewing four areas:

  • Renewal performance. What are your renewal rates by customer segment (size, geography, etc.)? On-time versus in-quarter renewal rates? What is the degree of revenue erosion?
  • Customer performance. Is nonrenewal ever a good sign?
  • Channel performance. How are channel partners performing? And how does channel performance compare to direct sales?
  • Financial performance. What is the discrepancy between bookings and revenue? What are your average discount, up-sell, and cross-sell rates?

This article outlines the eight questions CFOs should ask to get to the heart of renewals.
1. What are your renewal rates by customer and by customer segment?
Measuring – and understanding – the factors that drive renewal rates is the first step to increasing service revenue. Renewal rate, a standard measure frequently based on transaction size, gauges the effectiveness of seizing available service revenue opportunities. You may be satisfied with reporting renewal rates of 85 percent or even higher. But how much do you really know about how your organization performs by customer or by customer segment? You might find that these more detailed numbers paint a less satisfying picture.
Customers are your most valuable asset; capturing renewal rates by customer is vital to understanding service revenue performance and retention. Doing so identifies the strengths and weaknesses of your renewal process. Even a modest decrease in annual renewals within an account can lead to significant revenue erosion over time. In contrast, high renewal rates reflect good customer retention and loyalty – and retaining customers helps drive sales growth.
Customer segmentation helps you evaluate renewal rates by customer size, geography, or industry. A high overall renewal rate could mask problems in certain segments. For example, you might be doing well with enterprise customers because you use a dedicated sales force to work with larger accounts – but your small and medium business (SMB) customers may not be renewing at the same rate. Or North American and Western European renewals may be fine, but rates in Eastern Europe are dramatically lower. Such a discrepancy could highlight a need to better address language, currency, and business protocol differences.
Customer segmentation can also help you analyze cost-of-sale by segment and better allocate resources to cost-effectively increase service revenue.
2. How do on-time or in-quarter renewal rates differ from net renewal rates?
Tracking on-time (contracts renewed before expiration) and in-quarter (contracts renewed in the quarter they expire) renewal rates can help identify hidden problems. Many CFOs believe that it’s simple: if customers renew service contracts, then the renewal process works. But to really see how well your process works, you need to know when contracts renew. If too many customers wait until after expiration, you lose immediate revenue and increase the likelihood of lost renewals.
The answer is proactive management. Customers unaware of upcoming expiration dates often fail to budget accurately, then must jump through budgeting hoops to get renewal funds in time. Another hidden danger: after operating for a while without the services covered by the contract, customers may begin to view them as less valuable. The longer the lapse, the greater the risk that the customer will not renew, or will renew at a lower level of coverage.
To avoid such losses, an organization must reach out to customers early – 90 to 120 days before contract expiration. This lead time allows you to close a contract before it expires. On-time renewals also lower the risk of revenue erosion and allow you to recognize revenue sooner.
3. How much erosion occurs in the initial renewals opportunity?
Service revenue erosion is the delta between initial opportunity and actual renewal size. Erosion can be caused by factors such as service level downgrades, change in the number of products covered, or discounting. Though seemingly minor at first, the impact of erosion grows over time, leading to significant revenue loss in just a few years. After expiration, contract erosion accelerates for several reasons:

  • It diminishes the service’s perceived value. The longer a customer goes uncovered without incident, the less necessary the contract seems.
  • It increases the cost and difficulty of renewal. Penalties, back fees, and recertification after expiration make customers less likely to renew.
  • It opens the door for competitors. A customer with an expired contract is more likely to consider support offerings from third-party providers.

If you know what is happening with each renewal, you can take the appropriate action to avoid revenue erosion. Are more and more customers downgrading? You may need to work with marketing to ensure that customers realize the value of premium services, or with your service group to increase benefits offered. And motivating customers to implement and use products currently on the shelf helps put valuable service revenue back in play.
To direct your product development, marketing, or service organization toward strategic improvement, you need insight into the underlying causes of service revenue erosion.
4. Why do customers say no?
Not every customer renews, and it is important to understand why. Customers may lack the budget to renew, may decommission the product, may choose a newly released or competing product, or may dislike the contract terms. The renewal process offers a great opportunity for rich discussion; if a customer chooses not to renew, you then know the exact reason.
Not only must you capture this information – you also have to know how to use it. Tracking measurable, addressable cancellation codes allows executives to think more strategically, to focus on how to refine service offerings, and to shape overall product strategy.
Note also that nonrenewal isn’t always bad news. The trick is having enough information to evaluate it. Maybe a service contract isn’t renewed because the customer has upgraded to a newer version of your offering – that’s a good sign overall. The contract holder is still a happy customer and may already be on a service contract for the new product. On the other hand, a customer might switch to a competitor.
Tracking cancellation codes, along with early contact during the renewal process, can uncover customers that don’t plan to renew – so you can win them back.
For example, a leading software company in EMEA identified an unusually high loss rate for renewals in Eastern Europe. With help from ServiceSource, the company analyzed data over two quarters, tracing a significant increase in defections to a new Russian competitor selling an extremely low-cost solution. In response, ServiceSource worked with the company to ramp up reporting, adding real-time weekly updates, and helped train sales teams on how to sell against the competitor in affected regions. The cancellation trend was reversed, and the software giant remained on alert for new competitive threats.
5. How are your channel partners performing?
Channel partners – whether distributors or value-added resellers (VARs) – allow you to reach more customers and drive additional sales. These partners control the customer relationship and, in many cases, handle service contract renewal.
For many channel partners, however, renewals are a small and fragmented percentage of their business opportunity; they find it difficult to justify the investment required to hire, train, and maintain an effective renewals team.
To maximize service revenue performance, you need to track how channel partners are performing and reward partners that perform well. Tracking also reveals underperformers that might benefit from enhanced financial incentives, tools and technology, and partner enablement resources.
Take, for example, an EMEA company working with ServiceSource. The company was able to track, report, and benchmark its partners’ renewals performance over two years. Upon analyzing this information, ServiceSource found a significant difference in on-time renewal rates corresponding to partner performance. The ServiceSource team recommended driving partners’ behavior with larger discounts for on-time renewals. The result: a 10% increase in on-time renewals, and smaller margins paid to poorly performing partners.
6. What is the difference in renewal rates between channel partners and direct sales?
It can also help you to understand how well channel partners perform compared to your direct sales team. Typically, channel partner renewal rates are lower than those for direct sales, but they should not be significantly lower. The larger the gap, the greater the opportunity to help channel partners increase their services revenue performance – and yours.
If you know how both partner and direct sales teams are performing, you can identify where to help with tools, training, and incentives. Segmenting direct and channel renewal rates will highlight the size of the gap and show you where to focus investment and resources.
7. What is the difference between bookings and revenue?
To understand and report service revenue, you must differentiate between booking value and recognized revenue. Typically, renewal revenue is booked as deferred income and recognized as revenue over the life of the contract.
Whatever your focus on financial metrics – whether you report margins or earnings per share (EPS) – you need to know how renewal performance affects current quarter revenue and earnings. Because the timing of bookings doesn’t correspond to revenue recognition, you must be able to quickly and accurately identify the percentage of bookings recognizable as quarterly revenue.
ServiceSource has worked with customers to develop a methodology that maps bookings to earned and forecasted revenue. Customers gain an instant – and accurate – view of revenue from renewals, special expired projects, penalties, and back fees. ServiceSource customers know at a moment’s notice how service revenue performance affects earnings.
8. What are the average discount, up-sell, and cross-sell rates?
To answer this question, your organization must track each of these three rates. Boosting service revenue requires increasing up-sell and cross-sell rates while reducing discounts. You must also evaluate the amount of margin given away and the corresponding return on investment. Tracking and understanding up-sells to higher levels of service, multiyear contracts, and coverage of additional products – and replicating their causes – benefits your bottom line far into the future. For example, offering multiyear deals, rather than or in addition to a more typical annual renewal, drives revenue and can increase performance across the business.
The renewal touch point is the perfect opportunity to make customers aware of the benefits of higher service levels, multiyear contracts, and new or complementary products. Unfortunately, automated renewal and billing programs limit opportunities to educate customers about enhanced service options. Automated renewal also discourages dialogue with customers, making it difficult for customers to provide feedback and for your sales team to cross-sell consulting and services.
In over 100 customer engagements with the world’s top technology brands, ServiceSource has identified the data sources, processes, benchmarks, and best practices behind increasing renewal rates and optimizing service revenue. Now that you know the fundamental renewal, customer, channel, and financial performance questions to ask, you can identify problems and areas of limited visibility. Add data access, analytic tools, and an eye toward metric-driven improvements, and you can identify and influence the drivers of high renewal rates – with lasting and positive impact on your bottom line.
Mike Smerklo is CEO of ServiceSourceServiceSource and serves as Chairman of the Board of Directors. He is committed to advancing ServiceSource’s vision and mission to deliver innovative and market leading cloud-powered service revenue performance solutions for technology-based companies, and keep ServiceSource laser-focused on increasing customers’ maintenance, support and subscription revenue, profits and earnings.

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