In 2014, my team and I had been digging into retention for our new HubSpot Sales product. The more we unearthed, the more I realized how critical improving customer retention was to blowing out the product’s growth story. By May 2015, I was sharing our insights on retention with the wider startup community for the first time.
At the same time, high-profile startups like Homejoy, Fab.com, and others, that had raised hundreds of millions of dollars and shot to the moon on rocketship acquisition metrics, were bursting into flames and crashing back to earth.
Since that time retention has become one of the hottest topics among growth professionals. It has emerged as the antidote to this boom-and-bust storyline and the common denominator that separates the most valuable companies from the rest of the pack. It’s become the most valuable player in growth - and this is a great thing.
Yet, there’s still a problem - there is a lack of understanding why retention is the priority. Without understanding this, people end up working on the wrong things and missing the biggest opportunities.
Most people think retention is so crucial simply because it means you lose fewer users than you otherwise would. Though this is true, it misses the critical point.
Retention is the core of your growth model and influences every other input to your model. This is important because if you improve retention, you’ll also improve the rest of your funnel.
About the Author
Brian is the Founder and CEO of Reforge. Previously, he was the VP of Growth @ HubSpot. Prior to HubSpot, he was an EIR @ Trinity Ventures and founder of Boundless Learning and Viximo. He advises companies including Blue Bottle Coffee, Gametime, Lumoid, GrabCAD, and Help Scout on growth and customer acquisition.Learn More
Improving retention spurs growth in 4 key ways:
1. Retention drives acquisition
For many products, especially those that grow through virality or user-generated content (UGC), retention has a double effect. As you retain more users, those additional users take more of the key actions that accelerate acquisition, either through sharing, inviting, word-of-mouth, or creating content. As more of those new users retain, more are acquired - improving retention sets off a self-reinforcing cycle that drives acquisition.
2. Retention improves monetization
When it comes to monetization, two important things happen with improved retention - you can retain a larger proportion of a cohort, and in doing so, make more money from that cohort within a given period of time, and you can increase the length of time that a cohort retains, increasing LTV.
3. Retention builds an acquisition competitive edge
As you increase retention, monetization, and LTV, you can pay more to acquire a customer. In doing so, you can push competitors out of acquisition channels, open up new channels that were previously too expensive, and grow faster.
4. Retention accelerates payback period
Payback period is the time it takes to break even on the cost to acquire a customer. It also determines how fast you can start reinvesting in acquisition to fuel growth. Improving retention can help shorten your payback period to grow faster.
Let me walk you through how retention influences each growth driver outlined above, complete with examples of each dynamic in action.
Retention Drives Your Acquisition
It’s obvious that the more you improve your retention, the more active users or customers you will have over time. What’s less obvious is that as you improve retention you will simultaneously increase the number of new customers you can acquire.
This dynamic creates a multiplier effect. As you increase retention in your product, you’ll acquire more users. This is a virtuous cycle that continually feeds itself over time to compound acquisition efforts.
Because a number of acquisition channels, such as virality and UGC, work when existing users take an action that introduces new users to the product (via inviting friends, sharing, word-of-mouth, or creating new content), a larger base of active users leads to better acquisition metrics.
Let’s walk through a few familiar examples to demonstrate this point.
How Improving Retention Impacts UGC
For businesses that rely on UGC to grow, when a retained user creates new content, search engines index it. When people search and land on it, this experience introduces new users to the product, and some percentage of those people sign up. Some percentage of those registrations then go on to become active users who also create new content - and the cycle continues.
Example: UGC for Pinterest
Pinterest is a prime example of a fast-growing company that relies on UGC as its main acquisition channel. When a retained Pinterest user creates a new pin and adds descriptive tags, Google indexes the pin. When people search and land on it, this experience introduces new users to Pinterest, and some percentage of those people sign up. Some percentage of those registrations become active users who also create new pins, and on it goes.
In Pinterest’s growth model, the more users it retains, the more users there are to create the pins that lead to acquiring new users.
How Improving Retention Impacts Virality
For a business with virality built into the product, like Dropbox, Slack, or Loom (the example we’ll walk through in a moment), a by-product of natural usage is that users end up sharing it with friends and colleagues. These types of products naturally bring more users into the product - so the more existing users retain, the more new users will be acquired.
Shaun Clowes points out that that in addition to usage-based virality, improved retention also positively impacts word of mouth. Acquiring customers only to have them churn can lead to negative word of mouth and create a drag on acquisition.
In contrast, acquiring customers that stay engaged and go deep with a product often generates positive word of mouth that boosts acquisition. This is where Shaun sees NPS become relevant for the normally quantitative world of growth.
Example: Usage Driven Virality for Loom
Let’s consider a viral product. I'll use one of my new favorite products, Loom, as an example (disclaimer - I'm an investor). Loom lets you easily record a video in your browser and send it to a colleague via Slack, email, or another channel, or embed it in a product, app or website. It’s an easy alternative to writing out long explainer emails.
In Loom's case the more users they retain, the more videos those active users will create and send to others over their lifetime. This sharing behavior introduces new people to the product who go on to sign up and create and share their own videos.
Let’s walk through how this dynamic plays out quantitatively, demonstrating the impact a 10% improvement in retention would have on virality at Loom over the course of one year.
Note: All numbers in this spreadsheet and throughout the post are 100% fake and used simply for demonstration - these are NOT real metrics for any of these companies.
In the models below we assume the following:
- Each cohort starts with 10,000 newly acquired active users
- Retention levels off at 25% (Scenario A) and 35% (Scenario B) in month four
- 80% of active users share a video they created
- They share each video with 2 people (this is the branching factor)
- 50% of the people who are sent a video by a friend have not signed up for Loom previously
- 50% of those newly introduced people sign up for an account
In Scenario A, when Loom’s retention levels off at 25%, they end up acquiring 14,680 new users from virality for a single cohort over the span of 12 months.
Increasing retention by 10% increased the number of new users acquired for a single cohort by 3,560 in one year. At first glance, that may not seem like a meaningful improvement, but when you layer on each additional cohort for the year you see that 23,280 additional users are acquired with that 10% improvement in retention.
Increasing retention by 10% increased the number of new users acquired for a single cohort by 3,560 in one year. At first glance that may not seem like a meaningful improvement, but when you layer on each additional cohort for the year you see that 23,280 additional users are acquired with that 10% improvement in retention.
Retention Drives Monetization
Retention doesn't just help you retain and acquire more active users, it also drives monetization. Regardless of business model, two critical things happen when retention rate improves:
- Revenue within a given period of time increases as you retain a greater proportion of a cohort.
- LTV increases as you retain the same portion of a cohort for a longer period of time.
Let’s walk through a few examples of different business models and how improved retention impacts monetization for that particular model.
The Ad Model
If companies like Facebook and Pinterest, and any other companies that rely on ads to make money, get a greater proportion of users in a cohort to stay engaged over a certain period of time, they increase the ad inventory they can sell and the ad dollars they bring in during that time. Additionally, if they increase the length of time that users in a cohort stay engaged they increase the amount of ad inventory over time and lifetime value of the users in that cohort as a result.
The Subscription Model
The subscription model is even more obvious. With B2B SaaS companies like HubSpot and Zoom, and B2C ecommerce subscription companies like Ipsy and Dollar Shave Club, the larger the number of customers who remain subscribed within a discrete cohort and period of time, the more money that cohort will generate. Similarly, the longer customers remain subscribed to the product the larger their LTV.
The Transactional Model
For companies like Uber and Instacart that make money with transactional models, the more customers who retain in a cohort over a certain period of time, the more money they’ll make from that cohort in that time. Similarly, the longer the users retain the more transactions those users will produce over time, increasing their LTV.
The Freemium Model
Companies with freemium models benefit when users sign up for and continue to use the product for free over time. If they retain on the free product, this indicates that they are getting enough value to stick around and may be willing to pay at some point. The same retention dynamic from above applies here too - the more free users who retain in a given time period, the more opportunities the company has to upgrade them and increase revenue. Similarly, the longer free users retain, the more opportunities the company has to upsell them over time to the paid tier and increase their LTV.
How Improving Retention Impacts Monetization at Spotify
Spotify offers a great example of how retention can improve monetization for freemium models. When you sign up for Spotify for free, they serve you ads, many of which target you to upgrade to the premium ad free service. Let’s walk through two different scenarios demonstrating how improvements in retention impacts monetization for Spotify.
In Scenario A, we assume the following (all numbers are fake and for demonstration only):
- Retention levels off at 70% in month 7
- Each cohort starts with 10,000 active users
- The percentage of paying users levels off at 20% of the whole active user base
- There is no churn (for simplicity)
As you can see below, in Scenario A, Spotify generates $157,792 in revenue for this one cohort over the span of 12 months.
In Scenario B, all assumptions remain the same except retention levels off at 80% in month 7. In this case, with a 10% improvement in retention, we see that Spotify generates $173,726 in revenue from this cohort over 12 months.
This is only a difference of $15,934 for one cohort, but again, when we layer on all additional cohorts for the 12 month period, we see that the 10% improvement in retention actually drove $75,325 in additional revenue for the year.
Retention Builds An Acquisition Competitive Advantage
Above we talked about how improved retention increases monetization and LTV. When we dig deeper into this point, we see that the benefits of increasing LTV reach beyond simply making more money - it gives you acquisition muscle that can become a competitive advantage.
With acquisition muscle, you can push competitors out of acquisition channels to dominate a market and grow faster. This is key because as Andrew Chen, my co-host for Reforge’s Growth Series, explains, we are in an ecosystem where growth is getting harder.
Let's consider two competing companies - Company A and Company B. Company B has a higher LTV, and is therefore able to spend more than Company A on acquisition. This dynamic is most impactful for companies that rely on paid acquisition as a main channel for growth. Since paid acquisition channels are efficient marketplaces and ad inventory goes to the highest bidder, if Company B has a higher LTV, it can afford a higher CAC. This means it will be able to outbid Company A for the same inventory, effectively pricing Company A out of the channel.
Being able to afford a higher CAC not only allows Company B to push Company A out of an existing channel, it can also open up other channels that were too expensive when it had a lower CAC.
There’s one caveat - this principle of increasing LTV to get a competitive edge holds true for many companies, but not necessarily for companies that rely on virality or UGC to grow. Hypothetically, with higher LTVs, these companies could spend more on engineering and product to drive those acquisition methods. The problem with this argument is that the limiting factor on these channels is generally the supply of engineers in the market, not budget and LTV.
Retention Accelerates Payback Period
A lot of teams at the fastest-growing companies focus heavily on LTV. The problem with this is that LTV typically is not the limiting factor in growth - payback period is.
Payback period is the time it takes to break even on your fully loaded CAC. This is the limiting factor because the payback period determines how much cash is needed to fuel growth of the business. If you have a longer payback period, you either need to raise more money to fuel acquisition or wait longer to reinvest in acquisition. If you have a shorter payback period you will be able to reinvest the cash earned sooner in acquisition.
Since improving retention drives monetization - meaning you make more money over a designated period of time - it also shortens your payback period.
This concept applies to growth models in which cash is the limiting factor, especially those that rely on paid, company-created content, or sales to grow. Building a content and/or sales team is a cash-intensive way to grow, and the faster a company can turn content and sales into cash, and reinvest that cash into further expanding the sales and content teams and acquiring more leads, the faster the company will grow.
How Improving Retention Accelerates the Payback Period for Ipsy
To demonstrate this point let’s again consider an A and B scenario, this time for subscription ecommerce company Ipsy (reminder: these are fake numbers and don’t reflect inside knowledge. We are just using Ipsy as an example). In Scenario A, for one cohort retention levels off at 25% in month four, and in Scenario B, for one cohort retention levels off at 45% in month four. In both cases, the assumptions are as follows:
- Monthly subscription revenue is $10/user
- The company acquires 10,000 users per cohort
- Fully loaded CAC = $40 per user
- They spend a total of $400,000 to acquire each cohort
In the image below, you can see that in Scenario A, Ipsy would break even on that $400,000 acquisition cost in month 9.
In Scenario B, in which retention is much higher, leveling off at 40% in month four, the payback period shortens significantly to 6 months. This means that Ipsy is able to start reinvesting in acquisition 3 months sooner in Scenario B than it is in Scenario A.
If we go a step further, we can see that in Scenario B Ipsy generates a total of $670,000 in revenue from this one cohort over the span of 12 months, whereas in Scenario A it generates $480,000. The additional $190,000 in revenue earned in Scenario B allows the company to acquire an additional 4,750 customers than it would have in Scenario A over the same period of time.
As you can see from the walk-through of all the examples above, there’s much more to retention than meets the eye. It isn’t just about retaining more users, it impacts every facet of your growth model and has multiple layers of impact on the health of any business. In fact, retention is one of the key factors that determine the long-term success of any startup. Retention will make or break your company.
To build a deeper understanding of the principles, frameworks, and strategies that underpin retention and engagement, sign up for Reforge membership and enroll in the Retention+ Engagement Program.
Other posts in the 3-part retention and engagement blog series: