How does contract length impact ARPU and churn?
This episode might reference ProfitWell and ProfitWell Recur, which following the acquisition by Paddle is now Paddle Studios. Some information may be out of date.
Originally published: June 19, 2019
Relationships are where the beauty of the subscription economy truly shines. For the first time in the history of business, we have a revenue model where the relationship with the customer is baked right into how you make money. Interestingly enough though, we don’t have to test that relationship on a month to month basis – we can (and should) lock in a longer term. What’s the best term though? 1 year? 2 years?
As to not bury the lede - increasing the guaranteed subscription term absolutely lowers churn.
Regardless of ARPU, those companies with a higher percentage of annual contracts see significantly lower churn. This is because these customers have only one purchasing decision per year (albeit a larger one) whereas their monthly counterparts have 12 purchasing decisions per year. Note that the correlation is pretty strong here with those companies that have 100% annual contracts seeing 80% lower churn than those who only do monthly.
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We don’t have enough data on multi-year contracts, but qualitatively we’ve seen the effects to be similar with one important exception. As you increase the term beyond 1 year, the reduction in customer attrition is minimal, meaning there isn’t much to be gained in terms of retention for 2+ year contracts.
There is much to be lost though with longer term contracts. While many people use two or more year contracts to guarantee they recover acquisition costs, the impact is you lose out on the ability to increase prices or your overall average revenue per user.
Note how those companies using monthly or annual contracts tend to have some fairly decent increases in ARPU over the years. The flexibility of these contracts ensures that as the product improves, the price can also improve. Remember, your price is the exchange rate on the value you’re providing. Those with longer term contracts tend to have fairly flat ARPU, mainly because so much focus is being put on the longer contract that these terms don’t provide a lot of flexibility.
Of course, a big lurking variable here is longer term contracts tend to be used for much larger deals, so what should you do?
Well, in most situations you should definitely optimize for a healthy dose of annual contracts. Axiomatically I would say that most companies out there should avoid contracts longer than a year, strictly because you want to be able to raise prices over time. Some industries won’t be able to avoid the long term contracts due to constraints from the cost of acquisition, but these folks should then make sure contract terms are flexible enough to warrant price increases, especially as the product improves
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You've got the questions,
and we have the data.
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This is the ProfitWell Report.
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Hi, Neil. This is Vinish,
cofounder of White.
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My question is, how does the
contract plan impact ARPU and churn?
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Thanks.
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Welcome back, everyone.
Neil here from ProfitWell.
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Relationships are where the
beauty of the subscription
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economy truly shines.
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For the first time in
the history of business,
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we have a revenue model where
the relationship with the
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customer is baked right
into how we make money.
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Interestingly enough, though,
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we don't have to test our relationship
on a month to month basis.
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We can actually log
in a longer term.
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What's the best term
length, though? One year?
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Two years?
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To answer these questions,
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we looked at the data from over
three thousand subscription
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companies, and
here's what we found.
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As to not bury the lead,
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increasing the guaranteed term
of your contract with your
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customers absolutely
lowers churn.
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Regardless of ARPU,
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those companies with a higher
percentage of annual contracts
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see significantly lower churn.
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This is because these customers
have only one purchasing
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decision per year,
albeit a larger one,
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whereas their monthly
counterparts have twelve
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purchasing decisions per year.
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Note that the correlation is
pretty strong here with those
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companies that have one hundred
percent annual contracts,
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seeing eighty percent lower churn
than those who only do monthly.
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We don't have enough data
on multiyear contracts,
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but qualitatively,
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we've seen the effects to be similar
with one important exception.
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As you increase the
term beyond one year,
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the reduction in
churn is minimal,
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meaning there isn't much to be
gained in terms of retention
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for two plus year contracts.
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There is much to be lost though
with longer term contracts.
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While many people use two
or more year contracts to
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guarantee they recover
acquisition cost,
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the impact is you lose out on
the ability to increase prices
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on your overall average
revenue per user.
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Note how those companies using
monthly or annual contracts
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tend to have some fairly decent
increases in ARPU over the years.
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The flexibility of these
contracts ensures that as a
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product improves, the
price can also improve.
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Remember, your price range is
the exchange rate on the value
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you're providing.
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Those with longer term contracts
tend to have fairly flat ARPU,
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mainly because so much focus
is being put on the longer
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contract that those terms don't
provide a lot of flexibility.
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Of course, a big lurking variable
here is longer term contracts tend to
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be used for much larger deals.
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So what should you do?
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Well, in most situations,
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you should definitely optimize for
a healthy dose of annual contracts.
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00:02:24,850 --> 00:02:27,955
Axiomatically, I would say that most
companies out there should avoid
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00:02:27,955 --> 00:02:29,155
contracts longer than a year,
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certainly because you wanna be
able to raise prices over time.
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Some industries won't be
able to avoid the long term
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contracts due to constraints
from the cost of acquisition,
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but these folks should then
make sure contract terms are
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flexible enough to
warrant price increases,
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especially as the
product improves.
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Well, that's it for now.
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If you have any questions,
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send me an email or video
to neil at profit well dot com.
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And if you got value here or
any other week of the report,
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we'd love any shares on
Twitter and LinkedIn because that's how
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we know to keep going.
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Thanks, and I will
see you next week.
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This week's episode is
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