The Smarter Startup

SaaS Customer Success: Gross Margin vs. Churn Trade-Offs


Customer Success costs are a drag on a startup's Gross Margins, but much less of a drag than losing customers.

Readers of financial statements at growth and early stage SaaS companies tend to pay the most attention to the top part of the income statement: Revenues, then Cost of Sales, then Gross Margin. And then, maybe, they skip to the bottom to look at net income or loss. Or more likely to the cash flow statement, to look at Free Cash Flow. Revenue and revenue growth are clearly the most important metrics, followed directly by Gross Margin.

Gross Margin is closely scrutinized, with typical early stage SaaS margins in the high 70s to mid 80s. Gross Margin is so important that a lot of SaaS metrics are purposely margin adjusted. For example, Customer Lifetime Value (LTV) and Customer Acquisition Cost (CAC) Payback Period metrics should all be Gross Margin adjusted.

A lot of focus is placed on Gross Margins at SaaS startups. And one of the largest, most controllable expenses in Cost of Sales are Customer Success (CS) personnel costs. Adding new CS personnel has a huge impact on Cost of Sales and therefore Gross Margins, and immediately impacts key SaaS metrics.

Hiring additional CS personnel has a much higher impact on financial performance indicators than hiring a new software engineer, even if the cost is the same.

Consider what happens when a company hires a CS representative versus a software engineer with the same salary. The software engineer increases operating expenses and cash burn but only marginally affects some profitability metrics. Conversely, the same dollars spent on a CS representative increases Cost of Sales, reduces Gross Margin, and leads to a lower LTV and higher CAC Payback Period. All metrics which are more closely scrutinized. Hiring additional CS personnel has a much higher impact on financial performance indicators than hiring a new software engineer, even if the cost is the same.

SaaS startups that spend less on CS have higher churn and likely lower sales overall, if a reputation for poor service gets out to the marketplace.

But strong Customer Success means far more to the customer experience and retention. SaaS startups that spend less on CS have higher churn and likely lower sales overall, if a reputation for poor service gets out to the marketplace. A 5% lower gross margin is much less impactful than a 5% higher customer churn.

Companies shouldn’t be cheap on Customer Success just to protect Gross Margins.

The conclusion is that companies shouldn’t be cheap on Customer Success just to protect Gross Margins, to do so risks a worse outcome from higher churn.