An article I read recently analyzed a concept called “net dollar retention” (NDR) and how some companies use it to get a sense for business health. The allure of a simple metric to gauge health is clear. However, if the metric is too simple, it may hide complex problems.
Note that the input numbers must be within a reporting period but that such a period can be anything (e.g. a month, or a minute… whatever). Be careful not to mix them within an NDR calculation. As in other SaaS calculations, we consider cohorts of customers. Customers added during a reporting period form their own, distinct cohort.
Analyze the simple metric:
- If NDR >1, then the customer base value is growing
- If NDR <1, then the customer base value is shrinking
In my view, that simplification may cause one to declare a diseased company quite healthy. If NDR is 1.04 should you be concerned? It depends, because that number won’t help you understand:
- What causes growth
- What causes churn
- Why customers are spending at lower rates
Using NDR alone means you miss valuable information about the marketplace. For example, do the churning customers operate in the same vertical? Might that signal a market fit problem? Or might it warn you about a new competitive threat?
You may also lose valuable signals about your team. Perhaps one or two CSMs are responsible for all the growth. Rolling up your healthy/unhealthy analysis into 1 number may hide growth-oriented methods and procedures to grow more rapidly. Perhaps one salesperson sold all the churning customers or one on-boarding team handled the declining revenue customers?
- Churn based on customer volume (the number of customers) and customer value (the amount they spend)
- Additions through cross/up-selling separately from retention
- Each customer as if they are the only customer that matters to you. (That is how customers want us to treat them!)
The point here is not to dispel NDR, which has value and provides a useful rule of thumb. The pivot point is that NDR does not go far enough and is too simple to represent customer health. It is a bit like judging the health of your car by looking at the speedometer and neglecting engine temperature. The details matter.