Episode 365 | The Real Impact of Revenue Expansion

Show Notes

In this episode of Startups For The Rest Of Us, Rob and Mike define revenue expansion, talk about how it differs from revenue growth, why it’s important, and ways to increase it.

Items mentioned in this episode:

Transcript

Mike: In this episode of Startups For The Rest Of Us, Rob and I are gonna be talking about revenue expansion opportunities. This is Startups For The Rest Of Us episode 365.

Welcome to Startups For The Rest Of Us, the podcast that helps developers, designers, and entrepreneurs be awesome at building, launching and growing software products, whether you built your first product or you’re just thinking about it. I’m Mike.

Rob: I’m Rob.

Mike:  We’re here to share our experiences to help you avoid the same mistakes we’ve made. For this week, Rob, tell me the two most recent non mainstream board games you’ve played.

Rob: I played The Legend of Drizzt board game which is this $65 behemoth massive thing with these figures in it. It’s set in the D&D world. Drizzt is a character who’s been in a bunch of books, fantasy books by R.A Salvatore. It is pretty cool. It’s a simplified version of D&D in essence, you don’t have all the rules and the mechanics but it’s a lot quicker because you can play around in an hour.

I back a lot of games on Kickstarter so I could probably name five that are super not mainstream. There’s one called Mint Mint Tin Apocalypse. It was $2 or $3. It is literally a mint tin and then a couple wooden meeples and then some six sided dice. It’s cool because it takes 10 to 15 minutes to play and it takes 5 or 10 minutes to learn. It’s a long term, you’re gonna play all the time. When I know we just have a few minutes, you sit down and you can just hammer it out. It’s fun and it’s super cheap.

Mike: Aside from the board games, what else is new?

Rob: From the time this podcast airs, I will be wheels up to MicroConf Europe two days later. I’m excited to get to Lisbon. We’re gonna have folks speaking like Peldi Guilizzoni from Balsamiq, Andrus Purde who is the former head of marketing for Pipedrive, now has his own company called Outfunnel, we have Craig Hewitt from Podcast Motor, Mike Taber from Bluetick, Mojca Mars, a Facebook ad expert. We have several other speakers. I’m excited to get there and see some folks that we maybe haven’t seen for years as well as meet the new attendees who are coming for the first time.

Mike: On my end, when this podcast comes out, there will be an announcement for the tickets that will be available. I will be speaking at FemtoConf over in Germany in the spring. I believe it is the first week of March, it’s March 2nd to 4th. It’s over the weekend, it’s Friday, Saturday and Sunday. The tickets are actually going live the day that this episode goes out. If you head over to femtoconf.com, I’m told that they should be available, if they’re not it’s not my fault.

Rob: Aside from the fact that we like Christoph and Benedikt, I really like that they have the Drift right on their homepage, femtoconf.com, ladies and gentlemen. What are we talking about today?

Mike: For today’s episode, we are going to be talking about revenue expansion opportunities. I’ve been thinking about this a little bit just because it’s been on my radar for Bluetick to look at different ways that I can either rework the pricing or find other things to expand the revenue opportunities for Bluetick. I started looking into some of the different ways that that could be done but it also gave me the idea for this particular episode. We’re gonna be talking about revenue expansion.

Revenue expansion is different from revenue growth which typically comes from new customers. Expansion revenue is any revenue that is generated in excess of whatever the initial purchase price that the customer agreed to pay. If they signed up for $30 and they’re paying $30 a month, that’s great, that’s considered a new customer. It becomes expansion revenue if they move from a $30 plan to a $50 plan or to a $100 plan or if they add more users or purchase other services or other products that you have.

There’s a bunch of different ways that those types of things factor into it. The bottom line is when you’re defining expansion revenue, it’s really additional revenue that comes from your existing customer base that you would not have gotten otherwise.

Rob: The holy grail of running a SaaS app is having enough expansion revenue that you have net negative churn. I talked about this a few episodes ago. In essence, you always think of churn as lost revenue because of people cancelling. You can get to the point where if people are naturally upgrading to higher tiers as they use your product.

A good example of this is being ESP where as you add more subscribers, you naturally bump up every few months if you’re having any kind of success, you start paying more, that can be more, that amount can be more than the amount of revenue you’re losing because of people cancelling. When you see that effect, it’s called net negative churn. I’ll say it’s rare, it’s becoming more popular, strong word.

I’m seeing and hearing about it more as people catch onto how incredible it can be as a flywheel for growth because having low churn means you can grow at a certain pace. Net negative is super charge, it’s a completely different trajectory. If you’re lucky enough or smart enough, or both, to stumble into a business where people automatically have expansion revenue like ESP, I think web hosting if you do it based on maybe traffic or the number of sites.

I’m trying to think of other areas, Wistia for me. We had a small plan and we just keep adding videos and we’ve gone up. It’s not super often, maybe once or twice a year, we wind up going up. Mixpanel and Kissmetrics, they go based on number of events. As your website ramps up, you naturally go up the scale. I guess Help Scout or any types of support software where it’s a per seat, that’s a big one.

Per seat expansion is a big one because as a company has more success with their product, they are likely to either bring more people in because it’s working. What if they already have employees, they’ll add more seats or they’re likely, if they’re a startup, we went from 2 employees to 8 in the span of about 18 months. We just needed to add more people to all of our systems.

There are opportunities for some natural ways to get expansion revenue and to try to get to that Holy Grail as I’ve said, net negative churn. I hope I didn’t steal your thunder, I was going off the top of my head. Did I totally decimate this outline with that diatribe?

Mike: No, just the first little piece of it. We’ll link up in the show notes a couple of different blog articles specifically about how new recurring revenue is different from expansion revenue which is different from churn revenue and how those can combine to create that negative churn effect. Those blog articles, some of them are from parametric or Price Intelligently and then there’s also another one from geckoboard.com.

You already talked a little bit about why it’s important because it relates to negative churn. The bottom line here with going after revenue expansion is that it helps to offset your existing churn because, as Rob just said, when you’re losing people just on a regular basis, you’re going to lose people on a monthly basis or quarterly basis, whatever it is, that your billing cycle tends to be on. That helps to offset that.

It’s easier to get more money from your existing customers because presumably you’re keeping them happy, than it is to acquire new customers, it’s typically a lot more expensive to acquire those new customers. We talked about these acronyms like CAC which is cost to acquire a customer, that number tends to be substantially higher for a new customer than it is to get expansion revenue from existing customer where you’re doing some cross sell or upsell or you’re asking them to opt into this other thing.

It’s a lot easier to do those things because you already built that trust. When they’ve never purchased anything from you before, they’re much more reluctant to take that first step because they’re pretty sure that it’s going to take up time. It’s not that it’s not valuable to them but they’ve got other things that they’re doing in addition to paying attention to your product and other things that it can do for them. There’s only so many hours in a day for them to focus on the things that they need to do. That adds one more thing to their plate.

Let’s dive into some of the different ways that you can increase revenue. The first one, Rob alluded to this where some of the examples he came out were Mixpanel or Kissmetrics or hosting providers where as the customer becomes more successful, they use more of your services and by virtue of that, they start paying you more because they’re using more of the resources that you offer. This is essentially increasing their consumption.

There’s another way to look at it, which is to decrease the friction that it requires to use whatever that is as well. Some examples that come to mind are Apple’s iPod or the Fire TV from Amazon. Those things make it a lot easier to download music or to purchase movies or rent movies. Those devices make it a lot easier for you to consume them and to consume them at a faster pace. Those are some examples of that.

If you go over into the physical products world, this occurred to me a while ago, I’m sure somebody has talked about it at some point, if you remember going to McDonalds back in the 90s for example, the straws were insanely small. If you ever went and got a milkshake, it took you forever to drink the milkshake because the straw was so small. You go to McDonalds now, the straws tend to be substantially larger. They’re probably six to eight times the size that they used to be and put through a lot more liquid in there and drink it faster.

That leads you to increasing the rate of consumption, it also leads to larger portion sizes as well. As a consumer, you have to be careful but as a producer of whether it’s content or digital assets or something along those lines, if you can increase the rate that somebody is using your product or services by decreasing the amount of friction, that’s almost the same thing as being able to deliver more.

Rob: Another example that McDonalds was I think a pioneer of, we’ll talk a little bit later but that is cross-sells. When you’d order a burger, what was the famous saying, “Do you want fries with that?” We’re trying to encourage you to do that, and then they had meals. I remember, I’m old enough to remember, when you go to McDonalds and there were no meals. You order a hamburger and then you order french-fries and then you order a drink if you want that.

They started packaging the meals to do exactly this, increase consumption of overall amount of food. You could also call it a cross-sell. This of course can backfire on you, it’s very unlikely to happen to one of us running this small business. Remember that movie Super Size Me, it was a look at how bad McDonalds’ food was. That was the name of it, it was a take on.

You used to pull up to McDonalds and you’d ask for the meal deal, big mac meal deal and they’d say, “Do you wanna supersize that for $0.99?” You’ll get an extra-large drink and an extra-large fries or something like that. That was another way to increase consumption, it was an upsell in essence. A lot of people did that. There were complaints of you’re encouraging people to eat bad food and blah, blah, blah, the politics of it or I guess the morality or ethics of doing that aside, odds are you’re not selling unhealthy food to folks.

You are probably doing something like selling software, selling info products or ebooks. If people use or consume more of them, you can encourage them to do so, then that’s gonna help you increase your bottom line.

Mike: The next one is the very issue on that which is increasing the number of seats that people are using. Not every product is going to have a pricing model that’s going to be able to support this but there are certain cases where a per user model makes a lot of sense. There are ways to incorporate other people unto the team in an environment where there’s your customer or consulting companies that they use, whether they have contractors. Those people may need user accounts.

You do have to be a little careful with this because, as I said, the type of product that you have, you can easily end up in situations where people are just sharing an account and you’re trying to sell a single account for $50 and two accounts for $100 or maybe a slightly reduced price of $90. They won’t go for it because they’ll just decide, “We don’t need that, we’ll just share the account between these people. It’s not that big a deal.”

Just be aware that sometimes it’s an option, sometimes it’s not but there are opportunities to put people into a software package and other ways, other roles inside of it or other responsibilities which give them maybe different options or different features.

Rob: There is actually a really good rule for this on how to decide if your product should be seat based. This is hard and fast, I know lot of time we say, “This is a guideline.” I actually believe that you should not break this one either way. If someone logs into your software with their login, do they see something different than if they login as someone else? A good example of that is Mailchimp or Drip and ESP.

If you and I share an account and we both login with our own logins, we see the same thing, there really isn’t anything different. The only difference is if I were to login as you and do an export, you’ll get notified, you know any exports done but the minimal stuff. If I login to a CRM system or into Bluetick as me versus you, it’s a completely different inbox, completely different list of customers, completely different list of tasks.

The CRM always charges by seat because that’s their upsell and that is the differentiator. It is a minority of products that can charge by seat. Just ask yourself the question, “Does someone/should someone see something different if they login as a different person?” Trello is another example. If I look at my Trello account versus yours, they’re totally different. If we had a business account with seats, you should absolutely charge by seat.

I do see people make the mistake, you mentioned this, of trying to charge by seat when they don’t have the differentiator and then you just get one seat and then save it with everybody because there’s no difference, it doesn’t make sense. It feels to people like you’re being disingenuous if you did do that. I can’t imagine an ESP charging by seat.

There are some marketing automation platforms that charge by seat because they have CRM built into them. Infusionsoft, ActiveCampaign are examples of that. they do have per seat pricing. I’m almost positive if it did not have that CRM view, they would not do per seat stuff.

Mike: The next option for increasing your revenue is to have different upsells. These could either be a higher tier of an existing product or it could be add-ons, it could be additional integrations to give people access to, it could be plugins. There’s a variety of different options that you could give somebody that provide additional functionality on the base level package that you could use as an upsell opportunity.

If you’re using these, you can either have bundle deals on your website where you’ll just say, “Here’s a package deal. It’s $100 for these X things.” Or you can say, “Ala carte, you can get each of these if you want, each of these five but it’s gonna cost you $30 per piece if you’ll buy them individually. Buy them as a bundle, you can get them for $100.” That bundling is also an option for an upsell.

It doesn’t seem like it is but when you start looking at who the types of people are that are buying those things, chances are good that they’re not gonna use all five of them in that particular example. They’re gonna use maybe three or four but the package deal is appealing to them because they have in their head that, “I might use these things down the road.” Even if they don’t use them now, they may have an intent to use them later.

Whether they do or not is immaterial but you can get them to purchase that package deal whether or not they’re gonna use it especially if you position it as a good deal for them.

Rob: This is very different, there’s upsells. It’s different between info products and software. Upsells are very natural and tend to make a lot of sense with information. If someone’s gonna buy a book from you then you upsell them to the videos or you upsell them to a 30-minute console or some interviews you did, that’s pretty natural.

Software can be more of a challenge, it can take more effort. You can always upsell training, really hardcore training. You don’t just want documentation to be upsold, you want that to be free. Something that actually gives someone a mindset view or an architectural overview that they would normally have to pay for, there is that line of you look at pricing of segment.com, their tiers are less based on usage and much more based on the integrations that you use.

I’m sure they know that someone integration with Salesforce tends to have bigger budgets and a lot more value out of segment than someone not doing that. Zapier, I think it’s the same way. There are certain things that are locked behind higher priced paywalls. Drip tends to be that in these apps that integrate with a lot of things because they know if someone is using Drip, they’re probably a more sophisticated marketer, they probably have a larger list, they probably have a bigger budget, that type of stuff and they’re gonna get a lot of value out of these tools.

This takes a lot of thought. The hard part about this is knowing what to lock behind these feature gates and doing it incorrectly is pretty easy. I’ve seen it swing both ways and I do think that if you find one of these other paths where your expansion revenue can be based on number of seats or it can be based on number of subscribers or contacts or it can be based on number of events, there are certain things to fit in, storage size, if your Amazon has three, then go with those.

Probably stay away from trying the feature gate right now, feature gating meaning you can’t get this feature unless you go up a tier, you pass through this gate by paying more money. If you don’t have an obvious way to use one of those obvious numbers that everyone else is using or makes sense for your product, then yes, you do need to seriously start thinking about ways, how do you build tiers when you don’t really have an easy one number like seats or subscribers or contacts to look at?

Mike: That’s actually a really interesting discussion topic just because I think that people look at those features and say, “What should I put in here as a feature gate to create these different pricing tiers?” I remember when Segment used to feature gate based on which integrations you were doing because presumably if you were using Salesforce, you had the money to pay for Salesforce. Clearly, you had money to pay more for a segment license. I think that they’ve shifted their pricing model and you don’t have to do that anymore. When you sign up, they have three tiers.

Rob: I was just saying that they did, I was mistaken. Zapier still does that, Segment used to.

Mike: They used to do that, they don’t do that anymore. I think it’s partially because they got to a point where they were far enough down the road that they had the ability to dedicate somebody to take a hard look at those things and see whether or not they mattered. Having the conversation with the customers to try and find out what the more optimal pricing model was for them.

Rob: They do it now on monthly track users, empty use they call it. It can be dicey, although with Segment that makes sense. How many users are you gonna track in a given month? That’s actually pretty easy to get an idea, you can think of how many either customers or how many website visitors unique in a month. Other times you’ll see like Amazon has pricing like this where it’s number of elastic compute units. What does that even mean? It’s something that is not defined anywhere.

I’ve seen things based on events and it’s like, “I don’t know how many events I’m gonna have in a month. How am I gonna know that?” Kissmetrics and Mixpanel have that problem of trying to define what these things are.

Mike: Even Segment has that problem because the empty use that they advertise, that is for the number of tract users coming to your site, not necessarily the people logging in. It’s not your team. If your website suddenly gets a ton of traffic from Reddit or Slashdot or something like that, you could easily blow through that very quickly depending on the company. You could either end up in a world of trouble with a giant bill or they could say, “We’re gonna turn this off, we’re not gonna allow you access to the rest of this data unless you pay for it.”

Rob: Something that Segment is – I’m looking at not the pricing grid at the top but they have a breakdown of what the differences are between the plan limit levels. Without knowing what their internal data looks like, they both have empty use, that’s monthly tract users, plus they have seats, the lower end only has 1 seat, and the team one has 10 seats. I’ll go back to my question, if I log into Segment as you versus me, do I see something different because as far as I know, you don’t. I actually think that’s probably not a good idea.

They have sources which is how many sources are you going to connect to Segment. The developer panel has two and then all the others have unlimited. Maybe that one is harder to say right or wrong. When you’re first starting out, you don’t have the trust of the market, you don’t have a brand name, you look at people like Segment or Intercom or MailChimp or Drip, we have the luxury of having a brand name and people are actually seeking us out.

We can raise our prices and we can do more complex pricing schemes because people are willing to come and use a tool that they trust and a lot of people are talking about. In the early days, this was with Drip as well as Intercom as well as your tool today, I’m speaking to a listener there, you don’t have the luxury of being able to have super complex pricing because no one’s gonna wanna bother with it because you’re probably struggling to try to get people to come and try it out and try to use it.

I would go extremely simple and I would go for one of these numbers, per seat, per subscriber, per contact or something else that’s very noticeable and easy to figure out until you get to that critical mass. You’re gonna know it by the fact that people are gonna start telling you, “Boy, you should raise your prices, you’re too cheap.” Or you’re gonna look around and say, “I haven’t raised my prices in a year, I need to rethink this.” You should have pretty good flywheel growth by the time you get to that.

Drip is now on its fourth version. We have versioning for pricing. We’re on our fourth version of it in four years. We haven’t done it every year on the dot but we actually did it three times in the first probably year and a half or something and then we really haven’t done any restructuring of pricing since then. Do try to keep it simple in the early days and don’t try to copy companies that are way further along because they have the momentum and the flywheel and the brand and you don’t have that yet. You don’t wanna make this mistake of confusing people.

Mike: Everything that we just talked about is really adjusting your licensing model in order to create more opportunities for upsells using those pricing tiers. Another option that you have that’s available to you is offering some annual plan, whether you offer upfront or you offer it a couple amounts down the road after somebody has started using your product and he’s getting comfortable with it.

Maybe there are certain trigger points where you say, “Let’s offer them an annual plan or a special discount upgrade for three month upgrade. Try this out, the platinum tier for free for 30 days or 90 days.” There are different ways that you can position that and pitch it to people. What you’re trying to do is you’re trying to increase that overall revenue from them so that it decreases the number of times that they’re gonna have to sit down and think about, “Do I really wanna continue paying for this?”

I think Leadpages used to do that really well with their webinars, if you attended a webinar, you could signup for Leadpages account and they would pitch you on a two-year plan. For two years, you are probably not going to go look for another landing page provider because you have this account. Unless it’s not doing what you needed to do, you’re not gonna go look for something else because you’ve already purchased it.

Rob: One of the big benefits of annual plans, especially when you’re starting out is you’re tight on cash. To get someone to pay for 12 months of service in advance, even with a discount, that cash is invaluable. If you can figure out a way to get someone to pay you for that full amount of service and you’re doing any type of paid acquisition, you are gonna be in a great spot. Basically spend a dollar, get $3 or $4 right away. It is a flywheel, it allows you to then acquire more people faster.

It’s pretty incredible, the power of being able to get annual. That’s why you’ll see pretty hefty discounts, 20%, 30%, 40% on annual plans because the cash is just so important to startups in their early days.

Mike: We mentioned this next one several times throughout the episode, it would be cross-sells. If you have other products that you have to offer, cross selling them after somebody has purchased the first product if there’s another one that relates to it or integrates with it, if there are signatures that you can identify with the customer that would indicate that they would probably be a good fit for this other product that you have, then there’s obviously ways that you would wanna interject yourself into a conversation with them to put them in an email campaign or have somebody call them and say, “Would you possibly be interested in taking a look at this over here because we think that this would help your business as well based on what you’re doing and what we’ve seen other customers get in terms of benefits and the similarities between the customers.” That’s another one.

I’m gonna move on from that. The next one is services and customizations. I think this one is a key piece that most software people overlook because we’re trying to build software companies. Our natural inclination is to build a software and sell people software, but the reality is sometimes people need a little extra help, whether that’s onboarding assistance or they need you to do something for them whether it’s a productized service.

There’s lots of different pieces to your application, it’s not just signing up for and plugging in a credit card. There’s usually a lot of other things that the customer is gonna have to do in order to get the value out of that particular product. Because you have all the insights and the backend knowledge and the main expertise for that particular product, you can do those things a lot more efficiently than the customer can.

You can create a service that is going to use your product on their behalf to achieve whatever the goal is and now you’re able to do a lot more because you can dig into the guts of it. If something is not gonna work the way it’s written, you can find ways around it, you can import things directly into the database if you need to and then make the software do it so that you can deliver on that service that you’ve promised them.

They’re more likely to purchase those services because it provides a lot more value to them by having it as more of a done for you service rather than they signup and it’s self-service because that’s most of what SaaS applications are, most of them are self-service versus a productized service where you’re hiring somebody to do something or deliver some sort of value or output. That’s what you’re paying them for, you’re paying them for the output. With SaaS, you’re paying them for the license to use that tool for the duration of them paying for it but they still have to do the work.

Rob: I think there are two aspects to this. You said services, it’s like the productized service. There’s a second aspect which is customization. It’s going to be like if someone came to us, actually we’ve used this with DotNetInvoice all the time. It was downloadable software you run into your own server, it was like self-hosted Fresh Books, a simpler version of that. People would buy it and say, “I don’t want this this thing added,” more like yeah, we’re not gonna build that feature, we’ll pay you to add it.

At first it was like, we’ll charge you $150 an hour and then we moved up to $200 an hour because we just really didn’t wanna them. It made some money but it was a hassle. Consulting, if you wanna be in that business, go do it, it’s lucrative in the short term but if you wanna build something long term, it’s hard to mix those kinds of businesses because they’re two different businesses, serving clients, offering deadlines, doing the contracts.

What if they’re not happy with it, what if they request changes, that’s a type of business. Building your own software product is another type. You’re not gonna move forward full steam on your software product if you’re busy doing a bunch of consulting gigs. The problem is the consulting gigs are like the quick hit, it’s like the crack cocaine where you get the $5000 or the $10,000 because someone wants you to do something.

Of course you’re gonna run off and do that but that revenue isn’t worth nearly as much because it’s dollars for hours. You’re not spending that time marketing your product and building features that other people will use. Even the market itself speaks, if you were to go raise venture funding or you were to try to sell your company even through a broker or you were to go public or whatever, any type of valuation, software recurring revenue is gonna be 3X to 7X your revenue multiple.

Consulting revenue tends to be in the 1X, maybe 2X if you’re lucky. It is a third to a fourth as valuable on the open market because it’s just how these things work. I think you have to be really careful about taking the quick hit or the quick dollar because it is gonna slow you down. If you’re super desperate and you really need the cash, there’s times when it’s not an absolute rule, there’s times when you might need to do this but I advise founders against doing this if it all possible.

Mike: The last item on our list for revenue expansion opportunities is to have an affiliate offer. This could be in the form of a direct product that you are offering that is a third party product that you are getting a commission from or it could be a referral. If you have a good relationship with a provider and there’s a subset of customers that you know need something that you’re probably not going to do it but you have a good relationship with somebody who does provide that service or that type of product, then you could setup an affiliate relationship with them where you will refer customers over to them where you’ll get some commission or kickback or finder fees, something along those lines for referring them over.

You could also do this for free, I know that there are people out there who like those types of things and they’ll just say, “Here’s some free business because I know that you’re gonna take care of them and I don’t really want anything from it.” Those opportunities are available as well, you can probably find people who will do the same thing for you. I think it’s much more common to have some sort of an affiliate relationship setup so that there is a specific dollar amount tied to it or percentage. It makes it easier for you to quantify how much work and effort it’s going to take you.

Rob: If you have other ideas for revenue expansion that you feel like we missed in today’s episode, feel free to come to startupsfortherestofus.com, Episode 365. Post a comment or email us at questions@startupsfortherestofus.com. That wraps us up for the day. You can also call our voicemail at 888-801-9690. Our theme music is an excerpt from We’re Outta Control, it’s by MoOt used under Creative Commons. Subscribe to us in iTunes by searching for startups. Visit startupsfortherestofus.com for a full transcript of each episode. Thanks for listening. We’ll see you next time.

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