Compound interest has long been a point of fascination for the world. There’s a misattributed Einstein quote in which he supposedly called it “the eighth wonder of the world” (it was almost certainly actually from a bank ad), and in his philanthropic pledge, famed investor Warren Buffett said, “My wealth has come from a combination of living in America, some lucky genes and compound interest.” Whoever’s voice is behind it, the concept is central to how the world works.
The way compound interest works is often explained through The Rice and the Chessboard story, where the inventor of chess asks the king for just one thing in exchange for his invention: double the amount of rice on each square of the board. The emperor agrees, not entirely understanding the math, but soon “realized that he was unable to fulfill his promise because on the sixty-fourth square the king would have had to put more than 18,000,000,000,000,000,000 grains of rice which is equal to about 210 billion tons.”
(For New Yorkers, the other fun example is cascading dominoes: if each domino doubled in size, how many would it take to knock down the Empire State Building? The answer is 29.)
So what does any of this have to do with sales?
Net Dollar Retention (NDR) = Compounding Returns for Software
Growing up as a salesperson in media, there was one big thing on my mind: new customers. The job was to call, email, text, and knock on doors for as many new signatures as possible. But the beauty of SaaS is that your customer is, in theory, forever. In the first generation of enterprise SaaS, this was accomplished with big contracts that had long lifespans. But as customer-led sales has taken hold, the opportunity to start small with a new customer has become an even better opportunity than starting big. Why is that? Because a small customer that grows to be big is a) a better customer (you’ve proven your value to them and vice-versa) and b) is a whole lot cheaper to sell than having to find a bunch of new logos that may or may not stick. Unfortunately, this still isn’t how many software sales organizations work. Often the deal is immediately turned over to someone other than sales, and the customer is left to expand on their own while sales continues to “hunt.”
But even that seems to be changing as high-profile public SaaS companies make Net Dollar Retention their central metric. Snowflake, one of the largest IPOs and fastest-growing SaaS companies in history, reported a 158% NDR in their S-1 last year. What does that mean? “If Snowflake had suspended all customer acquisition activity a year before their IPO day, they still would have grown by 58% that year by the grace (and increased spend) of customers they’d already acquired. That is one solid foundation to be building on.” Solid is one word for it. Absolutely amazing is another.
And it’s not just Snowflake. NDR is increasingly a metric you read about in new SaaS S-1s and hear during earnings calls—a shift that has come quickly. An analysis by Sammy Abdullah from 2018 shows that the median NDR for a publicly-traded SaaS company at the time was 104%. A more recent analysis by Jamin Ball shows that the NDR today is closer to 115%.
Why is NDR improving across the board? It could be that companies are taking it more seriously, which would align with the models of customer-led growth that includes more investment in product and customer experience. It could also be the maturing of software generally, as companies continue to accelerate digital adoption. No matter the reason, though, it seems safe to believe that the surface has only begun to be scratched. As NDR plays a more central role, it will drive changes across SaaS businesses, notably how sales operate to drive trial conversion and expansion.
A 20% Difference in NDR is going from Willy Loman to Warren Buffett
While an 11% increase in NDR from 2018 to 2021 may not sound like much, it makes a huge difference when you think about it in terms of compounding returns. To illustrate, here’s a chart from Tomaz Tonguz that shows how a 20% difference in NDR fundamentally changes outcomes over five years:
The math works out that the company with an NDR of 160% versus ~100% will grow 10 times faster in just five years, not accounting for any new logos in that period. That is a pretty outstanding metric that isn’t just theory. It is happening with companies that are now focused on their NDR and expanding their customer base.
In a world of Customer-Led sales (one of our Five Forces) this isn’t just lip service, this is how you get compounding returns and grow an amazing business.
What if your NDR isn’t that high? You can still make it up with new logos, right? The answer is “not really.” As illustrated in this excellent chart from the Software Equity Group, it’s a whole lot harder to grow when you’re not also expanding your base. The more you stare, the more you realize that you should focus on growing your customers before looking to expand your new logo base. As more companies recognize this, there’s no way they don’t ensure their energy is focused on driving up NDR.
Don’t just renew your deals, focus on expanding them. How do you do that? By having a relentless focus on the customer and how they are using your product. But I think that is relatively obvious. The more nuanced approach, which I believe is overlooked, is to have a sales motion that is married to how your customer is using and growing with your product. Incentives create behaviors, behaviors create results.
We would like to hear from you. If you are calculating NDR, if you are building a strategy around it, where you have seen success and failure?