Promote annual subscriptions to improve retention and cashflow

Fact: the average SaaS company with 0% annual contracts loses 2 out of 3 customers within the year - while a company with 75%+ annual contracts loses less than half that number. Even having just .01 - 10% of customers on annual subscriptions reduces the average churn from 9% to 7.5% - a dramatic improvement ^[1] .

The lesson here is quite clear: Having more customers on annual subscriptions is good for your business - not just because of the better customer retention but also for other effects that we will discuss below.

How annual billing reduces your churn rate

Before we go any further, let us quickly talk how and why annual subscriptions are less likely to get cancelled.

It's simple when you think about it: Customers on a monthly subscription have twelve decision points where they may decide to cancel each year. They get 12 invoices - 12 reminders - to cancel.

Secondly and much less talked about, is the fact that customers on the annual plan have a whole year to start using your product and adopt it in their day-to-day business operation. Whereas with monthly billing they might fail to activate in the first month and cancel right after that.

These effects in combination explain why your business thrives from having more customers on the annual plans.

Why annual prepay is the cashflow king

Another benefit of annual prepay for your business is that it improves cashflow. Look at this example: 10 customers sign up for your product, which has a single $50 a month plan.

Obviously, you're making $500 that month. If you spend $100 to aquire each customer (or $1,000 for all 10 of them), you're short by $500.

Now add an annual plan at $500 a year. This means 2 months for free for your customers or a 17% discount over your monthly plan. Now assume that 2 out of 10 customers sign up for the annual plan while the remaining eight still select the monthly plan. Here's what that looks like in math:

Suddenly you're getting $1,400 in free cashflow each month. And you're still spending $1,000 to acquire those 10 customers. So you're making an additional $400 that you can invest in growing your business right now.

And that is the power of annual prepay: If everything works out, you're making more money each month than you pay to acquire new customers.

How to sell customers on annual billing

The problem with annual billing is that you need to convince people to give you a ton of money right away.

The most commonly applied tactic to overcome this objection is to give a discount. This is viable because most SaaS businesses operate at a high net margin of 80 percent or more. The lower profit margin from reducing the price even by 20 percent is outweighed by the benefits of annual prepay - namely higher retention and better cashflow.

The amount by which you discount is up to you, but the general copywriting wisdom is that framing the discount as "Get two months free" converts about 20 percent better than advertising the equivalent discount of 17%. Plus, you get an extra 3% of profit margin by discounting 17% instead of 20%.

Sell customers on annual prepay by offering prorated refunds

Another objection in the customer's mind is "Christoph will take all the money, make a run for it and spend the rest of his days on a beach in Thailand".

Which, obviously, I wouldn't do because sand is coarse and gets everywhere...

Yes, that was a prequel meme. You decided to read an article written by a Star Wars fan. Deal with it.

Where were we? Ahh yes, the objection of having to spend a lot of money now and the associated risks. The best way I know to counter this objection is to not be a scum bag who steals people's money. The second best counter is to offer (pro-rated) refunds generously. If someone decides to cancel two months in on their annual contract, give them the remaining balance. Don't heckle about every nickel and dime - it's not worth your time. If you have to refund them all the money (including for periods they used your product), do it and carry on crushing it with your other customers.

When to upsell customers to annual subscriptions

There are two timing options for upselling customers to the annual subscriptions:

1. Right at sign up
2. Later on (via email)

Offering your annual plans at sign up is a no-brainer. The harder decision is whether to offer them by default. This is dependent on the industry you are in, your average price point, whether Jupiter is in retrograde, and a bunch of other factors. If annual contracts are common place in your industry and you charge well north of $1,000 in annual contract value you should go with annual plans by default.

On the other hand, if you're selling a $7.99 a month B2C SaaS and every competitor offers only monthly plans, you're better off with having monthly plans as default.

The bottom line is to test this if possible.

Deciding when to offer annual prepay upsells via email

The other option is to ask your customers on the monthly plans to please upgrade to annual plans at some time after they signed up. Here the question is: When is it best to ask them?

The complex answer is that you want to reach them at the moment in time at which they are most likely to upgrade. This can be approximated by looking at different signals specific to your app (e.g. number of logins, feature usage), calculating an Upgrade Likeliness Score, and advertising the annual subscription upsell to them when the score passes a threshold.

OR, you ask them to upgrade after three months of being a paying user for an easy 80/20 solution. If your SaaS is like all the other subscription businesses out there - and it probably is - you'll see high onboarding churn during the first 90 days and after that period your churn will go down significantly.

By waiting three months you're waiting for the tire kickers to filter out and then try to convince the rest to upgrade to annual billing.

The email template for your annual prepay upgrade promotion

There is one email template I keep on using verbatim with all of my clients because it is so good. It was originally crafted by the folks at WPEngine and I came across it in an article by Rand Fishkin. Here it is:

This email is perfect because it:

• mentions that the customer gets two months free - instead of a 17% discount
• is clear about where it is from and what's the account in question
• is clear about the current monthly pricing, the annual pricing going forward, and the pro-ration rules
• provides an easy, one-click way to switch over to annual billing
• clearly states how to avoid any upgrades or changes

Additionally, it allows the customer to simply hit the "reply" button to ask additional questions. You can't draft an email much better than this.

Stitching it all together

Now that you know about all the individual pieces, let's jump right in and put it all together.

First of all, you need to enhance your app to enable an easy way for your users to upgrade to the annual plan. Ideally, you want them to click a link in the email and be automatically upgraded to annual with an easy way to roll-back the change on the upgrade confirmation page. In much the same way that Amazon's One-Click Checkout works.

Secondly, you need to set up the workflow. It gets triggered when a new customers subscribes to your app (e.g. by the "customer.subscription.created" event from Stripe). Next the workflow goes into hibernation for a little more than 90 days. After it wakes up again, it checks whether the customer is on a monthly plan right before it sends the promotion email. You want to check this right you send the email because the customers might have cancelled in the meantime or upgraded to annual on their own accord. The last step in the workflow is some sort of tracking of whether a customer has taken you up on the offer.

This is an example of what the workflow can look like in Drip. To make this work with Drip you need a generic URL in your app - e.g. /upgrade-to-annual/ - that does all the work and you need to authenticate the customer in your app before performing the upgrade. So despite this not being a true one-click experience for logged-out users, this is still a great approach because it is much easier to implement yourself.

Conclusion

Converting as many users as possible to annual prepay improves your cashflow and increases your retention rate. Asking the customers on your monthly plans to switch over is a guaranteed way to improve things in your subscription business.

Go ahead and try it for yourself!