Two decades into the birth of software-as-a-service (SaaS), the sector is only heating up with increasing intensity. Adoption of SaaS was well underway long before the pandemic magnified the need for cloud-based ways of working and digitizing workstreams.
But navigating and deriving actual value from the ever-expanding constellation of digital products available can be a struggle. This is where the tech company Gainsight seeks to help. The San Francisco-based software company helps SaaS companies optimize revenue with a platform that provides clearer views of net revenue retention—that key metric of SaaS company success—and the factors that drive it.
Gainsight CEO Nick Mehta is a SaaS veteran, having sold his email archiving start-up LiveOffice to Symantec in 2011 for $115 million. He spoke recently with Paul Roche, a senior partner who leads McKinsey’s Software practice, and Sid Tandon, a partner who heads up the firm’s software value creation work. Their edited conversation appears below.
McKinsey: Nick, thank you so much for joining us today. One of the things that we found in our recent research on SaaS value creation is that net retention is one of the most important metrics and is highly correlated to value multiples for SaaS companies. From your vantage point, having seen hundreds of your customers deploy this kind of software, how important do you think net retention is, and how does it evolve based on the size of the company?
Nick Mehta: Net retention has become, by far, one of the top metrics that people look at in SaaS. We’ve done research on publicly traded stock multiples, and net retention—as much as almost any other factor, right alongside growth rate—is one of the biggest drivers of shareholder value.
It’s showing up in all parts of the tech company ecosystem, from early-stage companies that are looking at net and gross retention, to investors looking at it to determine product–market fit: How is this product doing? Is it naturally sticky? Is it naturally growing? It’s often one of the first things early-stage investors ask about. In the growth stage, companies are looking at it constantly to see how efficient they will be at growth. We all know that going through existing customers is just so much more efficient, so companies with high, natural net retention are just going to grow more efficiently, and easily.
I know all the major growth investors heavily scrutinize retention as part of their investment thesis. In every single earnings call for publicly traded SaaS companies, there are questions about dollar-based net retention, or whatever terminology people use [such as net revenue retention or net retention rate]. And then in private equity, every PE sponsor is using it as a big part of their diligence, trying to understand not just the high-level metrics, but the cohorts, and what’s driving them all throughout the board.
Net retention and product-market fit
McKinsey: Could you talk a little bit about the product–market fit point you just mentioned, and how people look at net retention as a bit of an indicator of growth and market fit in earlier-stage companies?
Nick Mehta: Product–market fit is probably one of the most overused terms in technology, but also one of the most powerful. It really comes down to the idea of how much natural need and demand there is for a given product or service.
Obviously one measure of product–market fit might be ease of acquiring new customers—your customer acquisition cost, that magic number some people talk about. But another is how sticky this product is, and how naturally it grows inside an organization? We can pick an extreme outlier like Snowflake [the cloud-based data warehousing service] as an example. They have fairly good product–market fit, and their 180-ish percent dollar-based net retention just shows the natural demand that customers have for things like Snowflake.
I think for a lot of investors, dollar-based net retention is one of those things that can tell you, “Do you have lightning in a bottle or not?” Still, one of the things I always tell CEOs and operators is that, for a given type of business, there’s a range of dollar-based net retention. If you’re an application software company, you’re unlikely to ever have 180 percent net retention, because that tends to be more for the consumption-based businesses. But within your category of software, where you fall in that range is a sign of product–market fit.
McKinsey: When you talk to your customers and CEOs about net retention, how do you see companies unpack that metric and use it?
Nick Mehta: Net retention is interesting, because at a macro level it’s an indicator of how a company’s doing in terms of product–market fit and customer experience. But it’s also kind of a flashlight in terms of where you should focus as a company within your organization. I think most companies now have net retention as one of their core metrics in their dashboards, and in their quarterly business reviews. But then they’re looking at it by customer segment, and by product. They’re looking at correlations between activities that they’re undertaking, for example, the way onboarding works, or training, and then how that affects net retention. They’re looking at how future consumption drives or hurts net retention. They’re using net retention as an objective variable, and then looking at all the things that correlate with that outcome.
Defining (great) customer success
McKinsey: How do you define customer success and why is it important, from your vantage point?
Nick Mehta: Customer success came about as companies moved to recurring revenue business models like SaaS, subscription, cloud, and any model where you’re not getting all your revenue up front. That forced vendors to say, “I need to not just focus on getting new customers, but I need to focus on keeping and growing my existing customers.”
So, customer success is defined as the process by which a vendor maximizes the likelihood of a customer to stay, expand, and be an advocate by driving outcomes and a great experience for their customers. From a vendor perspective, it’s about your renewals, your expansion, and your advocacy. But the customer cares about getting the outcomes they were sold and getting them with a strong experience. And so, customer success, in some ways, has two sides—what the vendor wants, and what the customer wants.
McKinsey: Customer success has been evolving over the last decade, and you’ve been there from the beginning. How far has it come?
Nick Mehta: We launched Gainsight in 2013, when customer success was a concept that was practiced by a few dozen of the early SaaS companies, most notably Salesforce, Workday, Box, and a few other companies. If you looked on LinkedIn at that point, there were about 500 customer success managers [CSMs] in the entire world.
Today there are about 250,000 CSMs. Every single software company has a customer success program now. And it’s not just lip service anymore, where they put three or four people into the program. Many, many companies have hundreds and hundreds of customer success managers trying to scale the business and drive net retention.
McKinsey: What does a good or a great customer success function look like?
Nick Mehta: Number one, a great customer success function has a well-defined measurement, and some consistent definition of value to the end customer. Customer success is about driving outcomes and value for the end customer while giving them a great experience. So, a customer success program requires you to sit down as a company and think about what value means to your end customer. Typically, this shows up in what people call a “value framework,” where they’ve defined one of the value levers for which a customer buys a product or service. Maybe it’s increasing revenue or improving employee satisfaction—things like that. And so, they build that definition of value, and consistently run it from marketing on the website, to the sales process, to implementation, and then to customer success.
Number two is having a well-orchestrated process tied around a customer journey driving that value. It’s not just a bunch of people trying to do an excellent job for customers. There’s a well-defined journey that says, “Okay, this customer comes in, they have an expectation of value. We are taking them through a series of motions, across all these different functions in our company, to get them to that value.” It’s an orchestrated process with playbooks around a customer journey.
Number three, a well-defined customer success function has metrics to measure not just the lagging indicators—not just renewal rates, or net dollar retention, or even NPS [Net Promoter Score], but also the leading indicators. There is an understanding of what the leading indicators are that correlate with those lagging indicators, so you can sense where you’re going, and not just be driving the car through the rear-view mirror.
And then finally, a great customer success program isn’t just for your biggest customers. There are many companies that have customer success, and they do it for their top 20 customers or top 100. The best companies, however, have figured out ways to combine human resources and digital technologies to scale across all their customers.
Tracking customer success
McKinsey: One of the debates that software companies have is whether customer success should be tracked with a renewal or a revenue number. About 50 percent of companies, we see do that, and the other half do not. What do you think is best practice?
Nick Mehta: We did a study recently for our customers, asking them whether they have their customer success teams measured on a renewal rate or not, and 50 percent said that they do, and 50 percent said that they don’t. So, there’s still a great debate in the industry about this.
What I found is that if you look more closely, a lot of it depends on the company’s business model. If the company sells a product that tends to be higher velocity with a lower average selling price, and maybe a little bit more transactional, you find customer success teams are more closely oriented to revenue, and in some cases, owning the renewal, or owning expansion, as well. No matter what, they are being measured based on the efficacy that they have with respect to the renewal rate and net retention rate.
But on the other extreme, for companies with long sales cycles, complex products—maybe very technical products, or very change-management-oriented products, or long-term contracts—those companies tend to not just look at renewal rates, because frankly the renewals that happen now are the result of work that might have happened two or three years ago. Those decision cycles are long for the client. And because of that, you often measure the customer success team on early or leading indicators. Things like adoption, customer health, alignment with our stakeholders, demonstration of value. You’ve got these leading indicators that help focus the team on stuff that will drive the results in the future, not just always chasing things that’ve already happened.
Now, one thing that helps unify both sides is net retention. Because even in a business with a long sales cycle, you can often expand the customer outside that renewal cycle. So, many companies are saying, “We want to give some incentive to the customer success team for net retention, so they actually have motivation to work with the sales team, not just keep the customer, but expand the customer.” Customers that tend to buy multiple products end up being stickier long term. So, expanding customers is good for retention.
The customer success talent challenge
McKinsey: What about the talent piece of customer success—those 250,000 CSMs you mentioned. How do you attract that talent?
Nick Mehta: The biggest challenge right now in customer success, by far, is hiring. The job is so in demand, and software and tech companies are growing so rapidly, that they need so many CSMs. But because the job’s new, there are not that many out there. It’s an incredible talent challenge that is resulting in lots of turnover, skyrocketing salaries, and many unfilled positions.
The impact is that clients aren’t being served in the way that vendors want to be serving them. One thing that companies are trying to do is to better define the role of the CSM, because when you hear the term “customer success manager,” it’s probably one of the most open-ended job titles out there. “My job is to make the business successful, right?”
That level of open-endedness often leads companies to have such broad job requirements that it can feel like you’re trying to hire a unicorn. You know, somebody who is great with customer relationships, really organized like a product manager, understands our technology inside and out, has been in the shoes of the customer, has worked in consulting, has done change management. Honestly, that kind of person’s probably going to be a CEO one day, so hiring and holding onto them is not easy.
Some companies are trying to deal with this issue by saying, “We need to have a strategy for where customer success starts and stops as a role.” It is essential to keep in mind that there are two aspects to customer success in a company, the role, and then the strategy, which includes many departments in a company, between sales, services, product, marketing, and customer success management. So, the first thing is clearly defining the CSM role.
McKinsey: How do they go about doing that in practice?
Nick Mehta: What I’ve seen is that there are a few archetypes out there that help you get a little more clarity.
One is the product expert. If you’re in a company that has a pretty technical buyer, for example, DevOps, security, or infrastructure, it’s hard to go to that customer unless you have a deep understanding of the product. And so those companies end up hiring people with that kind of background, a former support engineer, a former sales engineer, or maybe somebody from professional services.
A second archetype is the domain expert. This shows up a lot in vertical software companies. You’re selling to a certain vertical industry, so it’s often helpful to have people that come out of that industry, who have been in the shoes of the buyer.
A third archetype is if you have software that really drives a lot of enterprise change. People often hire out of consulting for that role, because obviously a big part of consulting is driving change. And so, understanding the archetype needed is one of the critical things to being able to hire your CSMs.
Another thing that is important is expanding the hiring funnel. If all of us say, “We want to hire customer success people who’ve been customer success people before in other tech companies,” we’re playing a zero-sum game. Customer success is such a new profession that we all need to embrace the beginner’s mind and realize that there are lots of great people out there who can learn very quickly.
At Gainsight, we’re passionate about using this new, growing profession to drive more diversity and inclusion in tech. There are a lot of great people from many walks of life who don’t typically get a chance to break into tech, and we believe customer success could be that chance. So, we created a program called CS YOU where we bring people from underrepresented groups—including people of color, LGBTQIA+, stay-at-home parents, military veterans, and disabled individuals—into internships in customer success. After training them in the profession, we help to place them into tech companies where they can eventually become full-time. Whether you participate in that program, or you do it yourself, I’d encourage you to look more broadly than just hiring people that have already done it before.
SaaS and the Rule of 40: Keys to the critical value creation metric
Making customer success an organization-wide priority
McKinsey: That is such an important goal to drive. Can you talk more about the interplay between customer success and the sales product? How does that work as a function? What is the operating model?
Nick Mehta: As with most new initiatives in companies, you create an organization, and that organization starts driving some change, and inevitably, you figure out that the new organization on its own can’t solve all the problems. And that’s happening in customer success, where companies create a customer success management team, they staff the team, they have great people, they start working with the customers, and they realize that to truly drive customer success across the entire customer base, it can’t just be about that team.
Part of this is about the sales process and the expectations we’re setting in sales. Part of it is the implementation process, or professional services. Part of it is the channel that might be working with your customers—resellers, partners, folks like that. And certainly, one of the biggest parts of a digital business is your product itself. How does a product work? What functionality does it offer? Is the road map evolving to client needs? Is the product team giving you telemetry so the customer success team can understand how the customers are using the product?
Great customer success teams now have two jobs: Job number one is to work with customers to drive toward outcomes and great experiences. Job number two is to influence the rest of the company by looking at the end-to-end customer success process, the end-to-end experience.
Many companies are investing not just in customer success managers, but in actual customer success experience and operations programs to look at the holistic customer journey, and then go influence, for example, the product team on what road map requirements are needed, or what telemetry is needed. They work to influence the sales team in areas like the hand-off from pre-sales to post-sales, so that the customer success team knows why the client made the purchase. And they work to influence the services team to redefine some of those services packages in order to drive toward customer outcomes.
McKinsey: It sounds like one aspect of the operating model is the people and how they work, and another part is the technology and tools at their disposal. How do those factors come together to help make CSM as a function successful?
Nick Mehta: In almost every business, you start by saying, “Let’s have people work on a business problem and try to solve it.” Eventually, people figure out that technology can be a great lever to help the team be even more effective. The customer success management team is like any other functional team in a company, where they’ve got workflows, they’ve got data they have to look up, and processes they have to run. Any time those processes aren’t efficient or aren’t effective, that’s less time for them to work with customers. And that translates to less knowledge of which customers they should be working with. So, in one sense, technology is helping the CSM team get to the right customer at the right time, with the right message, in an efficient way.
The second way technology helps is by enabling you to build scalable, digital-first, customer success programs that aren’t just totally people-dependent. Instead, they rely heavily on automated communications—whether inside an app or via text messages—and only involve humans in certain cases, so they are not always the first line of defense.
I think perhaps the biggest benefit of technology long term is that, by digitizing the customer success process and driving toward more standardization, you create this incredible exhaust of data that lets you know not just whether your customers are renewing, but whether they are adopting your product. And you also know all the activities you’re engaging in to try to improve the renewal rate and adoption, so then you can start finally figuring out what’s working and what’s not. You can start using artificial intelligence to say, “Okay, for the clients that renewed versus the ones that didn’t, what were the factors that seemed to be correlated with the better customers versus the ones that didn’t work out better? Where are we spending our time well? Where are we wasting our time? If we had another dollar to spend next year, where should we put it?”
Technology makes your people more efficient and more effective. It lets you scale across all your customers. But most importantly, it lets you make sure that you’re putting your resources into the efforts that actually have an ROI.
Best practices and common errors
McKinsey: You’ve talked about how companies do things that work well. What are some of the things that you’ve seen companies overlook or get wrong with customer success?
Nick Mehta: Companies get excited about customer success as a concept, and most employees want their customers to be successful. But one of the first mistakes they make is focusing too much on platitudes, and not enough on actual operational implementation. Companies will declare it the year of customer success, or make it one of their values, or the theme of the all-hands. I think that’s good in terms of psychologically driving change, and necessary, but not sufficient. You also need the actual substance of change.
Another common mistake is believing it is just a people problem. You go to your boss, you get budget for hiring 100 or 50 people, and they say, “Okay, let’s go have them talk to the customers and figure it out.” In reality, it’s more of a process problem: the challenge is understanding what the process is to get that customer from their desired outcomes to delivered outcomes. Also, because they design such a people-heavy process, they have a tough time scaling. They’re able to cover their top 50 or 100 accounts, and then they just get stuck.
A fourth thing that companies struggle with is they launch this program, and they’re very excited about the intangible impact and focus on their customers. But they lose sight of measurement. They don’t realize that a year later, the CFO is definitely going to ask, “What was the ROI of that program?” They weren’t actually tracking things, and now they’re asking themselves, “Oh, gosh, where were our people spending our time? Which of the activities had an effect? Which programs are improving adoption?”
Finally, I think particularly for companies that have been around for a while, not getting a handle on adoption data early enough is a problem. Adoption data isn’t the only data source you need to track, but in a digital business it’s pretty darn important. Without the partnership between teams to get the telemetry, the usage data, your CS team is working blindly, unable to see what customers are doing on a day-to-day basis.
McKinsey: You mentioned scaling customer success efforts beyond the top 20, 100, or 200 accounts into the smaller accounts. I’ve seen companies try to do that with channel partners. Is that going to be the standard in the future?
Nick Mehta: We have worked with a number of our clients on this very initiative. What we found is that there’s going to be a mix of ways going forward.
Some channel partners are actually leaning into customer success, building programs across all their vendor partners. They’re really trying to innovate in customer success and drive a great experience for their end clients. With that model, the vendor’s coming up with some standards, sharing key info. such as telemetry data, and empowering the channel to be an extension of their teammates. That’s a great way, probably the preferred way, to do it. But the reality is that many channel partners are not in a position to do that. They’re too small, they don’t have the sophistication yet, they don’t have enough cloud revenue for it to make sense.
In those situations, we’re finding vendors having to do it themselves. In some cases, that might cause the vendor to eventually handle renewals directly. And in other cases, they may just continue to renew through the channel, but do the customer success work on their own, and maybe give an incentive for the channel partner to take on that customer success work overtime. For example, one approach could be a higher commission rate, or a rebate, if that partner is certified on customer success and delivering the customer success process.
Getting boards and top management focused on customer success
McKinsey: Let’s switch gears a little and talk about the board and CEO perspective on this. What do you see best in-class SaaS companies’ boards and CEOs, and even CFOs, doing in terms of paying attention to customer success?
Nick Mehta: We recently published a blog post1 about how to make your board decks less squishy in customer success. And what we meant by “squishy” is that, historically, customer success grew out of customer support and customer satisfaction, where there was in some ways an almost implicit belief that customers matter and customers’ experience matters.
Of course, I believe that, as many in the industry do. But that belief caused companies to not always quantify the ROI and the actual business impact of customer experience. And therefore, boards rarely paid attention to customer satisfaction and customer success.
The subscription business models changed that because boards now know that so much of the economic value comes from dollar-based net retention. Great board decks like the sample we published in our blog post show the lagging indicators of customer success, which typically are gross retention, available to renew retention (which basically does not include the benefit of multi-year contracts), and then net retention, which includes the benefit of upsells, as well as props in measurement of advocacy, like net promoter score.
But equally important are leading indicators, whether those are product adoption, product stickiness, executive stakeholder alignment, outcomes demonstrated to a customer, or onboarding time to value.
Ideally, you can show to the board the correlation and the connection between those leading indicators and the lagging indicators. “If our customer uses this sticky feature, they’re 20 percentage points more likely to renew. If we have an executive alignment conversation with our customer, they are 15 points more likely to expand.”
To me, this is a lot like marketing and sales, right? Sales is the lagging indicator, but great marketing teams can show that when somebody attends a webinar, and goes and watches an online demo, that interaction is this many more times likely to turn into a sales conversation, or to an actual deal.
The next horizon for customer success
McKinsey: You talked about the history of customer success and how far it has come. Where do you think customer success will be as a function and capability five or ten years from now?
Nick Mehta: In the first three or four years of this customer success movement, a lot of companies were trying to understand why customer success even matters. Why is this a thing? Why is this not just customer support?
And then companies switched to, “Okay, I get it. But what is it? What does customer success mean? You know, what type of people do I need, what else do I need to do, to get started?”
Companies today are totally past that now. If a company is still asking “why” or “what”, they’re definitely behind the curve. Companies today are focused very much on the “how.” “How do I scale customer success? How do I operationalize customer success? How do I measure customer success? How do I optimize my expansion?” It’s all about the practice now. It’s not about the theory.
So, in the next five years, I expect a few aspects of the “how” will become normalized.
Number one is having a very fluid strategy between human touch and digital touch. What I mean by that is, historically, companies might have said, “Our large customers get a high-touch customer success experience. Our small customers get a digital customer success experience.” But certain high-touch customers want parts of the experience to be digital. And some small customers want parts of the experience to involve a human being.
So, companies are going to be much more fluid about their segmentation. And that means doing it not just at a customer level, but at a persona level. Maybe there’s a digital experience for a certain type of persona, and a human experience for a different type of persona.
A second thing I think companies will have figured out in the next few years is they will have great operational capabilities in customer success. Think of how sales went through this renaissance where it went from an art to a science, and so the professional sales operations became vital. Every sales leader has a great sales ops leader typically reporting directly to them. Without that ops leader, the sales leader wouldn’t know how to ramp up new teammates, measure productivity, decide on incentive plans, or give data to the reps to make them more productive. And customer success teams are already building operational functions to do all the same things for customer success.
Finally, I think the combination of those first two—digital channels along with great processes and data—is going to enable companies to finally take advantage of AI and data science in customer success.
It’s a perfect use case. You’ve got some well-defined target variables. You’re trying to optimize the customer’s likelihood to renew and expand. You’ve got all these behaviors, what people in data science might call “features,” that you can use to train models. Things like, “Did the customer have an executive business review with us? Did they have a named customer success manager? Were they using a certain feature of our product? Did they take our online training? What was their sales process?” They’ll be able to use data to constantly optimize the customer journey and the customer success teams’ responsibility.
So those would be my three predictions for the future of customer success: fluid segmentation between digital and human touch, A-plus operations in customer success, and the ability to use AI to optimize the customer success process.
Comments and opinions expressed by interviewees are their own and do not represent or reflect the opinions, policies, or positions of McKinsey & Company or have its endorsement.
