For B2B companies, buyer-supplier relationships are often ruled by contract. The entire customer lifecycle is shaped by and steered by a contract, which is why companies invest in associated management tools. But, all of these commitments cannot completely prevent churn. Every company will experience customer attrition at some point (sometimes often). To hedge against these losses, and maximize customer lifetime value, one underutilized lever hardware and software companies can pull is leveraging discounts to drive multi-year contracts.
How does this look in practice? Consider two companies, both with $100 thousand in available renewal opportunity and a 75 percent annual renewal rate. One company offers no multi-year option or discount, while the other offers a 10 percent discount for a three-year commitment, and typically gets 20 percent of users to sign a three-year deal. In this hypothetical, the company offering a discount would book an additional 5.1 percent in support revenue over the three-year period at no additional cost. Although this company initially generates less renewal revenue in the first year due to the multi-year discount, over the three-year period, the fixed revenue from customers on a three-year contract will outweigh the discount that they received.
According to ServiceSource data, there is a direct correlation between the multi-year discount offered and the proportion of customers who sign multi-year agreements. By setting an appropriately aggressive discount policy, companies can increase the number of clients on long-term contracts. What discount rate will provide the best value can be difficult to calculate. Our research indicates the companies that offer a higher multi-year discount have greater success securing long-term contracts. Therefore, a moderate multi-year discount policy at 10 percent will derive more value than a weak multi-year discount policy at 5 percent. Companies can dramatically improve the number of clients who are on long-term contracts by moving from a weak to moderate discount policy.
Another determining factor when structuring a multi-year contract discount policy is the company’s overall renewal rate. Consider a company with a 75 percent renewal rate. Over a three-year period, that company can only expect to see 58 percent of the potential revenue from any batch of renewals due to compounding. Companies with lower renewal rates should offer very aggressive discounting to secure multi-year contracts and hedge against a large annual loss of maintenance revenue. If done correctly, clients that are in year three of a three-year contract are generating value that can help offset the natural erosion that occurs with customer churn. In addition, the supplier will see other benefits that come from their multi-year customers, including reduced sales costs, a more predictable revenue stream and a reduction in risk of unsupported customers.
The case for a discounting program on multi-year contracts is easy to make, but what is the right discount to incent renewals and not leave any money on the table? The answer is derived from the intersection of data and expertise. Knowing your true renewal yield and industry benchmarks will provide a base to test against with multiple discount amounts. This process will optimize total value of the contract period.