While revenue isn’t the most precise measure of a startup’s health, you’ll do pretty much anything you can to get more of it as cheaply as possible. Cash on hand makes running and growing a startup a lot easier.
We can break revenue down to two types: First order and second order.
First order revenue comes through the usual methods: customer acquisitions, upgrades to higher plans, upsells/add-ons, cross-sells, and any other ways you expand your accounts.
Second order revenue is quite powerful, but it’s often overlooked by startup founders. Second order revenue is when your startup really starts to grow and take on a life of its own.
- What is Second Order Revenue?
- Boosting Your Customer Lifetime Value
- Stimulate Second Order Revenue with Customer Success
- Going Forward
What is Second Order Revenue?
Second order revenue is the revenue generated by your post-sale service. Essentially, it’s how you extract more revenue from the same account.
Second order revenue usually comes through referrals. You can also get second order revenue when your contact at one company changes jobs and convinces the new company to use your service as well. This is coined the “champion of change” by Jason Lemkin, which is kind of like a referral, in its own way.Second order revenue is quite powerful, but it’s often overlooked by startup founders. Click To Tweet
The beauty of second order revenue is that you’ve already paid the customer acquisition cost. Perhaps a more accurate take: it lowers your customer acquisition cost while simultaneously raising your customer lifetime value.
In the long term, second order revenue can become a significant part of your total revenue. Some startups’ marketing strategies actually prioritize second order revenue as a way to drive customer acquisition.
Dropbox, for instance, is the most famous example of a startup that relied heavily on second order revenue as they grew. In 2008, they implemented a referral program that rewarded existing customers with extra storage space for successful referrals. In just over a year, they exploded from 100,000 to four million subscribers – almost entirely through second order revenue.
Now, that’s an unusual case study. Second order revenue doesn’t beat first order revenue at most startups. You’ll still have to build a growth strategy that includes cold customer acquisition, but Dropbox’s story is a great example of how profitable second order revenue can be.
Boosting Your Customer Lifetime Value
Customer lifetime value is a fairly straightforward calculation, but most startups fail to include second order revenue in their calculation.
“Standard first-order only CLTV analyses underestimate true revenue generated by customers by 50-100% in most SaaS models selling to anything larger than SMBs,” says Jason Lemkin.
If a customer spends $1200 on a year of your service, renews for another year at a higher plan (say, $2000), and purchases a $500 add-on during the third year, what’s their lifetime value?
- First year = $1200
- Second year = $2000
- Third year = $2500
- Customer lifetime value = $5700
But what if that customer refers you to another customer who also spends a similar amount? Suddenly the lifetime value of the first customer got a lot bigger, as did your average customer lifetime value.
As you can see, second order revenue has the potential to create massive shifts in your company. Referrals are easy growth without much of the cost.
Like all forms of startup revenue, early second order revenue helps you incite more growth. Cash on hand means faster experimentation and iteration. Then once you find the tactic that drives the most growth, more cash lets you invest into deeply. So it’s important to quickly find ways to drive second order revenue.
Stimulate Second Order Revenue with Customer Success
The most effective way to drive more second order revenue is to hire a customer success manager (CSM). The CSM should own the account renewal process (because startups that actively manage referrals tend to grow faster) and seek referrals.
Your CSM’s job isn’t to convince customers to spend more money. Instead, they should help customers realize value with the product so the customers can’t help but refer your company to their friends. (This also helps prevent churn.)
Customer success isn’t a new discipline, but it isn’t backed by years of study and evolution like, for example, sales, operations, or product development. Colleges doesn’t even have degree programs or courses for it yet. Many of the first customer success managers are still working, driving the discipline forward.
Nevertheless, customer success is critical for every modern SaaS.
In most cases, an organization’s first CSM comes from another part of the company, like sales, customer support, or account management. The skills for these positions overlap with the skills for customer success somewhat, but they’re substantially different in many ways.
Customer success is a big-picture role. The day-to-day isn’t that important, so long as the actual tasks support a long-term strategy. CSMs often perform vastly different tasks at each organization.
For instance, at one startup, a CSM might focus on creating robust product documentation because he knows that’s what keeps people using the product. At another startup, a CSM may focus on tweaking the onboarding process because he knows that’s how to keep people using and paying for the product.
Once a new CSM starts to understand the purpose of customer success, he or she can be reasonably effective rather quickly. This is why it’s often standard to build a customer success program by bringing someone in from another team, rather than hiring from outside. It’s also good to hire internally because customer success requires a detailed understanding of the product and customer.
A CSM’s job is to drive customer satisfaction and value so your customers renew their accounts every month (or whatever interval you charge them), refer their friends, and champion your product wherever they go.
They should track referrals over time and look for trends. For instance, are some customers more likely to refer than others? Does a customer need to hit a certain milestone before they refer? Will they only refer if they also award you a nine or ten Net Promoter Score?
Then, your CSMs should reach out to customers directly to solicit for referrals. You can do this automatically through your tool or with an old fashioned phone call. How you set up your referral marketing program depends on your customers’ preferences.
“In the beginning (and probably always), a pretty good customer success manager that is driven and committed, is far, far better than no customer success manager at all,” Jason says. “Because getting just that one or two extra second order customers, those one or two extra upgrades, from happy existing customers, is the magic in SaaS.”
Hire your first CSM as early as possible. The general rule is to have at least one CSM for every $2 million in annual recurring revenue, or as soon as you have one customer who represents 20% of your income (because you definitely don’t want to lose that customer).
Your CSMs should be built to serve, says customer success consultant Nils Vinje. “They must thrive in an environment of helping other people. They must derive success from watching other people succeed. They must focus on other people’s problems.”
CSMs play a proactive role to help you keep your customers and obtain second order revenue, so the earlier you hire one, the faster you’ll grow.
None of this is to say that second order revenue is more important than first order revenue. When you break down all the ways a startup makes money, upgrades, expansions, and renewals are the primary money-makers.
But growing second order revenue is an important way to scale your startup. The sooner you measure it carefully and take steps to exploit it, the faster you’ll grow.