Renewal Calculation with early renewals

Brody Horton

I have a question about looking at churn and renewal data for a relatively unique purchasing model.

We sell a product that is both tied to an annual contract, but is also consumable. Our customers are purchasing not per "seat", but per assessment. A client will purchase a quantity of assessments that get used. The contract is typically for 12 months, meaning they have up to 12 months to use those assessments. The trouble comes with new clients. They will often purchase a small amount of tests to get started, albeit on an annual contract. When they run out just a few months into the contract, they purchase a larger amount though that is sometimes smaller than their true annual need. Here is a concrete example:

Customer A purchases 5,000 assessments Jan 1, 2020 on a 12 month contract expiring Dec 31, 2020.
Customer A uses those assessments over a 3 month period, and on April 1 purchases 10,000 assessments on a 12 month contract.
Customer A uses those 10,000 assessments over a 3 month period and on July 31 purchases 75,000 assessments on a 12 month contract. It is determined that 75,000 assessments is a strong estimation of their true annual need for assessments.

Since Customer A first purchased in January, they would typically be considered a January or 1Q cohort member. However, every indication is that they will not purchase again until next July. Furthermore, if you look at their first year of purchases, they purchased 90,000 assessments for the year. We do not expect them to need that volume again as 75k is their annual need. 

These scenarios are very common for us. As we are a relatively early stage company, we do not have a lot of historical data yet. However, of the deals we are closing about 75% of them purchase an initial annual order that is below what their true annual need is. 

My questions:

Are there similar scenarios out there you have seen and how do you calculate churn, renewal, etc?

Russell Bourne

Brody, a couple questions immediately jump to my mind:

1) Do you think selling quantities of assessments is truly recurring op-ex revenue (i.e., what is there to renew, exactly?) or are these purchases better seen as one-time cap-ex purchases?  
2) Answer separately for your company and your customer: is it important to have a master renewal date where all assessments are up for renewal at the same time?  Or is it okay if they have multiple overlapping renewal terms based on different purchase dates?

The way you describe it, it sounds like your assessments aren't really a subscription because the assessments are single-use and it isn't clear how this year's use translates to next year's need.  That would be as opposed to purchase and renewal models where licensing is based on seat count or data size, numbers which are typically flat with a slight upward trend over time.

All of that being said, if you fit into a renewal model, I generally favor a model that uses a master renewal date.  The initial purchase date is their master renewal date, and upon renewal, any mid-year purchases are trued up and included in next year's renewal.  You would pro-rate the renewal price of the mid-year purchases since they didn't see a full year of use before they were renewed.  This model is easier because it eliminates the need to tie specific assessments to their purchase dates (no license key rat holes!).  The downside is your customer may not have budgeted for the early renewal of the mid-year purchases, so you'll want to make sure the sales and upsell teams are very clear about setting the expectation, and including language in the T&C and even on the order form.