Is Pushing Annual Contracts the Right Move?

From Free Trials to Long-Term Commitments: Assessing the Impact of Annual Contracts.

DEAR STAGE 2: We just raised our A round and are getting pressure from our board to focus on annual contracts. The vast majority of our customers have come inbound through our free trial and to date we have defaulted to monthly contracts. We started offering annual (with a 20% discount) last year and have <10% of our customers on this model. What are the pros and cons of pushing annual contracts? Any ‘gotchas’ we should watch out for? ~Debating Annual Contracts

DEAR DEBATING ANNUAL CONTRACTS: I’ve been in that boardroom.  I’ve made that gentle nudge. And you are right - there are real pros and cons. So before you start swinging for the fences with annual contracts, let's break them down. I called on Mike Kavanagh, Vice President of Commercial Sales at OneTrust to help tackle this question. Here's what you need to know.

Contract terms v. Payment terms

First up, don't confuse contract terms with payment terms. As Mike points out:

"I found companies are comfortable signing annual contracts; the push back comes from the large outlay of cash; especially in this climate where CFOs are reviewing every deal and trying to hold on to as much cash as possible."

The solution? Be flexible with payment terms. Quarterly or even semi-annual payments can make that annual contract much more palatable. But don't give this away for free. Instead, Mike suggests: “Companies have to be prepared to offer semi-annual or even quarterly payment terms, but not without something in exchange i.e. reference calls, webinar, case studies, etc."

This is a great way to build your marketing arsenal while making life easier for your customers and can be a win-win.

This solution does present it’s own challenges: what happens when a customer doesn't pay? Before making these arrangements, Mike warns: "Companies have to have the processes / systems in place to deal with customers who do not pay; including suspending and or cancelling their accounts. This puts a higher expectation on the product & customer success to make sure the customer is getting value from the product."

This is crucial. Annual contracts mean you're on the hook to deliver value for a full year. Make sure your product and customer success teams are ready for this challenge (or opportunity!).

Managing your existing monthly customers

Now, let's talk about the elephant in the room: your existing monthly customers. Mike doesn't sugarcoat it: “The board will always want to move to long term; multi-year annual agreements. The sooner you start the easier it will be. If you let everyone sign up month-to-month, it is just delaying an inevitable problem."

The key here is to start now, but to be smart about it. Mike advises: "Make sure that the board understands there is little to no way to move off of month-to-month contracts without writing down ARR. Unless you can upsell customers to a higher price SKU, with a small discount for an annual contract"

This option gives your existing customers a reason to switch beyond just the 20% discount you're currently offering and sets you up for further opportunities to provide value in the coming term as you enable them with new features. 

It all comes back to incentives

Finally, don't forget about your sales team. As Mike points out: “The comp plan has to align with your priorities; give sales spiffs for selling new customers on annual contracts; kick it up even more if they can sell them on a 2 or 3 year agreement."

Your sales team will push what you incentivize so you have to ensure those incentives align with your long-term goals.

Annual contracts can be great for predictable revenue and customer stickiness. But they come with higher expectations and potential pitfalls. Start making the shift now, be flexible with payment terms, make sure your product delivers long-term value, and align your sales incentives. And remember, you don't need to flip a switch overnight. Start with new customers, then work on converting your existing base. 

Until next week!