Latest / SaaS Business with Fexingo: Software-as-a-Service Companies, ARR, and Recurring Revenue / Why SaaS Contracts Are Trapping You In Low Growth
Transcript
- Lucas: If these conversations are useful for what you're building or running, I want to mention something quickly about how this show exists. Lucas: We don't run ads. The only reason we can keep producing thirty episodes a week without selling your attention to third parties is listener support through buy me a coffee dot com slash fexingo — that's F. E. X. I. N. G. O. Luna: Yeah, it really does make a difference when people chip in monthly. It keeps the lights on. Lucas: Exactly. So let's get into it. We've talked a lot about net revenue retention and expansion, but there is a structural trap I see founders walking into every single quarter. It involves the very thing they think is solving their cash flow problem: long-term contracts. Luna: You mean locking customers into three or five year deals? That sounds like a win, doesn't it? Predictable revenue. Lucas: It feels like a win because it stabilizes the top line, but here is the math most executives ignore. When you sign a three-year deal at today's price, you are effectively capping your compound annual growth rate on that account to zero percent, unless you have explicit escalation clauses. Luna: Right, so if inflation hits or your product value doubles, you're stuck charging them the same amount for thirty-six months? Lucas: Precisely. And in the current October twenty twenty six environment, where procurement teams are aggressively demanding longer terms to protect their own budgets, this is happening more than ever. A company might look like it hit its ARR target because they closed a massive multi-year deal, but that deal is actually diluting their forward-looking growth velocity. Luna: That is such a subtle drag on valuation. If investors see a big contract but no YoY growth potential, they discount the multiple. Lucas: They do. And it gets worse. Let's look at a typical enterprise software scenario. You have a customer using your platform at fifty thousand dollars annually. They love it. They want to commit. Your sales team offers them a two-year deal at a ten percent discount to close it faster. Luna: Okay, so they pay forty-five thousand a year instead of fifty. That seems fair for the commitment. Lucas: It seems fair until year two rolls around. In year two, that customer has likely expanded their usage. Maybe they added three new departments. Their actual value derived from your product is now worth seventy-five thousand dollars annually. But because of that initial two-year lock-in, you cannot raise their price. Luna: So you're essentially giving them a free upgrade while they grow, just because you wanted to secure the signature early? Lucas: You are subsidizing their internal budget savings by sacrificing your own revenue recognition. What happens is that in year three, when the contract renews, you try to jump the price back up. That sudden shock causes churn risk. They realize they could have been paying less if they hadn't locked in early. Luna: I've seen this happen. The customer feels betrayed because the price jumps, even though usage went up. It damages the relationship right at renewal time. Lucas: It does. And the worst part is that many SaaS companies measure success by signed contract value rather than net dollar retention. So leadership celebrates the big multi-year check, not realizing they just planted a bomb under their next year's growth trajectory. Luna: So the incentive structure is broken. Sales reps get commission on the total contract value, regardless of how much growth is baked in. Lucas: Spot on. The rep closes the deal, takes their bonus, and moves on. The CRO or CEO is left holding the bag with a portfolio of static-revenue accounts that aren't expanding. It creates a disconnect between front-office motivation and back-office reality. Luna: This feels like a classic agency problem. How do you fix the comp plan without making sales reps hate multi-year deals entirely? Lucas: You shift the compensation model. Instead of paying full commission on the total contract value upfront, you accelerate payouts based on annualized run-rate growth. Or better yet, you tie a portion of the commission to the customer's expansion metrics over the life of the contract. Luna: That aligns their interests. If the customer grows, the rep gets paid more later. It encourages them to sell value, not just duration. Lucas: Exactly. But there is another layer to this, which is the procurement side. Procurement teams know they have leverage. They know SaaS companies need pipeline visibility. So they push for longer terms specifically to hide cost increases from their own boards. Luna: They use the SaaS company as a shield against inflation. 'We locked in the price for three years,' they tell their CFO, even though the vendor isn't getting richer. Lucas: That is exactly it. And smart vendors are starting to fight back by introducing mandatory annual reviews with pre-agreed escalation formulas. These formulas are tied to independent indices like CPI or PPI, plus a fixed percentage for innovation. Luna: So you aren't locking the price forever. You are locking the relationship, but keeping the pricing dynamic. That protects both sides. Lucas: It does. But here is the hard truth: you have to be willing to walk away from a deal that demands a flat-price multi-year lock. If a prospect insists on zero escalation for three years, you are leaving money on the table that you will never recover. Luna: Walking away is scary when you are trying to hit quarterly targets. But staying silent kills the company slower. Lucas: Silence is deadly. Let me give you a concrete example from a mid-market logistics software provider. They were struggling to maintain thirty percent growth. They audited their book and found that forty percent of their revenue was locked in flat-price multi-year contracts from the previous two years. Luna: So almost half their business was stagnant. No wonder they couldn't grow. Lucas: Right. They changed their playbook. For new logos, they stopped offering discounts for length. Instead, they offered extended payment terms or additional implementation services. For renewals, they enforced strict annual reviews with built-in hikes. Luna: Did customers balk? That usually triggers immediate pushback from procurement. Lucas: Some did. About fifteen percent of small accounts churned because they couldn't absorb the hike. But the remaining eighty-five percent stayed, and their average contract value increased by twelve percent year-over-year. The churn loss was far outweighed by the expansion gain. Luna: That is a textbook case of optimizing for net revenue retention rather than gross bookings. Short-term pain for long-term health. Lucas: It is. And it requires a cultural shift inside the company. Customer success teams need to be empowered to discuss price changes well before the renewal date. If you wait until the last month to bring up a hike after a three-year freeze, the customer is shocked. Luna: Communication is key. If you frame it as 'your usage has grown, so the price adjusts to match the value,' it feels logical rather than predatory. Lucas: Precisely. You anchor the price change to usage data. Show them the dashboard. Show them the number of seats, the volume of transactions, the integrations active. Make it undeniable that the service provided has scaled. Luna: Data removes the emotion. It turns a negotiation into a confirmation of facts. Lucas: Exactly. Now, let's talk about the exception to this rule. Sometimes, a flat-price multi-year deal is actually the right move. When does that happen? Luna: Maybe when the market is extremely volatile? Or if you are a startup needing cash to survive a burn rate issue? Lucas: Both valid points. Cash flow stability has value. If you are facing a liquidity crunch, securing three years of revenue at a slight discount can keep you alive. Also, in highly commoditized markets where switching costs are low, a long contract can act as a moat. Luna: So it's a strategic trade-off. Liquidity or moat versus growth potential. You have to choose consciously, not accidentally. Lucas: Consciously. Most companies stumble into the latter without realizing it. They treat contract length as a binary choice: one year or three years. The nuance is in the middle. Annual contracts with auto-renewal and scheduled price adjustments offer the best of both worlds. Luna: Auto-renewal ensures continuity, but the annual review ensures the price stays fair. It forces a conversation every single year. Lucas: Which keeps the relationship active. Stagnation is the enemy of SaaS growth. Every year should be a chance to prove value, expand scope, and adjust pricing. Luna: It keeps the seller honest too. You can't rest on a five-year deal and stop innovating. You have to earn the renewal every twelve months. Lucas: That pressure is good. It drives product development. If you know you have to justify the price tag annually, you build features that customers actually care about, not just features that pad the technical roadmap. Luna: So the contract structure dictates the product strategy. Interesting connection. Lucas: Very much so. If you look at the highest performing SaaS companies in October twenty twenty six, they all share this trait: they treat every contract as an annual event, not a lifetime commitment. Luna: Even the enterprise giants? They don't lock in forever either? Lucas: Rarely. Even the giants prefer annual or bi-annual terms with clear escalation paths. They understand that their moat is integration depth, not contractual handcuffs. Customers stay because leaving is painful, not because they are trapped. Luna: There is a huge difference between sticky and stuck. Sticky means you want to stay. Stuck means you hope you can get out. Lucas: Sticky is sustainable. Stuck leads to resentment and eventual exit when the market allows. As operators, we need to design contracts that reward growth, not punish it. Luna: By allowing price to rise with value, we incentivize the customer to use more. It becomes a virtuous cycle. Lucas: A virtuous cycle. That is the goal. Stop hiding behind long contracts. Embrace the annual rhythm. It keeps you sharp, it keeps your revenue growing, and it respects the partnership. Luna: Agreed. The future of SaaS isn't in locking people down; it's in proving why they should stay open. Lucas: Well said. Next time you are negotiating a term, ask yourself: am I buying safety, or am I killing my growth?