A rigorous method for evaluating software vendors based on a framework you know and trust
In the earliest days of society, “banking” was pretty straightforward. We loaned money to people we knew and trusted, and we had a pretty good idea if they were going to pay us back. But today, things are a bit more complicated… lenders and borrowers aren’t nearly as connected, but we still need to underwrite each borrower’s ability to repay. So how do we get to that same comfort level BEFORE we hand over the cash? The answer: The 5C’s of Credit… the modern framework for understanding the credit worthiness of each and every borrower.
The story isn’t so different when it comes to buying subscription-based software solutions. Today’s landscape is like the Wild West, and knowing which vendors we can count on is getting more and more difficult. So, how do we choose? How do we ensure that the vendor we select is going to “pay us back?” We already have a framework that we know and trust, so what if we took a credit underwriter’s approach to vendor selection? Enter, The 5 C’s of Vendor Assessment and Selection… Company, Culture, Customers, Churn, and Conditions.
By exploring a series of very specific questions and breaking down the answers, we can quickly determine if a software vendor is truly worthy of our trust… and our cash.
A bit of background
Over the years, we’ve done thousands of product demos for banks and credit unions all across the country. We’ve also seen our share of demos, and most vendors seem to be getting better and better at sharing an engaging story, highlighting their best features, and minimizing their flaws. It’s no surprise that you walk away from most with a favorable view.
So how do you separate the promise from the reality? What questions could you ask each vendor to help underwrite their claims?
The great news for banks and credit unions is that there’s already a trusted framework for underwriting such promises. In fact, this capability is at the heart of one of your most important activities: credit underwriting.
The credit underwriting process is a disciplined method of asking questions and gathering the most pertinent facts and evidence to underwrite a borrower’s promise to repay a loan (plus a nice return). Most credit underwriting processes are based around a very useful framework known as The Five C’s of Credit… Character, Capacity, Capital, Collateral, and Conditions.
We analyzed the demos we’ve done over the years, and asked ourselves: What were the best questions we were asked by a potential client – either during the demo or even later as a part of their vendor due diligence process? Two very interesting patterns emerged:
- The prospective clients who consistently asked the best questions took a credit underwriter’s approach to vendor and solution assessment and vendor due diligence. They were trying to underwrite the promise of the webcast/demo with facts and evidence.
- The questions they asked could be grouped into what we will call here The Five C’s of Vendor Assessment and Selection: Company, Culture, Customers, Churn, and Conditions.
It’s no coincidence that these five C’s map over, almost directly, to the Five C’s of Credit – likely because those who apply the credit discipline to their vendor selection process tend to view solutions more like assets (loans) that require an initial investment of both time and capital but should, if the promises are kept, pay back the investment plus a meaningful return with minimal risk. Their goal is to underwrite that risk.
The first, and perhaps most obvious and important, questions that you must ask yourself are, “Is this someone that I would be proud to do business with? Can I trust them to deliver? What if things go wrong?” But again, these are questions we must ask ourselves – judgments that we must reach in the end. What questions can we ask the vendor that would reveal facts and evidence to help us answer these questions?
There’s an old saying in credit underwriting: a “1 Credit” is Bill Gates married to Mother Teresa with joint accounts – a borrower with both the proven ability to repay and the moral character to actually do so. You can think about these first two C’s (Company and Culture) in a very similar way.
Understanding the Company (its size, financial strength, ability to attract and retain great people) will help you underwrite their ability to deliver. Understanding their Culture (how they measure customer success, how they handle difficult situations, how transparent, open, and honest they are) will help you understand whether or not they will actually deliver on their promises.
- How large is your company?
- How large is the group within the company that supports, maintains, and develops this product? How big was it a year ago? Two years ago?
- Is that group dedicated to this product or shared with other products?
- How many developers are dedicated to this product? How long has each of them been dedicated to and working on this product?
- What are your company’s Core Values?
- How do you measure customer success?
- Who within your company will be responsible for ensuring OUR success?
- Tell me about a case where a customer was unsuccessful. Why weren’t they successful, and what did you do about it?
Interpreting the Answers
You can learn a great deal about a potential vendor’s Company and Culture by asking these simple questions, but in many cases, how they answer can reveal even more. Do they answer in terms that are more relevant to you, or to them? Even more telling, do they answer in ways that seem to obfuscate the most relevant details?
For example, take the first question, “How large is your company?” Do they answer in terms of employees, revenues, or market capitalization (terms relevant to them), or do they openly describe the actual size of the group dedicated to developing and supporting the product that they are asking you to buy? Companies of all sizes will sometimes try to puff out their chests and seem bigger than they actually are. Asking the question in this way allows honesty and openness to shine through.
When assessing the Company and its ability to deliver, you want to understand how much they’re actually investing in product development and support. Is their investment growing or shrinking? The number of issues you encounter and the pace at which they resolve them is directly related to their investment in this specific product. The fact that they have 5,000 employees serving other clients using other products is, at best, irrelevant; at worst, it’s a deliberate distraction or overstatement.
The Culture questions are, in most cases, far more important and telling. They can be summed up simply… “How do you know if your clients are getting a return on their investment? What do you do if they aren’t?” The answers you get here, just like in credit underwriting, will have an enormous impact on how you view the Conditions of this relationship (the fifth and final C).
There are two big things to look for in their answers to the Culture questions:
- When you ask how they measure customer success, they may try to answer using customer satisfaction survey results. Customer satisfaction is necessary, but not sufficient, to ensure customer success. Pay close attention to their answers here and see if they “foot” with their customer retention answers in the Churn section below. High customer satisfaction with low customer retention indicates that their satisfaction surveys are doing a poor job of measuring success.
- Every vendor should be able to tell a story (or two) about an unsuccessful customer. No vendor is perfect, and there will always be cases where things just didn’t work out. Through these stories, you should get a sense of the vendor’s level of openness and honesty. Do they blame the customer? Do they blame external factors such as the economy? Or, do they focus on what they could have done better during the sales or delivery processes? And most importantly, what did they do about it? Did they make things right?
Every solution will require an investment of both time and money on your part. In return, the vendor offers the promise of a return on that investment, an ROI. There are really only three meaningful ways this return can be delivered:
- Increased Revenue through:
- Volume improvement (sell more)
- Pricing improvement (charge more)
- Decreased Expense through:
- Increased efficiency (do more with less)
- Elimination of expenses/loss (just need less)
- Decreased Risk through:
- Reduced likelihood of losing revenue
- Reduced likelihood of increasing expenses
Any vendor should be able to connect their solution’s value proposition to one or more of these. If the value isn’t crystal clear very early in the process, it’s probably time to move on as there’s no need to underwrite a loan to someone with no clear path to even repay the principal.
Growth and retention (See Churn below) of customers are very strong evidence of a positive ROI. If these number are flat, or worse yet, declining, you should be very concerned. A growing customer base almost always leads to growing investment in the product, support, and service. A declining customer base often leads to just the opposite. If they described a growing level of investment in the product, but show a declining customer base, eventually something is going to give.
- How many customers do you currently have?
- How many are actively using exactly the same solution we’re considering?
- How many customers did you add last year? The year before? How many do you expect to add next year? What sort of customers are growing fastest?
- How many of these customers are similar to us?
- If I were to call [customer x] what would they say about their investment in your solution? About your company overall?
Interpreting the Answers
As with the Company section, the first question here will give them the chance to overstate or embellish the number of relevant customers. If they say they have 10,000 customers and it becomes apparent (after question 2) that only 50 are using the product they’re offering you, you should probably ask yourself… have they overstated any other claims?
The goal is to narrow things down to the set of customers that are most relevant to your situation, and determine whether future investment in this product will be aligned with your needs. If their existing customer base consists of a certain type of bank and that’s where they’re growing, you should expect future investment to be focused primarily on that group. Assess what that means for you (it could be good or bad), and if they have customers who are similar to you, ask for names so that you can speak with them.
Jeffery Gitomer said it clearly in the title of his book: “Customer Satisfaction is Worthless, Customer Loyalty is Priceless”. While the previous section focused on customer growth, this section focuses on something far more important: customer attrition, commonly known as Churn.
Many solutions today are offered as “Software as a Service” or on a subscription basis. Churn is the ultimate measure of loyalty and ultimately of customer success. After all, given the option, customers only keep paying for things that are producing benefits that exceed their costs. Think of it this way… a company charges $10k per year, and conducts an “annual survey” of its customers. This survey has only one question: “Did you receive value that greatly exceeds your investment?” If you answer “yes” to this question, you staple a check for $10,000 to your response. If you answer “no,” you have just churned.
Churn is the single best metric for underwriting the vendor’s value proposition. It correlates more than anything else with actual customer success. Buying any subscription-based solution and not asking the vendor about churn would be like booking a loan without asking to see financials.
- What is your Net Revenue Renewal Rate? What is your customer churn? [see discussion below]
- Who are your best/strongest competitors and how do you compete with each of them?
- How many clients have you lost to each competitor? Why?
- How many clients have switched from each competitor to you? Why?
- If clients have left you for a competitor, did any leave before the renewal point (before the initial term of the contract was even up)? If so, what did you do? Did you refund the remainder of their term?
Interpreting the Answers
Churn, and its counterpart Retention Rate, are the most important metrics for assessing the health of any subscription-based business. This is just as true for a software business as it is for a cellular phone business, a cable TV business, or even a lawn service.
Like a lot of the ratios that a credit analyst might review to underwrite a loan, Net Revenue Renewal Rate is a fairly straightforward concept… of the dollars up for renewal in the last 12 months, what percentage of those dollars renewed? What is good about this metric is that it takes into account such things as:
- Was the vendor forced to cut the price just to keep the business?
- Is the vendor just losing clients?
- Are customers expanding their relationship with this vendor and buying more stuff? This could lead to a Net Revenue Renewal Rate greater than 100% – a great sign.
Unfortunately, like all metrics, this one has some blind spots. It misses customers who left in the middle of their contract since they weren’t up for renewal. This is especially true for vendors who do a lot of multi-year contracts. In fact, the main incentive for some vendors to push multi-year commitments is, in fact, to slow the rate of customer churn (more on this in the Conditions section below). The fifth question should help you to understand if this is the case and if the churn numbers are understated.
The discussion around Competitors is really where the best vendors will truly separate themselves. If there are four competitive vendors for a particular product, odds are that you will get the straightest and most honest answers from the market leader. They’ll likely have the lowest churn and will compete on results and references based on actual customer success. Others may compete by pushing significantly lower prices with longer terms. It’s not unusual for the market leader to have 100 clients switch from a lower priced competitor for every one client that might churn away to a competitor.
Just as in credit underwriting, you must also understand and evaluate the Conditions of the deal in the context of what you’ve learned from the other four C’s. In the end, these Conditions serve to either mitigate, or exacerbate, the risk.
Generally, you’ll see the actual terms in a written proposal and/or a formal contract, but it’s still worth asking these questions directly and listening closely to the response. It’s also important to take notes and ensure that the actual contract reflects the answers you were given.
- How do you price your solution?
- Do you offer a guarantee? Why or why not?
- What is your typical contract term? Why?
- What level of service and support is included? Do you charge for upgrades?
- What happens if we grow our assets organically? Through acquisition?
Interpreting the Answers
With vendor assessments, the linkage between the Conditions and the other four C’s is even more pronounced because, unlike in credit underwriting, the vendor is setting the proposed terms and conditions. If you’ve done a good job of assessing the Company, Culture, Customers, and Churn of this vendor, the Conditions will fall right into place… “That’s exactly what I expected.”
Let’s look at a simple example. Consider the case where a vendor’s new customer growth is slowing, and at the same time, they’re losing existing customers to competitive solutions. When they offer you a rock-bottom price in exchange for a 5-year commitment, is it really any mystery as to why? Caveat emptor indeed.
The trend toward buying powerful, highly specialized solutions (particularly cloud-based software solutions) will likely continue as more banks look to improve performance, increase efficiency, and reduce cost. And it makes sense… when a vendor focuses on solving a very specific problem, competitive pressure forces them to build a better mousetrap. After that, the very best vendors spend their time listening carefully to their users and then incorporating everything they’ve learned into their solution – giving each individual customer the benefits of the entire pool.
The trick, of course, is identifying the vendors you can truly rely on. Fortunately, you’ve already developed a framework for understanding which borrowers are most likely to pay you back. There’s no reason you shouldn’t know the same thing about your vendors.