A juicy 5-year contract is the best. There is guaranteed revenue for the contract period so this must be the kind of contract that an acquirer prefers right?
Not so fast!
A long contract creates a cliff edge in the customer’s mind, they are very aware of the upcoming expiry date and over such a long time period, it’s often a big deal financially too. So the customer gets ready for battle and calls upon their procurement department (if they have one) to drive a hard bargain or even go out to tender. And the customer often achieves a great deal because there’s a 5-year prize for the supplier, so the leverage is with the customer and the margins get driven down as the supplier trades off profitability for 5-years of secured revenue.
In contrast, a 12-month contract which auto-renews for another 12 months (say 90 days before the expiry) has no such cliff edge because the customer knows that it’s only one year before they can change it up if they want to. Furthermore as it auto-renews it takes advantage of the customer’s inertia to automatically tie them in for another year, but not for an unfairly long time period.
A 12-month contract keeps the supplier on their toes as it’s only a year away that the customer could leave so they don’t let a customer relationship deteriorate over 5 years past the point of no return, which we have seen time and time again.
And if the 12-month contract no longer meets the customers needs, they only have to suck it up for the remainder of the year, whereas an unsuitable 5-year contract is a disaster for customer as they feel trapped and the supplier will be much less prepared to renegotiate the contract as they have 5-years’ worth of revenue to lose and may also have made significant financial investments on the securing of the revenue.
In truth, contract lengths can be a red herring. Ultimately what we care about when making an acquisition is that the customer churn is low going into the acquisition and that it stays low after the acquisition. It’s that simple.