The Essential Guide to Churn
In the modern marketplace, the consumer holds the power. That’s especially true in the SaaS or recurring revenue realm: buyers have access to a virtually infinite array of software solutions, and saying sayonara to any one of them is as easy as clicking “cancel service.” So, how do you stop your customers from getting to that point and walking out the metaphorical door? Well, as the old saying goes, you can’t manage what you don’t measure, and in this day and age, the business metrics that provide the most actionable data are those that measure performance at the customer level. These are the data points that will tell you whether your business can sustain its current performance in the long term. And the big kahuna of customer-level metrics is—you guessed it—churn rate.
What is Churn?
No, it’s not the process of making butter—at least not in the context of business. It seems like every expert has a slightly different take on what constitutes churn, but at its core, a business’s churn rate represents the speed at which its customers are leaving. In other words, how quickly are your customers clicking that cancel button?
Investopedia defines churn rate as, “The percentage of subscribers to a service that discontinue their subscription to that service in a given time period.” Under that basic definition, a business could calculate its churn rate by dividing the number of customers lost over a given period by the number of customers it had at the onset of that time period. In mathematical form, that equation would look something like this:
(Number of Customers Lost) ÷ (Original Number of Customers)
For example, if a business started the month with 20 customers and, over the course of that month, lost one customer, then it would have a monthly churn rate of 5%. (Keep in mind that you wouldn’t include any new sales as part of this data; those customers would be part of the calculations for the next time period.) Simple enough, right?
Well, sort of. Things get a bit complicated when you bring revenue into the picture. You see, there are different ways to quantify churn. And because businesses often are most interested in seeing their churn rate’s impact on company revenue, it can be helpful to calculate churn in terms of revenue. That’s where the formula gets more complex.
To figure out your revenue churn, you’ll need to know your monthly recurring revenue (MRR)—that is, “income that a company can reliably anticipate every 30 days,” explains TechTarget. Then, divide that figure by the amount of MRR you lost over the course of a particular month. Important note: when calculating these figures, you must subtract any new revenue you generated from existing customers (i.e., from upselling and cross-selling). Including new revenue as part of the equation would skew your picture of how much revenue you actually lost, and in this case, that is the data point you’re truly after.
For the purposes of this explanation, let’s assume you’re calculating everything in monthly terms. While you can calculate revenue churn for any time period, you would need to use the recurring revenue figure that correlated with your time period of chose. For example, if you were determining your quarterly revenue churn, you’d need to use your quarterly recurring revenue in place of MRR.
One quick note on time period selection: if you choose to calculate churn for a longer time period (e.g., quarterly), then, as this evergage article explains, you’ll need to consider the fact that “some new sales from the first month in the quarter…could churn in the second or third month of the quarter. If those churns are accidentally included in the calculation, then we’ll overstate churn.”
Here, in the interest of simplicity, we’ll look at churn from a monthly perspective. Let’s take a look at an example adapted from the above-cited article. Say your MRR at the beginning of the month is $100,000. At the end of the month, it’s $80,000. During that time period, you also add $10,00 in upgrades from existing customers. So, your revenue churn rate would be:
(($100,000 – $80,000) – $10,000) ÷ $100,000 = ($20,000 – $10,000) ÷ $100,000 = ($10,000) ÷ $100,000 = 0.1 = 10%
Customer Churn vs. Revenue Churn
Your customer churn rate may not always be the same as your revenue churn rate. This is especially true for companies that have different product lines or different service packages, because those items almost certainly have different price points. Thus, some customers are more valuable—in terms of recurring revenue—than others. Let’s look at another example inspired by evergage:
Say your company has two product lines. Your basic service has 10,000 customers at $200 a month per customer. So your MRR for that line is: (10,000) X ($200) = 2,000,000
Your premium service has 5,000 customers at $500 a month per customer. Therefore, your MRR for that line is: (5,000) X ($500) = $2,500,000
So, in total, you have 15,000 customers and $4,500,000 MRR.
Now, let’s say that over the course of a month, you lose 500 basic customers and 100 premium customers. That means your customer churn rate would be:
(500 + 100) ÷ (15,000) = (600) ÷ (15,000) = .04 = 4%
To calculate your revenue churn rate, add in the associated dollar amounts:
((500 X $200) + (100 X $500)) ÷ ($4,500,000) = ($100,000 + $50,000) ÷ ($4,500,000) = ($150,000) ÷ ($4,500,000) = 0.033 = 3.3%
As you can see, your customer churn (4%) is slightly higher than your revenue churn (3.3%). It’s important to distinguish between these two metrics because each figure provides different information about your business. Furthermore, separating out the product lines can help you see where your business is strongest in terms of customer retention and revenue generation. For example, even if you lose a relatively high number of basic service customers—thus producing a relatively high customer churn rate—your revenue churn rate might not look as bad, comparatively speaking. Why? Because if you are focused on retaining your premium customers (i.e., the customers with the highest monetary value), then losing some of your basic customers might not have a huge financial impact.
Voluntary Churn vs. Involuntary Churn
As you’re making your churn calculations, it’s important to distinguish between those customers who leave you by choice and those who leave by force. Involuntary churn occurs when customers discontinue service due to factors beyond your control (e.g., they go out of business or lose access to a service that they need in order to access your service). Typically, you wouldn’t count such losses toward your churn rate.
Voluntary churn is where you should be focusing the majority of your attention and prevention efforts. These are customers who make a conscious decision to discontinue their use of your products and services. Understanding the factors that influence those decisions is the key to preventing future losses—and thus, reducing churn. That means taking a proactive approach and identifying churn risks before the loss actually occurs—perhaps by implementing predictive processes and technologies. But more on that later; right now, let’s talk about why churn is such a crucial customer-level business metric.
Why is Churn Important?
Your churn rate can tell you a lot about the current health of your business. Namely, you can get a solid snapshot of how many customers are bailing on your business—and how fast they’re departing. You also can get a sense of the immediate impact those lost customers are having on your company’s bottom line. But the impact of churn extends beyond the here and now.
Just as it’s easier—and less expensive—for a business to retain its current employees than it is to go through the rigmarole of hiring and training new ones, it’s much less costly for a business to retain its current customers than to try and replace those customers with new ones. In fact, according to Kissmetrics, it can cost seven times more to acquire new customers than to retain current ones.
Furthermore, churn decelerates your business’s growth, because for each lost customer, you must acquire one new customer just to maintain an even growth rate. For example, if your customer base grew by 15% over the course of a month, but you had a churn rate of 10%, then your actual growth would not be nearly as impressive—or as worthy of celebration.
And while a single churned customer might not seem like a big deal in the short term, the impact is much more significant once a business moves beyond the early stages of growth. That’s because the more customers a business has—and the more monthly revenue the business is pulling in—the greater the financial loss associated with each percentage point of churn. To illustrate this crucial point, this For Entrepreneurs article provides an example of a startup SaaS company that generates $10,000 in bookings in its first month of business and increases its monthly revenue amount by $2,000 each month after that.
In the first few months, the company’s churn rate of 2.5% doesn’t put a huge dent in total revenue. As the company continues to grow its MRR, however, that all changes: “…as the company gets towards the end of its fifth year, even at a relatively low churn rate of 2.5%, you are losing $64k a month which is extremely hard to replace with new customer bookings,” the article explains. And that’s exactly why it’s so worthwhile for a company to invest in customer retention in the earliest stages of business—before the effects become crippling to growth.
Finally, if you’re trying to get funding, it’s worth noting that venture capital (VC) firms pay close attention to churn rates, because those numbers provide a solid indicator of whether a company has a good product and is a good market fit. And while growth rate is paramount to SaaS valuation, customer retention is a strong secondary factor.
What is Negative Churn?
Yes, there is such a thing as negative churn, and it’s pretty much the holy grail of all things churn. Essentially, negative churn occurs “when the expansions/up-sells/cross-sells to your current customer base exceed the revenue that you are losing because of Churn,” states the For Entrepreneurs article. To continue with the example cited in the above paragraphs, if in addition to the revenue you’re getting from new customers, you’re tacking on 2.5% worth of revenue expansion from your current customer base, you could be generating nearly $180,000 a month in expansion revenue by your fifth year in business—a number that more than makes up for revenue losses due to lost customers.
So, how do you achieve this magical churn status? As For Entrepreneurs explains, you must do at least one of the following three things:
- Employ a pricing model that draws more revenue per customer over time. For example, some cloud technology companies charge more as customers use more data storage. This allows you to generate more revenue from a single customer the longer that customer uses your product.
- Actively sell upgrades to current customers. If you have different product or service levels, focus on moving customers up to the next tier.
- Introduce current customers to new products or add-ons. If you offer several different types of products or product add-ons, cross-sell those items to your current customers.
Keep in mind that if you plan to emphasize upselling and cross-selling with your sales department, you may benefit from establishing a dedicated team whose focus is on closing additional sales with existing clients.
Furthermore, remember that upselling and cross-selling shouldn’t necessarily be top priorities for businesses that are still in the early stages of growth. Startups are better off focusing on driving broad customer adoption of their main product offering and doing everything they can to keep those customers (i.e., prevent churn). And for fledgling companies, that means sticking with a simplistic approach to pricing, products, and support. Once you’ve successfully gotten your business off the ground and on solid footing, you can start building strategy around negative churn.
What are Some Strategies for Reducing Churn?
For most companies, some degree of churn is inevitable. But, there are actions you can take to keep your churn rate at a minimum. Here are a few suggestions from For Entrepreneurs:
Talk to your quitters.
When a customer decides to cut ties with your business, don’t just let that customer walk out the back door without saying anything. This is an opportunity for you to glean valuable feedback; take it! That advice rings especially true for businesses in the early startup stages. When a customer quits, make sure you connect with that customer and find out how he or she came to the decision to part ways with your company. Many times, customers abandon a product because it didn’t solve their problems the way they had anticipated it would. Other times, they had trouble implementing and using it. Either way, you’ll learn what you need to do to improve the actual product as well as your onboarding and customer service models.
Keep a pulse on customer engagement.
This is easier said than done, but when done well, it can do wonders to ward off churn. Engaged customers—the ones who are interacting with your product and your company—tend to be more satisfied customers. If they’re using your product consistently, chances are good that they’re getting something out of it—and that makes them less likely to churn. Similarly, if they’re interacting with your business, then you have ample opportunity to continue winning back their business with your stellar customer service—another major churn deterrent. But how do you track and analyze such complex data? Probably the easiest, most efficient way is implementing a Customer Success solution to dig into your customers’ behavior for you. Such solutions can actually pinpoint customers who are churn risks well before they give your company the boot—and that gives you a major leg-up in the quest for customer retention.
Make it hard to leave.
The more barriers that exist between a customer and his or her exit point, the less likely it is that the customer actually will walk away. That means making your product “sticky,” i.e., eliminate “one and done” solutions. If new customers can get everything they need out of your product in the first month—or even the first year—then what’s the incentive for them to continue giving you their business (and their money)? On the other hand, if your product is integral to your customers’ daily lives or workflows, then they’ll have a much tougher time saying goodbye. Furthermore, it behooves you to track whether your customers are using your company’s “stickiest” features. If they’re not, then it’s time to open up the lines of communication before it’s too late.
Remember that it’s not over ’til it’s over.
When a customer calls to cancel, you still have one last chance to save him or her from falling into the abyss of churn. This is where you need your A-players—your reps who not only know your product line inside and out, but also are skilled customer advocates. If they can diffuse the customer’s frustration, offer a clear path to fixing the problems that are causing the customer to be dissatisfied, and lead the customer back to seeing the value of your product, then that customer might just give you one more chance.
Test out long-term contracts.
Yes, contracts deter sales, so it’s important to take this suggestion with a grain of salt. But in some cases, it might be worth testing. After all, a long-term contract (six to 12 months) gives your customers time to get out of the precarious “rookie” stage. By the time the contract is up for renewal, ideally they will have successfully implemented your product and worked through any hiccups. Even better: at this point, they hopefully will have already started seeing results. All of these factors work to reduce churn.
Look deeper into the factors that contribute to churn.
You might find certain types of customers—or those in certain markets or verticals—are more likely to churn. For example, B2B companies that target a variety of business sizes often find that small business customers churn more than their larger counterparts because they go out of business more often and are quicker to cut costs when revenue is down. The data around these trends can help inform your product and marketing strategies and help ensure you’re focusing your energies on the right types of prospects and customers—thus making it less likely that those customers will bid you adieu at some point down the road.
What’s the Takeaway?
Customer retention is crucial to the health of any business, regardless of size or industry. Churn is a common representation of a business’s ability to keep its existing customers and thus, maximize its revenue growth. But the true value of any metric—churn included—is the action it inspires. In this case, digging into the factors that drive your churn rate can bring to light opportunities for improvement in your Customer Success strategy