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. So, how do you stop your customers from walking out the metaphorical door? The key is measuring data points that will tell you whether your business can sustain its current performance in the long term, and that data point is churn rate.
What is Customer Churn?
Customer churn is the percentage of customers who discontinue their service with your business over a given time frame (typically a month or a year). This is an important metric to measure for many businesses, especially ones with a recurring payment structure for customers. Understanding how many customers are leaving your platform is important to understanding revenue and growth potential. So calculating that rate and knowing its value is critical to success.
How to Calculate Churn Rate?
Churn Rate = (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%. This doesn’t include any new sales or customers during that time period. We want to see the velocity of cancellations for existing customers. 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 customer retention’s impact on company revenue, it can be helpful to calculate retention in terms of revenue. That’s where the customer retention formula gets more complex. To figure out your revenue churn, you’ll need to know your monthly recurring revenue (MRR)
What is MRR?
MRR is the expected income that a company reliably expects every 30 days. If you have 100 customers on a monthly billing plan at $5, you can reliably estimate a $500 MRR.
To calculate revenue churn, divide that figure by the amount of MRR you lost over the course of a particular month.
What is Revenue Churn?
Revenue Churn = (MMR Lost from Churn) / MRR
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. Let’s take a look at an example: Say your MRR at the beginning of the month is $100,000. At the end of the month, it’s $80,000.
What is the Difference between Customer Churn and 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: Say your company has two product lines. Your basic service has 100 customers at $10 a month per customer. So your MRR for that line is: (100) X ($10) = $1,000 Your premium service has 50 customers at $40 a month per customer, $2,000 So, in total, you have 150 customers and $3,000 MRR.
Let’s say you lost 20 basic service customers and 10 premium service customers. Your churn rate would be calculated as:
30 / 150 = 20%
Revenue Churn takes into account the value of that customer. So you take the MRR lost instead:
(20*10)+(10*40) / 3000 = 20%
As you can see, your customer churn rate (10%) is slightly lower than your revenue churn rate (12%). It’s important to distinguish between these two metrics because each figure provides different information about your business.
Separating out the product lines can help you see where your business is strongest in terms of customer retention and revenue generation.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.
Why is Customer Retention Important?
Your customer retention 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 customer retention 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.
Customer Churn is Expensive
In fact, according to Kissmetrics, it can cost seven times more to acquire new customers than to retain current ones. Customer attrition 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.
Churn is More Costly as You Grow
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 customer attrition 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 customer attrition rate of 2.5%, you are losing $64k a month which is extremely hard to replace with new customer bookings”.
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 client retention 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.
How to Improve Customer 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 on how to defeat churn.
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.
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 leave. 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.
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 your product is integral to your customers’ daily lives or workflows, then they’ll have a much tougher time saying goodbye.
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 increase customer retention.
Look deeper into the factors that contribute to Customer 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 are more likely to leave 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.
Voluntary Churn vs. Involuntary Churn
As you’re making your retention 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 customer retention 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 client attrition.
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.
Negative Churn occurs when revenue actions (such as up/cross selling, expansions, etc.) exceed your Revenue Churn. There are some key factors you should consider when trying to get negative churn:
Employ a pricing model that draws more revenue per customer over time.
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.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 customer attrition).
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’s the Takeaway?
Customer retention is crucial to the health of any business, regardless of size or industry. Customer retention 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 customer retention rate can bring to light opportunities for improvement in your Customer Success strategy