In a subscription business, churn is the rate at which customers/subscribers either cancel or don’t renew their subscriptions.
You might say: ‘Hey, let them churn. There will be more..’, but a business with a 5% monthly customer churn rate: will end the year with approximately half the customers it had at the beginning of the year.
In other words, it will have to add around 50% more customers during the year to reach the customer base it had at the beginning of the year. And acquiring these new customers is six times more expensive than the retention of existing customers. This kind of Customer Acquisition Cost (CAC) is often a worrying indicator to potential investors.
So, calculating and having a grip on your churn rate is a crucial driving factor for growth. But before we get into the fundamentals of calculating churn––why does churn happen in the first place?
Types of Churn
Voluntary churn is a result of a purposeful cancellation. That is, your customer no longer needs your product or switches to a competitor.
Involuntary churn occurs when a customer’s credit card or payment fails upon renewal of their subscription.
What causes (voluntary) churn?
Attracting the wrong customers
You need customers who will sign-up, spend on upgrades, and spread the word about your product. More often than not, companies spend time and resources onboarding customers who have no clue what they signed up for. When these users don’t achieve their desired objective, they churn out. You need to work on continuous customer development and product direction to find out who you need to be selling.
Poor onboarding experience
This stage helps ease your new customers into the product ecosystem. Samuel Hulick from Useronboard believes: guiding a customer from ‘signed up to satisfied’ requires you to construct an experience that does three things,
- Educate users about the problem
- Showcase your features
- Get some user actions going
When customers don’t find the value of your product, you risk a churn out. It would be best if you defined your ‘Aha-moments.’ For example, one of Intercom’s aha-moment is when their customers see the performance stats of the first message they sent––this shows them the value of the product.
Poor customer service
Your entire organization needs to focus on customer success. Why? Because 96% percent of customers will leave you for lousy customer service. You need to communicate with your customers across their journey and solve any bottlenecks. Even if there aren’t any problems to solve, set up an outreach, just the same. As Sergei Anikin writes on Forbes:
You must strive never to drop the ball. Even if your customer seems to be happy, there are always problems to solve. If you don’t find and solve them, your competitor will.
Be diligent about customer feedback; use them to improve your product or service continuously.
How do you calculate Churn Rate?
You can calculate two kinds of churn: customer churn and revenue churn.
Now, customer churn would give you the rate at which you’re losing customers. But, revenue churn can indicate two things. It’s either revenue lost from a churned customer (customer churn). Or that a customer is still subscribed but is now paying you less––termed as ‘contraction.’
It’s essential to keep an eye on both metrics. In a given period, you could have 10% customer churn. But your revenue churn could be 30%. And that’s a worrying sign.
Let’s start with the first one.
Customer Churn Rate
Customer churn (or logo churn, or customer attrition) is calculated as the ratio of the number of customers lost during a specific period (typically a month or a year) and the number of customers present at the beginning of that time. It’s usually expressed as a percentage.
Customer Churn = [(Customers at the beginning of a period) – (Customers at the end of that period)] / [(Customers at the beginning of that given period)]
For example, consider the total number of customers at the beginning of 2019 to be 100. And through 2019, 5 of those customers canceled their subscriptions. Therefore, the customer churn rate would be: 5/100 or 5%
For a complete guide on analyzing customer churn, click here.
Revenue Churn Rate
There are two types you could calculate under revenue churn: Gross Revenue Churn and Net Revenue Churn.
Gross Revenue Churn
Gross Revenue Churn shows you how much revenue you are losing, irrespective of revenue expansion, and upgrades within the existing customer base. It helps you focus on how much revenue leakage is happening.
Gross Revenue Churn Rate = [(Downgrade MRR + Cancellation MRR) / (Total MRR at the beginning of the period)] * 100
For example, if a company had $100,000 monthly recurring revenue at the beginning of the month, and the subscription downgrades and cancellations totaled $10,000––then the gross monthly revenue churn rate would be 10%
Net Revenue Churn
On the other hand, Net revenue churn attempts to paint a picture of the actual reality after taking into account what’s lost (via cancellations, downgrades) and what’s gained (via expansion, reactivation, and upgrades).
Net Revenue Churn Rate = [(MRR beginning of the month – MRR end of the month) – (Expansion MRR)] / [(MRR beginning of the month)] * 100
Net revenue Churn can be a negative churn, which is an excellent problem to have. That’s to say the business is making more money out of a cohort of customers than losing from the same cohort during a given period. Hence, net revenue churn is a better indicator of how your business is fairing.
For example, If a company had $300,000 MRR at the beginning of the month, $250,000 MRR at the end of that month, and $70,000 MRR in upgrades from existing customers, the net monthly revenue churn rate would be -6.6%
Revenue Retention Cohort Analysis
Cohorts are specific sets of customers or users grouped within a certain time frame based on their actions. It could be users who canceled their subscriptions in a particular month or users who decided to upgrade their subscriptions in a specific month, etc.,
Cohorts help you observe customer behavior better––leading to actionable insights. It’s a lot easier than trying to follow each customer individually.
Below, we have an MRR Retention Cohort from Chargebee’s RevenueStory. Reading this chart is relatively simple and offers actionable insights.
Imagine the year to be Apr 2020, and you happen to be looking at this graph. Then, starting from the left:
- ‘Nov 2019’ would be a cohort of customers and indicates the MRR for that month.
- ‘$10.6k’ would be the MRR obtained for the cohort of customers in Nov 2019.
- In this case, there is 0% churn since we have retained 100% of the Initial MRR.
- ‘113%’ indicates a 13% increase in revenue in Dec 2019, through upgrades from the customers’ cohort activated in Nov 2019.
In the same way, we get the numbers all the way up till Apr 2020. So, how does this chart help us, and what does it indicate?
If we follow the purple arrow downwards, it shows you how much new revenue you acquired month on month. In the cohort above, observe an adverse revenue impact across customers (or cohorts) in April. But what’s more interesting is that customers acquired in the recent months (activated in Feb 2020 and Mar 2020) seem to have churned more than the older ones – indicating a high early-stage churn.
We’ll talk about ways to reduce the churn, but we need to know the acceptable churn rate before that.
What is an Acceptable Churn Rate?
A 2019 SaaS report by KeyBanc Capital Markets pegged the median annual revenue churn benchmark at 13.2% and yearly median logo churn (aka customer churn) at 15%. However, this report excludes companies with less than $5 million in revenue.
Churn rates vary across businesses depending on the market, the customers they serve, and the competitive levels in those markets. For instance, B2B SaaS businesses are likely to see lower churn than OTT providers or those in consumer services.
Factors such as pricing plans, contract duration, and business maturity also significantly impact the churn rate. According to Profitwell, companies that are less than three years old see a wide churn range of 4%-24%, whereas companies that are more than ten years old see a churn rate of 2%-4%.
You need to continuously improve to get that churn rate to the 5-7% annual range. Anything above would be a high churn rate. High churn rates are a symptom of an underlying business problem. If you want to scale to new heights: you need to address these problems.
Now, if you’re thinking: “where do I even start?” fret not––below, we’ve listed the best ways you can get that churn under control.
10 Ways to Reduce Churn
1. Invest in Subscription Analytics
2. Double Down on Customer Engagement
3. Nail a Positive Onboarding Experience
4. Identify high-risk customers that are likely to churn
5. Define High-value Customers
6. Improve Customer Support
7. Learn from Complaints and Tickets
8. Offer Annual Pricing
9. Implement Smart Dunning Workflows
10. Improve Product and Features Consistently
If you want a detailed explanation of the above 10 points on reducing churn, you can check out this blog.