Going by the definition, you might think that the renewal rate is a straightforward concept. Analytically though, it can travel depths.
Before delving into the subject further, one should note that the terms ‘renewal rate’ and ‘retention rate’ are often used interchangeably, and wrongfully so; let us see why.
The difference between the renewal rate and retention rate lies primarily in the customer intent. Renewal rate is the measure of customers who actively choose contract renewal, whereas retention rate refers to customers who had chosen not to cancel their subscription even when they had the chance to. This could either be an automatic decision or an active decision on their part to renew the contract.
Moreover, the renewal rate tells you how many customers choose to renew their contract at a time. On the other hand, the retention rate tells you how many customers you have been able to retain over a time period. This is true when the contracts are of a longer duration.
There are two methods of calculating the renewal rate.
Count/Customer Renewal Rate
The number of renewed items against the number of renewable items gives the count or customer renewal rate. The formula is as follows:
No. of customers who renewed their contract / No. of customers who had a chance to renew their contracts
Here are a few examples:
Example 1: 100 customers have subscribed to your product at the beginning of this month. At the end of the month, 90 renew their subscription. The renewal rate for your product (this month) is 90%.
Customer renewal rate can be a maximum of 100% and is best used when your customer base is homogenous - similar types of customers, contract terms and conditions, price range, and the like.
Dollar/Revenue Renewal Rate
Unlike the count formula, the dollar/revenue renewal rate considers the contracts’ dollar value renewed. The formula is as follows:
Value of contracts that are renewed / Value of contracts that have a chance to be renewed
Customer X has a $100 subscription.
Customer Y has a $1000 subscription.
Customer X cancels, and Customer Y renews.
The renewal rate is 91%.
Additionally, let’s assume Customer Y renewed with a 10% price upgrade. Now, the revenue renewal rate is 100%.
Total number of customers - 100
Deal value - $12,000 for a 12 month contract ($1,000 MRR)
Number of contracts up for renewal - 10
Contracts lost in churn - 2
The renewal rate is 80% ($8,000 MRR / $10,000 MRR).
Additionally, assume you managed to up-sell to one of them from $1,000 to $5,000.
Now, the MRR renewal rate is 120% ($12,000 / $10,000).
To sum it up, MRR takes into account the MRR at the beginning of the month, the MRR gained from new customers, expansion revenue (MRR change gained from upgrading customers), shrunk revenue (MRR change lost from downgrading customers), and the MRR churn. Once you know MRR, ARR = MRR * 12.
Revenue renewal rate can be more than 100% and is best used when your customer base is heterogenous and you have to process data across various demographics. Hence, high renewal rates is something companies should aim for.
As mentioned before, the renewal rate might seem like a somewhat vague or straightforward concept. Well, not unless you want it to be.
That’s because you can calculate it with many different data points based on different customer segments.
For instance, you can consider these questions to calculate renewal rate: How many customers are renewing their contract for your lowest priced product or plan? What about the higher-priced tier? How many renew after their subscription has lapsed? Has the renewed contract value expanded or shrunk? What is the length of the renewed contract?; Was the renewal for the given period or prepaid for a longer duration? - If so, is there a discount?
Once these questions are factored into the calculation, it looks somewhat like this:
Customer Y buys 100 seats of product A at $1300 per seat per year on 2nd Jan 2020. The terms of the contract state that the price cannot increase by more than 5% a year. The same customer then renews his contract on 1st Jan 2021. This time he buys 120 seats at $1300 per seat per year. He makes a prepaid commitment for 5 years which allows him a 16% discount.
Not so straightforward anymore, is it?
This is how real-world renewal rate calculations look like in SaaS companies. Additionally, different customer success teams have different ways of processing the same data. Even though these questions make the analysis somewhat complicated, the results are rewarding. Let’s understand how.
It costs five times more to acquire new customers (CAC - customer acquisition cost) than to retain an existing customer. As a CSM (customer success manager), customer retention should be one of your primary focus areas.
Moreover, we know that renewal rates prove useful in revealing purchase patterns. Since renewal rates catch trends, it helps improve retention, lead to better customer success outcomes, and helps predict revenue growth.
For instance, you may notice that one segment of your customers is renewing more than another. In reaction, you might optimize their response by upselling or cross-selling. Similarly, you may choose to revisit your product pricing, packaging, and value proposition for the customers you think are not renewing as much.
Given what you discover, you can take measures to make the best of the situation, leading to better customer success outcomes for your company.
Renewal rate is also closely linked to customer churn, as Renewal Rate = 1 - Churn Rate. Focusing closely on churn and renewal rates allows you to improve your customer retention. For more on churn, visit our blog on churn rate calculation.
Rocking renewal rates don’t occur overnight. The journey has to start from day one, and the obvious secret is to have happy customers. Thankfully, there are many ways to achieve this:
Focus on product stickiness
Discover gaps and build efficiency to deliver the best customer-centric platform you can to improve product adoption.
Know when, and whom, to roll out offers to
You do not want to offer heavy discounts to a customer who will likely pay the entire renewal amount.
Identify those customers who are most likely to churn
By engaging them with attractive offers, you can help increase renewal or even increase new revenue.
Promote your product
Just because you have a set of loyal customers doesn’t mean you shouldn’t talk to them about your product anymore. You can use social media and email campaigns to offer discounts and convey important information about your product. Not only will this help with renewal (and retention), but also in upselling and cross-selling.
Engage and nurture your customers
Understand their needs, and work toward a mutually beneficial alliance. Remember – your success is your customers’ success.