What is churn rate and why you should care

Put simply, the churn rate is the rate at which your customers are canceling their subscriptions. It is the percentage of subscribers who stop paying you.

Your subscription business thrives on customer retention, and the churn rate is the hole in your customer retention bucket. (Sneaking in a quick formula here: Retention Rate = 1 - Churn Rate)

Need one more reason to pay attention to this?
Here you go:

The ultimate metric for most SaaS companies is the LTV/CAC ratio, where LTV is the LifeTime Value of the customer and CAC stands for the Customer Acquisition Cost. (Head here for CAC)

Now your churn rate is one of the prime levers of the Customer LifeTime Value (CLTV), and thus a drop in your churn rate will invariably boost the value of the "god metric".

So it goes without saying that one minor mistake in your churn calculation will mess up the unit economics of your business.

Let's get on with it.

The fantastic churn rates and how to calculate them

Before we begin with the nuances, here are the basic ingredients to calculate churn:

  • Number of customers lost during a specific period = The number of customers at the beginning of the period - The number of customers at the end of the period

  • Revenue lost during a specific period = The revenue generated at the beginning of the period - The revenue generated at the end of the period

Now there are three main types of churn rates

  • Customer Churn Rate

    which deals with the number of customers lost

  • Gross Revenue Churn Rate (or Gross MRR Churn Rate)

    which deals with, you guessed it, the revenue lost from the existing customers

  • Net Revenue Churn Rate (or Net MRR Churn Rate)

    which is the MRR churn rate that additionally factors in the new revenue gained from the existing customers (aka Expansion MRR)

Here's an example to see how this works in detail:

Let's say that you have a $1/month plan and a $2/month plan.

At the beginning of the month, you have 200 customers, who all pay you $1/month. Out of these 100 customers, 8 customers leave you within the month, while 4 others upgrade to the $2/month plan.

So what are your churn rates?

Now we can extract the following details from the above scenario:

  • Customers at the beginning of the month = 200
  • Existing customers who left during the month= 8
  • Revenue at the beginning of the month = $200
  • Revenue lost from the existing customers during the month = $8
  • New revenue gained from the existing customers during the month = $4

And these are just what we need to get our churn rates churned out (pun intended):

Customer Churn Rate = (8/200)% = 4%

Gross Revenue Churn Rate (or Gross MRR Churn Rate) = (8/200)% = 4%

Net Revenue Churn Rate (or Net MRR Churn Rate) = ((8-4)/200)% = 2%

Which brings us to the main difference between the types of churn rate - while your customer churn rate can give an overall picture of the health of your subscription business, it might paper over certain cracks (or gold, in the case of upgrades).

Only a Net MRR Churn Rate will truly reflect how your business is faring, and nailing a Negative Net MRR Churn Rate (when the new revenue becomes higher than the revenue lost) is one of the best goals that you could have for your SaaS business.

Because, when your Net MRR Churn Rate hits a negative, it means that your revenue will still increase even if you don't make any new sales.

Note:

If you're opting for Net MRR churn rate, then you'll be including scenarios like upgrades and downgrades in your churn rate as shown above. In such a situation, please ensure that you don't include upgrades in your MRR calculation as well, which will turn out to be a double-counting, and might mislead you.

Wisdom nuggets for the churn nerds

Growth Rate vs. Churn Rate

Now let's make things a bit more interesting.

Let's suppose that apart from those 200 existing customers, 15 other customers sign up for the $1/month plan in the middle of the same month, out of whom 3 customers leave you before that month ends.

What now?

Just add the data related to the new customers to the churn rate calculation, right?

Wrong!

Remember, no matter how many new customers join you in the middle of the month, you should simply ignore them while calculating the churn rate for that specific month.

Because if you include those customers in your calculation, you'll no longer be calculating your churn rate, you're finding out your growth rate.

Annual Churn Rate vs. Monthly Churn Rate

While calculating the monthly churn rate (MRR Churn Rate) is the general norm for SaaS companies, it's better to check your annual churn rate as well, in order to get a realistic bird's-eye view of your business's performance.

Remember the little formula that was sneaked in in the introduction? It's now time to put that to use.

Let's consider the above example, where your Net MRR Churn Rate is 2%

Monthly Retention Rate is 1 - 0.02 = 0.98 = 98%

Your Annual Retention Rate should be (0.98)^12 = 0.7847167237

Therefore you Annual Churn Rate = 1 - 0.7847167237 = 0.2152832763 = 21%

See how it quickly escalated from a mere 2% to a whopping 21%?

To put things in perspective, if you begin the year with 100 customers and $100 in MRR, and if your annual churn rate is 21%, you need to acquire 21 new customers and get an additional $21 in MRR, just to match with your beginning of the year benchmark. A stomach-churning disaster, that's what it is (this is the last pun, promise).

Customer success consultant, Lincoln Murphy says that a healthy annual churn rate for a SaaS business is about 5 - 7%, which will translate into a monthly churn rate of around 0.42 – 0.58%.

And the major tricks to ace this, apart from working on your customer retention strategy? Negative Churn and Expansion MRR.

In other words, set up a pricing strategy that grows with your existing customers, upsell them to higher plans, and cross-sell them to additional products.

  • Plan-wise segmentation

    Which plan has customers with the highest churn rate? Why did the plan perform better than the other plans? Was it the price? Was it the value of the offering?

  • Channel-wise segmentation

    Customers acquired from which marketing channel churn the most? Which channels bring in customers who stay?

  • Voluntary vs. involuntary churn

    Did a customer churn because of a failed payment or an expired credit card (involuntary) or because they didn't receive the expected value from your product (voluntary)?

  • Cohort Analysis

    What is happening to customers who join you in a particular month? Are most of them churning in the first few months? Is the churn rate stabilizing after a few months?

Churn is just the aftermath

We all are pretty aware of the statistic that says it's 6-7 times more expensive to acquire a new customer compared to retaining an existing customer.

We are also aware of the age-old adage, "Prevention is better than cure".

What we are also aware of, is that we have to ensure that our customers are satisfied, before they churn.

Here are the metrics that you need to track, in order to nip the churn in the bud:

  • Net Promoter Score (NPS)

    Get your customers to rate their experience on a scale of 1 to 10, ask them about the reason for their score, know what's working and what needs work.

  • HubSpot's Customer Happiness Index (CHI)

    How engaged are your customers? Pick your stickiest features (which customers seem to draw the most value from), and measure the overall engagement score of your customer with respect to those features. Find out the common traits amongst the customers with the highest scores (to acquire more customers who fit that persona), and improve the engagement of those with low scores.