Oftentimes it is easier to understand a concept by defining its opposite. In our case, “Churn” is diametrical to “Retention”. If you are running a business - especially a SaaS business - you want more customer retention and less churn.
Churn can thus be defined as the amount of business you lose over time.
Want to know how to calculate your churn rate? Then keep reading to get an in-depth understanding of how the churn rate formula can help your business.
Understanding the value of SaaS Churn metrics
In our competitive industry, metrics related to retention and churn are paramount.
You’ve worked hard to acquire customers. The last thing you want is for them to leave.
And if they do, it is wise for you to figure out why they did and how to remediate the issue.
A customer’s departure can take many forms:
- Canceling a contract
- Not renewing a subscription
- Payment lapse
- Downgrading a service
In all cases, customer churn manifests as a loss of revenue for your business. Which is terrible news. But more importantly, a high churn will require you to dig deeper into the underlying causes of loss:
- Is there a problem with your product or service?
- Is it a customer service issue?
- Are your prices too high?
- Are you delivering too little value?
- Do your customers have issues with their payments?
- Are you losing business to the competition?
The list can go on, but as you can see, further examination of your churn numbers forces you to reevaluate your business proposition and model from the ground up.
Churn and its associated metrics (churn rate, renewal rate etc.) are critical profitability metrics for a SaaS company. It would be wise for you to understand the differences and correctly interpret them.
SaaS Churn Metrics
- Churn Rate is simply the rate customers drop off their subscription plan over a defined period. It is often expressed as a percentage of the acquired customers.
- The Renewal Rate is the rate (in percentages) of customers that renew their subscription at the end of a period.
- Retention Rate (the opposite of churn) is the portion of customers that continue to use your product or service after a defined period of time.
- Customer Churn (or attrition) is the rate at which you lose actual customer accounts. Analyzing this metric allows you to figure out if you are good at keeping customers.
- Revenue Churn examines the loss of revenue. You may have a low customer churn (meaning you are not losing actual accounts) but each remaining customer is spending less in your business. Thus the revenue churn rate is still high.
- Gross Churn is the total monthly revenue lost through service cancellations.
- Net Churn is the revenue lost by existing customers that downgrade their subscription or simply pay less than usual.
As you can probably see from the definitions of churn related metrics above, nuances exist.
Each metric tells a different story and leads you to consider varying aspects of your business.
For example, for a SaaS company, a loss of customers does not always equal a net loss of revenue. Some of the revenue lost by departing customers can be offset by new ones that sign up for more expensive services or larger accounts.
Delving deeper into the different aspects of churn will thus help you gauge your overall profitability and most importantly, determine the causes of departure.
So, in light of its importance, how do you calculate your churn rate?
How to calculate churn rate
In essence, the math is simple for the churn rate formula:
For example, if you started the month of April with 500 customers and, by the end of the month, 150 of those left, your churn rate for April would be (150/500) x 100 = 30%
If you decide to calculate an annual or quarterly churn, the formula remains the same. Simply plug in the numbers that are relevant to your preferred time period.
Interpreting the numbers
Now, try spending time on your spreadsheets and figure out your annual, quarterly and monthly churn rates. The numbers may surprise you.
Churn is inevitable for a growing business. You lose some, and you win some.
That being said, your churn rate should be within an acceptable range.
According to Lincoln Murphy, the founder of Sixteen Ventures, for typical SaaS companies, the average annual customer churn rate should range between 5% and 7%.
As for the start up fundraising platform https://visible.vc/, they suggest an annual churn rate below 10%.
Note that the metrics quoted above are annual figures. A 5% annual customer churn is acceptable. A 5% monthly churn compounds and becomes catastrophic for your business.
Furthermore, you can notice that we have been speaking about customer churn. There can be a disparity between your customer churn rate and revenue churn rate. If the revenue churn rate is higher than the customer churn rate, this would mean that on average customers are spending slightly less on software and services rather than quitting altogether.
If your company is still in its early stages and making baby steps, having a higher churn is acceptable to a point. Of course, it takes time to refine your unique offering, marketing, product design and operations systems. Your churn rate should go down with time as you gain the favour of your customers.
On the other hand, if your company is already established and starts to have a higher churn rate, that is a bad sign. You will have to investigate the matter further as this can reveal serious underlying issues with your products or services, or a lack of competitiveness. In any case, it means the company is bleeding out, and you will have to take strong measures to put a stop to the losses.
How to reduce churn
Each situation is unique. That being said, all solutions invariably revolve around a simple concept: keeping your customers happy.
Competition in the SaaS sphere is stiff, and with so many options available on the market, customer loyalty is fickle at best. Unbridled dedication to delivering the best product offering almost always translates to higher user retention.
Why would a customer with the means and the need for your service go elsewhere if he is happy with your offering?
If a customer is able to extract the value he requires at a price he is comfortable with, then he is likely to stick with you.
As an entrepreneur, the churn metrics should be seen as a signal. And that signal is directing your attention to what matters most in business: your customers.
Fortunately, with gini’s SaaS benchmarking tools, you can easily use our models to calculate the relevant metrics. Quickly skim through the results and correctly interpret the numbers. It doesn’t hurt to be as prepared as possible for your next investor presentation or team meeting.