What is churn?
Churn is a measure of failure rather than success, simply because it measures the loss of customers. But it is an important metric to track–especially if your business relies heavily on subscriptions to generate revenue.
Your churn rate is an actionable metric that helps you turn failure into success. It tells you more than just the number of customers you’re losing. When paired with other metrics, you’ll gain insights on growing your business. It answers the following questions:
- What went wrong?
- Why are the customers leaving?
- Where is the problem?
- What needs to be done?
How do I calculate my churn rate?
To determine your churn rate, you only need to identify:
- The value at the start of the period = A
- The value lost during the period = B
The formula to calculate your churn rate is fairly simple:
(B/A) x 100% = Churn rate
Now, there are multiple ways to calculate churn itself. You can either use your Monthly Recurring Revenue (MRR) or your customer retention to calculate your churn rate. There is no “best” way to calculate churn because both are equally important. Let’s take a look.
To determine your MRR churn rate, you will need:
- The MRR value at the start of the period = $14000
- The MRR lost during the period = $350
($350/$14000) x 100% = 2.5%
Your MRR churn rate is 2.5%.
When calculating metrics such as Customer Lifetime Value (LTV), it makes the most sense to use monetary-based metrics in the calculations.
For example, using your MRR churn rate instead of customer retention churn rate to determine your LTV. Let’s continue to build on the above scenario.
The formula to calculate your LTV based on your gross margin rate and churn rate is:
(Average Revenue Per Account x Gross Margin %) / MRR Churn rate = LTV
Assuming your variables are:
ARPA = $100
Gross margin % = 80%
MRR churn = 2.5%
($100 x 0.8) / 0.025 = $3200
Your LTV is $3200.
Customer retention Churn
Your customer retention churn tells you the rate your customers are leaving you–this is unavoidable. It doesn’t give you an accurate estimate of how it affects your monetary-based metrics. But it gives you insights into areas you need to focus on in order to increase your customer retention.
For example, assuming you are doing an annual calculation of your churn rate, and your variables are:
- The number of customers at the start of the year = 2000
- The number of customers lost during the year = 250
To calculate your churn rate:
(250/2000) x 100% = 12,5%
Your annual churn rate is 12,5%.
That means you’re churning at approximately 1% every month.
That’s not too bad, right?
What is a good churn rate?
According to Lincoln Murphy from SixteenVentures, the average acceptable annual churn rate for SaaS businesses is 5-7%. That means not losing over 140 customers (7%) out of 2000.
The logic behind this is that you’ll then have to spend money acquiring more customers to replace the lost ones instead of focusing on expanding your Net Revenue Retention (NRR).
This study by Bain & Company concludes that increasing customer retention rates by 5% increases profits by 25% - 95%. That’s right–it costs more to acquire new customers than to keep existing customers!
Reminder: Your churn rate is an actionable metric!
If you’re churning above the 5% benchmark, it’s time to sound the alarm bells for some serious review. Among the top reasons for customers ending their relationship with a business are:
- Your product or service needs further development
- Your pricing is too high
- Your customer service needs improvement
- You are selling to the wrong customers who don’t get value out of the product
Here are some examples of how to lower your churn rate:1. If your product or service needs further development, then…
- Invest in your research and development to ensure product success.
- Listen to your customers to better understand their needs (we all want to be heard).
2. If your pricing is too high, then...
- Review your pricing model to ensure your customers are getting the best value out of your product.
Either make more features available with the same price or build a pricing package based on an upselling pathway that starts low but allows customers to easily upgrade through add-ons that suit their needs.
3. If your customer service needs improvement, then...
- Start taking care of your customers–especially the best ones!
- Invest in your customer success department. That means hiring more customer success specialists and/or investing in training the existing team. Customers are likely to end their relationship with a business after a few unsatisfactory experiences. You’ve probably done the same.
4. If you are selling to the wrong customers who don’t get value out of the product, then...
- Refine your customer segment analysis. Find out who are your best customers and what are their profiles.
These are some examples of how you can use your churn rate as an actionable metric.
How does your churn rate affect other metrics?
Your churn rate affects other critical metrics such as Net Revenue Retention (NRR) and Customer Lifetime Value (LTV) that play an important role in your company’s valuation.
Churn and LTV
Your LTV is the total amount a customer is worth during their lifetime with your business. To obtain your LTV, you first need to determine your customer lifetime. The formula is:
1/Churn rate = Customer Lifetime
For example, if your churn rate is 2%, your customer lifetime is:
1/0.02 = 50 months
You can then proceed with the remaining calculation for your LTV.
Go deeper: What is Customer Lifetime Value?
Churn and NRR
Your NRR is a broad metric that gives you an idea of what your revenue streams will look like over time if there are no new customers.
The variables needed are:
- MRR of the last month = A
- Expansion revenue from upselling and cross-selling = B
- Revenue lost due to downgrades = C
- Revenue lost due to churn = D
To calculate your NRR:
[(A + B - C - D) / A] x 100 = NRR
Your goal is to grow this metric in order to obtain a better valuation of your company. As shown in the formula above, your churn plays a key role in the calculation of your NRR.
Go deeper: Net Retention Revenue
You may wonder: should I then focus on revenue growth or churn?
Those two aren’t exclusive. But if you have to choose ONLY one, choose to focus on your churn. Losing customers is expensive. You have a better chance at increasing your revenue with existing customers who are more likely to buy from you than spending more acquiring new customers.
While churn is not ideal, it is also inevitable. The 5% benchmark helps keep you in check. Once you lower your churn rate, you’ll most likely see an increase in your growth rate.