What is Customer Churn?
Table of Contents
I. What is Customer Churn?
A. How is Churn Used?
B. How to Calculate Customer Churn
C. When Do You Count a Customer as Churned?
D. How to Reduce Customer Churn
II. Churn Rate
A. What is the Average Churn Rate for Saas?
B. What is a Good Churn Rate for Saas
III. What is Customer Churn?
A. Why is Analyzing Your Churn Important?
What is Customer Churn?
Customer churn is a SaaS business metric that measures the amount of customers, accounts, contracts, bookings, etc. that a business has lost over a period of time. Also known as the rate of attrition or just plain “churn”, customer churn is one of the most widely-tracked and heavily-discussed subscription company metrics.
Customer churn is typically expressed as a rate or a ratio (“churn rate of 12%”), but can also be expressed as a whole number (“we churned 12K of ARR” or “we churned two customers”). When discussed as a rate, customer churn is the inverse of your renewal rate. Thus, an 80% renewal rate is the equivalent of a 20% customer churn rate. Whereas a measure of customer churn captures the amount of customers that your business loses, renewal rate captures the amount that stay.
How is Churn Used?
In the financial departments of SaaS companies, it is used as a:
- Critical input to Customer Lifecycle Valuations
- Critical input of revenue, bookings, and cash flow projections
A single customer churn number is suitable for discussions with analysts, press, peers, and other interested, non-operational audiences, making this particular metric highly valuable.
However, to better inform key business decision-makers in product or service pricing, planning, packaging, and marketing (among others), SaaS businesses employ a variety of more sophisticated churn metrics to help them understand the true performance of their business and relative to their peers.
SaaS businesses should define clear terms for each of their relevant customer churn metrics and measure them consistently from period to period. Again, this requires well-defined and agreed-upon definitions and metrics for measurement. Product management should look for potentially dramatically different customer churn numbers that have values determined by cohorts and dimensions such as:
- Marketing campaigns
- Length of sales cycle
- Functional usage
- Licensed modules
- Sales channels or organizations
- Industries or market segments
- Customer size or segmentation
- Total customer revenue or contract size
When Do You Count a Customer as Churned?
If measuring customer churn for operational performance, you are free to determine the timespan during which a customer is to be considered churned, as there are no generally accepted practices. In fact, the ways to count customer churn are similar and parallel to new customer counts, which tend to focus around either the order date or the subscription commencement date, if different.
For customer churn specifically, the common methods of determination are:
- On the date of notification of cancellation, if it is before the actual subscription end date (often called a booked cancellation)
- On the end date of the subscription even if notice is given before such date
- On the date you have sufficient evidence that the customer will churn, typically as evidenced by a contract breach such as failure to pay
If measuring customer churn for use in CLV calculations, the answer is much simpler. The customer is churned when the reportable recurring revenue stream from that customer goes to zero. This method counts the customer if they are contributing revenue all the way until such contribution ends, even if notice is provided well in advance of that end date.
How to Reduce Customer Churn
There are multiple ways a business can seek to reduce its customer churn:
1. Understanding Why You’re Losing Customers
You can’t really solve a customer churn problem until you’ve identified its source. Why your customers are leaving is an absolutely necessary precursory question to answer before you move on to ameliorating the loss you’re suffering. Try conducting interviews or sending out cancellation surveys to understand why customers aren’t staying with your company.
2. Ensure You’re Providing Stellar Customer Service
If your customers find your ramping process to be too hard (or non-existent), they might just cancel their services rather than seek out help. If that’s the case, then you need to figure out the best way to offer them help. Consider starting a blog on your web domain, auditing your customer service department, or building out a more intensive onboarding process in order to provide more thorough and straightforward services to your clients.
3. Read The Room
Customers don’t usually up and disappear without a moment’s notice. Start familiarizing yourself with the qualities of accounts that might be considering cancellation— have they not logged in for weeks? Has their usual level of activity and communication been lowered? If so, consider reaching out to this customer proactively.
What is a Customer Churn Analysis?
Customer churn analysis is the process of measuring customer or revenue churn to either 1) assess a business’s performance against operational objectives, or 2) for pure financial analysis. This analysis can either be historical or predictive in nature.
Types of Customer Churn Analyses
A customer churn analysis of operational objectives is meant to measure the success of packaging and other go-to-market programs; or the success of processes, typical customer success, or renewal processes. This analysis is frequently done in support of and used in the determination of bonuses and incentive payments for hitting churn and retention targets. It is for this purpose that it often comes with an ever–changing array of rules and exceptions.
A classic example of a customer churn analysis can be found with the compensation plans of customer success managers who are incentivized to minimize churn and maximize ARR and revenue. Because the core objective is to motivate employees to minimize customer churn, exceptions are made for churn that is deemed “uncontrollable.” Examples of this include exceptions made for customers who went out of business or who merged with other accounts. In the same vein, the loss of the customer and ARR is an exception left out from the performance review and quota/commission computation.
Another example may be the “forgiveness” of the loss of “seats” due to a change in company pricing and packaging decisions, which might actualize as something along the lines of “It’s not our fault that we now offer 10 seats in a bundle for less than what we used to get for 5 seats….”, when in actuality, these numbers are important to consider when analyzing customer churn and contraction.
However, when you are computing churn for the purposes of pure financial analysis, there should be little to no exceptions. An error often made by SaaS and other subscription businesses is defining the rate of attrition based on their unique views and using guidelines that are acceptable and subject to stakeholders’ and potential stakeholders’ opinions. But such guidelines can corrupt the underlying math involved in understanding the single most important metric influenced by churn: enterprise value as measured by Customer Lifetime Value.
Customer Lifetime Value, or CLV, can be calculated very easily if you know the formula to do so— and it is a formula with little to no purpose in the lives of most business people. It does however help to answer the question asked by all founders, investors, and entrepreneurs: What is my business worth?
When it comes to calculating CLV (which happens to be the most objective measure of a business’s true value), there are two primary inputs that are necessary: recurring revenue and customer churn.
In the calculation of CLV that takes customer churn into account, it is important not to rule out circumstances that count as customer churn, but aren’t things your business could have prevented. For example, a customer that goes out of business has churned. It’s no one’s fault, but it can’t be used as an exception to amend the equation. When two of your customers merge, you lose one. Simple math is not debatable. In this instance, your recurring revenue may have increased from the one merged customer, but the simple math prevails: you have one less customer.
Why Analyzing Your Churn is Important
Case studies over the decades have shown that it is typically far less expensive to keep a customer than to find a new one. The fact that revenue from returning customers has a lower cost per dollar of revenue is the simple driver behind most of the focus on churn.
A “low churn rate” or an “improving churn rate” are indicators that your business is operating well or improving in its ability to use capital efficiently in order to acquire more revenue. It is for this reason that businesses analyze and report rate of attrition to investors as a normal course of operations. Additionally, as a business matures, it measures churn performance against objectives to keep on track for various growth objectives.
How to Calculate Customer Churn
In order to calculate your business’s customer churn rate, you have to take your business’s monthly recurring revenue (MRR) at the beginning of a business month and divide it by the monthly recurring revenue you lost over the course of that month, and subtract it by any upsells or addition revenue generated from existing customers. Every time you go to calculate customer churn, your formula should be as follows:
Customer churn rate = [(customers at beginning of month – customers at end of month) / (customers at beginning of month)]
What is a Good Churn Rate for SaaS?
Generally, the venture community has circled around a number of 10% customer churn as a bellwether number. Every point below 10% is better and better, and every point above 10% is worse. However, there is no universal average rate you can benchmark against. Customer churn rates vary widely based on target market, price, value proposition, product quality, and operational execution in customer support and service. And rates without consideration of customer acquisition costs are often meaningless metrics.
What are the Most Common Churn Metrics for Subscription Businesses?
- Customer Churn and Logo Churn: Lost customers, expressed as a percentage/rate as well as an absolute count. Customer Churn measured as a percentage is an important part of the overall CLV calculation process.
- Recurring Revenue (ARR/MRR) Churn: Typically expressed as a ratio of ARR or MRR lost as a percentage of renewals candidates, but can also be expressed as the total MRR or ARR value lost to customer cancellations and attrition.
- Revenue Churn: GAAP revenue, MRR or ARR churn, typically reported as a ratio. This metric has a slightly broader breadth than recurring revenue churn in that it can include lost, non-recurring revenue.
- Average Recurring Revenue Churn: Typically expressed as the average amount of average recurring revenue or monthly recurring revenue decrease due to lost customers.
- Bookings Churn: A traditional approach to measuring churn in software companies, this approach has been replaced using ARR and MRR churn ratios. It was originally a measure of the bookings, or executed contracts, between a client and a subscription company.
How Does SaaSOptics Help Track Churn?
SaaSOptics measures churn by interpreting your subscription financial records, and thus provides the most accurate measurement of customer churn, including logo churn and recurring revenue churn. SaaSOptics doesn’t rely on user transaction “tagging” because user tagging is error-prone and unscalable. User tagged records kept in a CRM or a spreadsheet do not include proper validation to ensure the tagging is correct and can lead to materially incorrect metric reporting.