What is Churn?
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What is Churn?
Churn is a measure of attrition or loss and is the most widely tracked and discussed SaaS and subscription metric. It can measure lost customers (what many refer to as “logo churn”), contracts, ARR, MRR, GAAP revenue, contract value, seats/units/quantity, or bookings.
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, churn is the inverse of your renewal rate. An 80% renewal rate is the equivalent of a 20% churn rate.
Why analyzing your churn is important?
Case studies over the decades have documented well the reality that it is typically far less expensive to keep a customer than to find a new one. This concept of reduced 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 efficient use of capital to acquire more revenue. To that end, businesses analyze and report rate of attrition to investors as a normal course of operations. Additionally, as a business matures, it establishes and measures churn performance against objectives.
What is a Churn Analysis?
Churn analysis is the process of measuring customer or revenue churn to either 1) assess performance against operational objectives, or 2) for pure financial analysis. This analysis can either be historical in nature, or forward looking. Regardless, measuring churn involves simple math but minor differences in the objectives and processes can result in material differences in the results.
Churn analysis of operational objectives is meant to measure the success of packaging and other go-to-market programs, or for 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. This analysis for this purpose often comes with an ever changing array of rules and exceptions.
A classic example is often found in 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 it, exceptions are made for churn that is deemed “uncontrollable.” Classic examples include exceptions from churn metrics for customers who went out of business or who merged. Oftentimes, the loss of the logo 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. “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….”
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 to define the rate of attrition based on their unique views and using guidelines (less often hard rules) that are acceptable to stakeholders and potential stakeholders. 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 is a pure mathematical equation – it’s a 9th grade-level math formula dating back thousands of years that most learn for a test and then forget. A formula with little to no purpose in the lives of most business people, but one that elicits a question of interest by all founders, investors, and entrepreneurs: what is my business worth?
In the calculation of CLV, which happens to be the most objective measure of a business’s true value, there are two primary inputs: recurring revenue and customer churn. When the ancient mathematicians created the equations to calculate the present value of an infinite series (that is the basic math formula used in CLV), they didn’t publish a book of exceptions. In the calculation of CLV using churn, 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 goes up may have increased from the one merged customer, but the simple math is that you have one less customer.
What are the Most Common Churn Metrics for Subscriptions 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. Slightly broader than recurring revenue churn in that it can include lost non-recurring revenue
- Average Recurring Revenue Churn: Typically expressed as the average ARR/MRR 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.
How is Churn Used?
In the finance function, it is used:
- As a critical input to Customer Lifecycle Valuations
- As a critical input of revenue, bookings, and cash flow projections
A single churn number is suitable for discussions with analysts, press, peers, and other interested, non-operational audiences. 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 relevant churn metric 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 dramatic different churn numbers by cohorts and dimensions such as these:
- By marketing campaign
- By promotion
- By product
- By length of sales cycle
- By functional usage
- By licensed modules
- By sales channel or organization
- By industry or market segment
- By customer size or segmentation
- By total customer revenue or contract size
What are some KPIs?
The most common KPIs in churn are measurements of customer or logo loss and ARR renewal rate (primarily B2B subscriptions) or MRR renewal rate (primarily B2C subscriptions).
When do you count a Customer as churned?
If measuring customer churn for operational performance, you are free to define the rules for the date of the logo churn as there are no generally accepted practices. In fact, the ways to count 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, the common methods are:
- On the date of notification of cancellation if 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.
What is the average 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. 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 is often a meaningless metric.
How does SaaSOptics help track Churn?
SaaSOptics measures churn by interpreting your subscription financial records, and thus provides the most accurate measurement, 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.