December 9, 2021
7 Min Read
Depending on how it is calculated and how it is used, churn rate can be a valuable indicator of customer retention rates, customer satisfaction, the success of your marketing, sales, customer service strategies, and how your customers value your product. Plus, overall, looking at revenue churn rate, you understand the general financial viability of your business.
In this article, we explain churn, break down the different types of churn, and try to dispel some of the sources of confusion that can arise when trying to calculate it.
“Churn” is the term used to describe lost customers for a subscription-based product or service, especially in the technology, software and SaaS spaces. Contract cancellations, bounced credit card payments, and downgrades to free plans are all examples of common sources of churn.
Churn rate is a measure of the number of customers – or revenue – lost as a SaaS or subscription model business over a certain time period, usually expressed as a percentage of the total customer or revenue base at the start of that period.
Given the unique revenue model of a SaaS business, the high costs to acquire each customer (CAC) can only be offset and ultimately outweighed by that customer’s subscription. But only if they remain with you long enough for their lifetime value (LTV) to exceed the initial CAC. Every time a customer churns before reaching the optimal LTV, you’ve lost rather than made money.
If your churn rate is too high, regardless of whether you are signing on new customers, over the long-term, your business is unlikely to succeed.
With this in mind, it’s no wonder that measuring your churn and churn rate is so important to keeping abreast of your SaaS business.
Your customer churn rate is the number of customer subscriptions lost over a certain period, such as a month, quarter or year, out of the total customers you had at the beginning of that period. It’s expressed as a percentage, but because it's over a specific time period, it is in fact a rate, so should always be given as a percentage value per such-and-such time period.
The period can make a huge difference to whether a given churn rate is good or bad. As an example, a 5% annual churn rate is admirable, but this doesn’t average out over the year. Instead, that 5% monthly churn rate compounds, to give an annual churn rate of 46%, which is actually disastrous.
When a founder or CEO tells you their company’s churn rate is 5%, your next question should always be: “Over what period?”
(Number of customers lost over a set period / Number of customers at start of same period) x 100
= customer churn rate
For example, if at the start of a year, you had 200 subscribed customers and you lost 15 subscriptions over the year, you would calculate your churn rate over that year as follows:
(15/200) x100 = 7.5%
There are a variety of scenarios in which this simple formula becomes more complicated, but for the most part, this is a good basis to work from.
Things get a little more complicated when it comes to looking at churn through the lens of lost revenue rather than lost customers.
While customers can be fairly easy to measure and customer churn rates can look promising, interpreting the rate of value loss in terms of revenue can be done in many different ways, all of which can give you a different picture of your SaaS business’s health.
Most revenue churn rate formulas used give the percentage of monthly recurring revenue (MRR) lost over a period as a result of customer churn.
(MRR lost due to churned customers over a period / MRR at start of that period) x 100
= MRR churn rate
Calculating revenue churn rate accurately and informatively can be more complicated, however, if you have a tiered system of different price plans or different contract lengths or both.
Revenue churn can present a totally different number to customer churn if the majority of customers you’re losing are enterprise or premium plan customers rather than on freemium or entry level plans.
In this case, simply measuring the number of customers you lose over a period is almost less important than knowing which price plan those customers were on, in order to accurately calculate the impact their loss has on your revenue.
Here, you’d ideally segment your MRR churn rate calculation for each contract category: MRR (premium) churn, MRR (mid-plan) churn or MRR (entry level) churn for example.
An important factor to bear in mind when calculating each component is to ensure that the starting total you use for each category is only the starting total from that category of customers. Taking premium contract churn rate for example:
Correct calculation for premium contract churn rate:
(MRR from premium customers lost over a period / Total MRR from premium customers only at the start of that period) x 100
Incorrect calculation for premium contract churn rate:
(MRR from premium customers lost over a period / Total MRR from all customer groups at the start of that period) x 100
The latter formula would give a much lower percentage value because the total being divided by is larger, creating the false impression that your churn rate in this group is actually better than it is.
In addition to the fact that a healthy-looking monthly churn rate can balloon up to a very scary figure when compounded to produce an annual churn rate, it’s important to watch out for miscalculations if your customer base is made up of both monthly and annual contracts.
Just like segmenting your revenue churn by plan, it is often more accurate to look at your churn in monthly contracts separately from your churn in annual contracts.
If for example you have 1000 customers, 950 on annual contracts and 50 on monthly contracts and over the year you lose 25 monthly contract customers: the simple churn formula would tell you your churn was as follows:
(25 / 1000) x 100 = 2.5%
Calculating your churn in monthly contracts more accurately gives a much more frightening figure:
(25 / 50) x 100 = 50%
Spotting that you’re losing half of the monthly contracts you get every year should warn you that there are major problems in your monthly contract funnel that need to be addressed if this aspect of your business is going to survive.
While these examples have been magnified for illustration, you should be able to see already why calculating a normalised single meaningful revenue churn rate figure that is easy for everyone to understand can be difficult.
The best option is usually to keep it as simple as you can while being informative.
You’re never going to be able to eliminate churn, and nor should you aim to. There are perfectly legitimate reasons for customers to leave an app or a service, several of which are simply beyond your control. This might be related to their personal needs or their cash flow situation.
However, there are always elements of churn that you can reduce. These include technical issues, competitors offering a better service, customers feeling unheard, or poor pricing models. These are all aspects of your business that need to be streamlined and refined over time. When you’re motivated to reduce churn from these sources, that’s a useful mindset to get stuck in.
Segmenting your churn rates accurately is an important part of this diagnostic process.
If customer losses are concentrated in one price plan, in downgrades rather than cancellations, or in failed payments, the causes behind those higher churn rates may be specific to that group too, and therefore the strategy for reducing that churn can be properly tailored.
Finding out that your churn rate is high is unpleasant for any leadership team. There are textbooks, academy courses, and much longer articles than this which go into the myriad different strategies for reducing churn. Many come back to the same basic themes:
If the answer to any of these questions is no, reducing your churn will require taking targeted steps to address this.
If you need help measuring your churn, or developing a strategy to reduce it, take a look at some of our recommendations for SaaS analytics platforms, all of which include extensive options for calculating churn, or find out about our vetted freelancers who can help you develop a strategy to combat churn.