SaaS churn is the nemesis of the recurring revenue model.
Ask any SaaS entrepreneur about the metrics they’re most concerned with and there’s a 100% chance at least one of them will include the word “churn”.
Just to get started, let’s keep things straightforward and define “churn” as: “the loss of a customer or subscription.”
However, SaaS being a relatively complex revenue model, there’s much more to churn than this simplified explanation.
Before shining the spotlight on our topic for this post, let’s take a look at the two major types of churn and why it’s important to differentiate between them.
What are the Two Different Types of SaaS Churn?
Essentially, this is the loss of a customer. It happens when a subscriber cancels their subscription. The Customer Churn Rate is an expression of the amount of customers that have been lost during a specified period. It is typically expressed as a percentage of the number of active subscribers at the start of the period in question.
Often overlooked by SaaS companies in favor of Customer Churn, which is an easier metric to calculate and interpret. Revenue churn is an expression of the income lost over a period of time due to customer churn. In the case of Revenue Churn, companies also have to factor in the loss of income due to customers downgrading their subscription packages.
Why is this Differentiation Necessary?
It makes sense to think that there’s a direct correlation between customer and revenue churn. However, there’s a critical factor that makes it important to look at these metrics separately.
Since most SaaS companies have different subscription options and price points, certain customers are more financially valuable than others. Losing subscribers that have signed up for the cheapest pricing plan can be managed, while a high churn rate amongst customers that subscribe to the most expensive plan is a potential disaster.
Calculating Customer Churn Rate
Customer Churn Rate is expressed as a percentage figure that covers an agreed upon time frame. Assessing customer churn on a monthly basis is the most typical approach, but there may be scenarios where a business may want to take a narrower or longer view.
The most common formula used to calculate customer churn rate is:
(‘Number of customers lost during period’ / ‘Number of customers at the start of period’) x 100
Let’s look at this in the form of an example:
The following is a description of a hypothetical SaaS company’s growth during September 2019:
- Starting customer base of 20 000.
- Loss of 1 000 customers (5% of 20 000).
- 2 000 new signups.
- 2.5% of the new signups, (50) cancel their subscription before the end of the month.
- This means that the company lost a total number of 1 050 customers during September.
Entering these values into the formula gives us the following calculation:
(1 050 / 20 000) x 100 = 5.25%
This is where the conversation about Customer Churn Rate often stops. A satisfying metric has been produced.
However, when we factor an additional real-world condition into this oversimplified example, a worrying possibility emerges: the misinterpretation of customer churn rate data over time.
While it’s certainly valuable for this business to know that they lost 5.25% of their customers during September, the real value in this metric emerges when they compare it to that of August and October.
Let’s see what happens when we expand this example to October, assuming the company maintains its rate of gaining and losing new customers.
- October’s starting subscriber-base is 20950 (20 000 + 2 000 – 1 000 – 50).
- During October, the company again loses 5% of the months starting subscriber-base: 1 190
- The company again acquires 2 000 new subscribers.
- Again, 2.5% of the new subscribers cancel their contracts: 50.
- The company has lost a total of 1 240 customers during October.
When we plug these variable into our formula, something worrying crops up.
1 240 / 20 950 x 100 = 5.91
Despite losing and gaining the same percentage of customers, the company’s Customer Churn rate is significantly different. When looking at this data, the CEO will instantly be under the impression that October was a worse month than September when it came to retaining customers.
The problem is compounded as the number of months evaluated are increased.
How Do We Address This Issue?
Clearly the formula-of-choice is one that helps a company achieve a single view of a very helpful metric but when using it to monitor growth, some serious problems emerge.
Fortunately there is a relatively simple answer that requires the use of an adjusted formula:
(‘Number of customers lost during period’ / (‘Number of customers at the start of period’ + ‘Number of customers at the end of period’) / 2) x 100
Using this formula normalizes the metric and provides a more stable view of the actual churn rate growth.
Why Do Smart Entrepreneurs Pay Attention to this Metric?
Simple. Churn is an actionable metric – one that is designed to illustrate a problem and prompt a solution. Often SaaS metric tools highlight what’s referred to as vanity metrics. These are designed to make the business feel good about growth but seldom provide value other than a temporary morale boost.
Actionable metrics challenge organizations. They are statistics that point out where the growth opportunities are being missed. Smart CEOs favor these because it gives them real insight into the areas of their business where improvement is necessary.
Conversely, it also allows them to see where they are succeeding. In such a case, a CEO may opt to “action” by shifting resources or overhead to solving a more worrying metric.
What is a Healthy Customer Churn Rate?
As can be expected, the answer to this question is highly dependent on the type of business being analyzed and the industry they serve.
However, in a recent survey of approximately 300 SaaS businesses that fall within the sub-$1M to $50M revenue range, Totango published the following findings.
Understandably, the main commonality between companies with similar customer churn rates is whether they are in a period of high, medium, or low growth. In this case, “growth” refers to the increase in yearly revenue.
Totango’s findings were as follows:
- HIGH GROWTH: The majority of these companies reported a customer churn rate below 5%.
- MEDIUM GROWTH: Majority of these companies’ churn rate was between 5%-10%.
- LOW GROWTH: The majority of these companies have a customer churn rate above 10%.
While the results are relatively vague, there are two major things that can be taken away from them:
- Sub-5% annual customer churn rates were surprisingly common. This value has been generally regarded by commentators and industry experts the point where churn can be compensated by reasonable customer acquisition rates.
- The majority of SaaS companies included in the survey (more than 65%) reported a customer churn rate below 10%.
While every SaaS business is different and hard comparisons aren’t always good to make when putting down objectives, it’s good to know figures like these.
Why Preventing Customer Churn is Critical to SaaS Success
This goes way beyond the generic statement that it’s “bad business” to lose a customer.
Traditional enterprises do what they can to create loyal return customers, but their business models are seldom entirely reliant on doing so. For them, a customer going to another store or service provider is simply the loss of a single sale.
For a SaaS business,however, a customer isn’t just a sale – a customer is also the promise of future sales. This concept is part of the DNA of the SaaS business model.
The main reasons for this are highlighted below:
Acquisition is More Expensive Than Retention
This has long been a maxim of the SaaS industry and it has been proven with hard data time and again. Business.com reports a statistic that it costs between 5-10 times more to acquie a new customer than retain an existing one. Of course, this is highly dependent on the methods of retention – although great technical support and providing users with the features they require from the product are amongst the usual suspects.
Customer Acquisition Cost (CAC) is a SaaS metric that every CEO and CMO will be highly familiar with. Driving this figure down is an incredibly difficult challenge and one that receives as much attention as any other popular SaaS metric.
Despite this, acquisition is frequently reported as a much higher priority for companies than retention. In fact, Invespcro published findings stating that 44% of companies surveyed cited acquisition as a top priority. While a stark 18% stated that retention is their number one goal.
Of all the statistics advocating the reduction of churn, few are as powerful as this one published by Bain & Company: Increasing your customer retention rate by as little as 5% can increase profits by 25% to 95%.
Existing Customers Can Be Upsold
One frankly astonishing statistic that again emerged from research performed by Totango is that, on average, 70% – 95% of a SaaS company’s revenue comes from upsells and renewals. While between 5%-30% of revenue comes from an initial transaction with a customer.
Bearing this in mind, it stands to reason that preventing customer churn is one of the most profitable priorities for a SaaS business.
A company cannot upsell or renew a customer that isn’t already on their books.
More Active Users Means Higher Likelihood of Viral Growth
Viral growth is an incredibly effective means to achieve SaaS success and there are two ways it can happen.
The first has very little to do with marketing or promotion, but rather just by ensuring that customers are constantly delighted by the product, onboarding and technical support.
At some point, the right person is going to have an exceptionally positive experience with a product which they’ll tweet about to their 500k followers.
One way to trigger “artificial” viral growth is to implement a well planned referral program. When correctly planned and executed, a referral program that offers measurable value to the referrer can be a massive growth mechanic for a SaaS business.
The correlation between the success of a referral program and the number of customers acting on it is obvious. By reducing churn and maximizing the number of active users, the success of a referral program is greatly enhanced.
How To Prevent Customer Churn
Arguably one of the most-discussed topics in the SaaS world is how to bring the customer churn rate down to that mythical 5% figure.
There’s no shortage of hacks and tips but the following have a proven record of success.
Find Out Why it’s Happening
When a high-value customer downgrades or cancels their subscription, a phone call with their CEO to find out their reasoning is extremely valuable. Not only because it may save the relationship, but it will provide information that could prevent further churn.
There’s always the temptation to implement an automated survey as part of the cancellation process, but nothing is going to give as much insight as an in-person conversation.
Think Critically About Price Points
Businesses should pour their time and effort into devising price point logics that make sense to their users and are directly linked to measurable value for them. It’s also generally a good strategy to keep en eye on the competition. Another product that offers similar functionality at a disruptive price could seriously damage a SaaS company’s churn rate.
Listen to Customers
In a survey conducted by FE International in which 20 leaders in the SaaS industry were asked to give the primary reason for their success, more than half responded with “Customer value”.
Intelligent SaaS business owners know that the best way to keep a customer paying their monthly or yearly subscription is to provide them with the functionality they need and ask for.
This tip is doubly important when it comes to the needs of high-value customers. Many young companies find themselves in a position where they are providing a service to an enterprise level customer. In these cases, it makes sense to bend over backwards to keep them delighted.