Churn is a critical KPI for SaaS and other subscription businesses. It gives you an indication of how your service is resonating with customers and allows you to calculate other key performance indicators like customer lifetime value and projected revenue.
While you most often think of churn as just the number of subscribers lost within a given timeframe, there are actually several different variations that can provide other important insights into your business. In addition to the better-known customer churn, there is also discretionary churn, MRR churn and negative churn.
Basic Customer Churn
Also known as the attrition rate, basic customer churn is typically expressed as a percentage and is the rate at which SaaS customers cancel, close or do not renew their recurring billing subscription in a given period.
While those who are considering or have a financial stake in a SaaS business closely analyze this rate, there is a complication. There are a number of different ways to calculate customer churn and there is no universally agreed upon ‘correct’ approach. This ambiguity saw Netflix slapped with a lawsuit when it published what many thought were artificially low churn rates that were calculated using quarters where significant numbers of new subscribers were added.
While the lawsuit was dismissed, it did prompt a standard definition of churn to be adopted by publicly traded companies who now report churn rate as “the percentage of participants who discontinue their use of a service divided by the average number of total participants during a given period of time.”
While publically traded companies use this formula, be aware that others may use other formulas with differently defined variables for a more desirable result. You should also be mindful of the limitations of this metric, as it implies churn is equally spread out over the time period being measured. If you are calculating basic customer churn over a quarter, fluctuations between months will not be distinguishable.
Another problem with the basic customer churn formula is that is does not accurately calculate churn for SaaS companies who have customers locked into contracts until a specified renewal date. To account for this, a discretionary churn formula can be used to determine the number of clients churning in a month as a percentage of the total clients eligible for churn. In other words, this metric looks at all customers in a time interval who have the option to unsubscribe while removing those whose contracts don’t give them the option.
The formula can be seen as:
An extension of the basic customer churn rate, MRR churn determines the total of monthly recurring revenue lost due to customers not renewing or cancelling. While it is imperative to track customer retention rates, MRR churn is arguably more important because changes in revenue do not always correlate directly with the number of users lost. For example, you may have a low churn rate of 2.5% in a given year, but that 2.5% included several marquee customers representing a much more substantial proportion of your recurring revenue. Investors frequently look at MRR churn to see whether a SaaS company is successfully retaining larger clients.
There are two formulas that can be used to calculate the monthly recurring revenue churn. While it is up to the discretion of the company as to which formula they prefer, it is important to be transparent with how you calculated the metric.
Negative churn is the one type of churn where you want to strive for a higher rate. It is actually one of the most powerful accelerators for growth within SaaS businesses and is achieved when the revenue from expansions, upsells and cross-sells on existing customer accounts matches or exceeds the revenue lost from basic customer churn. Therefore, companies can aim to achieve 0% churn, where the expansion of existing revenue offsets customer churn throughout a certain period. This, accompanied with new customer acquisition can result in very high growth for maturing SaaS companies.
To successfully achieve negative churn SaaS companies must have a pricing structure that allows for upsells, cross-sells or that increases pricing according to some usage metric. For example, DropBox increases their price according to the amount of storage used. Alternatively, Salesforce has a tiered pricing structure based on the number of features included in a package, allowing for upsells.
Here is the formula to calculate this churn as a percent of net monthly recurring revenue. A negative result indicates you have achieved negative churn.
The various churn rates are essential to understand how your SaaS business is performing. While customer acquisition is fundamental for SaaS startups, too frequently it remains the main focus as companies scale. But as SaaS firms mature, it becomes increasingly difficult and costly to replace churn with new customer acquisitions.
While lower customer, discretionary and MRR churn are necessary stepping stones for successful subscription businesses, the ultimate goal is engaging customers to the point where you achieve negative churn. Only then will you achieve higher customer lifetime values and substantial recurring revenue growth.
Fortunately, there are a number of quick customer engagement strategies that you can implement right away like simplifying your signup process, providing incentives for referrals and engaging customers on social media.