How SaaS Companies Are Assessing Churn Rates

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The subscription business model is so popular because it gives business leaders the ability to easily predict recurring revenue. But, when too many existing customers are canceling their subscriptions—especially if it's happening at a faster rate than you're signing new customers—it can be disastrous for your SaaS business.

If not properly addressed, customer churn rate can have a negative impact on your business, so monitoring it should be one of your key focuses each month. Reducing it can increase revenue and grow profit margins.

The churn rate is one of the most important metrics for a subscription business to measure. It allows you to determine if there is a problem with your business’s processes, pushing customers away from your business. It also affects the other primary metrics your SaaS business should be monitoring:

  • Growth –The amount the business’ revenue increases by.
  • Growth Efficiency Index– The amount it costs to grow.
  • Recurring Profit Margin – The difference between revenue and the cost to grow.
  • Other SaaS Metrics - related to customer retention

In this article, we'll cover all the basics you need to calculate churn rate, and how the right tools and processes can help influence how many customers your SaaS business is able to retain.

Let's dive in.

Why is Customer Churn So Important?

First thing's first: it's costly to replace those customers who have left your services. We've all seen the stats showing that customer acquisition costs are up to 5X more expensive than the cost to retain customers. In fact, just a 5% increase in retention spending can lead to a profit increase of up to 95%. A high churn rate reduces your profitability and opportunity for lower-cost expansion revenue.

But high levels of customer churn could also indicate one or more specific larger problems that could potentially be affecting your business, such as:

  • bugs in your software,
  • poor onboarding or customer service experiences,
  • features that customers aren't using to their full potential, and/or
  • a high number of bad-fit customers.

"Customer churn isn’t just an outcome of lack of features or development," says Jonathan Herrick, CEO of Benchmark. "It starts with having a good product-market fit and then attracting the right customer through marketing. Once you win a new customer, you want to make sure they have all of the resources they need to succeed with your product, so your customer success initiatives need to address churn as well."

A high customer churn rate also means it'll be tough to maximize your business’s revenue and value.

There is a direct correlation between a business's churn rate and its valuation: just a 1% increase in customer retention can increase a business's valuation by 12% in five years' time.

A high number of churned customers decreases the potential value of a recurring revenue stream and its potential. To investors, it also indicates there is something wrong with the product and implies poor management, which can impact customer service, product development, and staff management.

So, when it comes to selling or seeking investors for your business, having a low churn rate is paramount.

There are different average and acceptable churn rates depending on the industry; however, there's always the opportunity to diversify from the expected results and achieve better.

 


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Dunning Management is an Important Part of Customer Retention

Issues with your product or service—known as voluntary churn—aren't the only reasons your customers may churn out. There's also involuntary churn, where customers' payments don't go through for whatever reason, causing them to churn out.

Involuntary churn can be the most frustrating cause of lost customers because if only that payment had just gone through, they'd probably still be happy, paying users of your software.

This is where having in-depth dunning processes come in handy.

  • Notifying customers when their card on file is about to expire,
  • retrying failed transactions, and
  • keeping an eye on aging accounts receivables

are all important steps to take to reduce the number of customers your business loses to churn.

So How Do You Calculate Customer Churn?

Calculating customer churn isn’t difficult. In fact, it's one of the easiest accounting exercises your SaaS business should be regularly working on. The equation to calculate churn rate is:

Number of lost customers during a period / Number of customers at the beginning of a period

You could use this formula to calculate monthly churn, quarterly churn, or even your annual churn rate. It doesn’t matter which time period you use, as long as the two figures are consistent. Don’t include any new customers during that time period, either.

Example:

If a business has 500 existing customers and lost 25 during the year; its customer churn rate would be:

25 / 500 = 5%

A similar calculation can be used to calculate revenue churn using the monthly recurring revenue (MRR) figure (the amount earned through subscription revenue). The customer churn rate formula would look like this:

Amount of lost MRR / MRR you had at the start of the period

For example:

A business's MRR at the start of the month is $200,000 but it loses $40,000 in churned subscriptions during the month.

40,000 / 200,000 = 20%

However, with this calculation, you will also need to include the value of revenue from those who upgraded their services. So the equation becomes:

(Lost MRR - Upgraded MRR Value) divided by MRR at the start of the period

So if the business had $20,000 from customers who upgraded during the period, then the churn rate formula would look like:

(40,000 – 20,000) / 200,000 = 20,000 / 200,000 = 10%

Again, new customers are not included. For revenue churn, you can get a negative value. This is when the upgrades are greater than the lost MRR. Therefore, despite losing customers, your business can still see growth. 

 


 

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Stay On Top of Customer Churn with The Right Tools

Calculating churn is important in your SaaS business. It helps to determine if there is a problem with your product and is related to your business's valuation. To properly assess your business’s churn rate you must consider both your size of customer base and MRR.

A holistic recurring billing software solution provides upward of 40 reports on metrics important to your SaaS business, including reports on MRR and customer churn rate. It also has a host of dunning automation features to help cut down on that pesky involuntary churn.

The ability to see how many customers have churned out—both voluntarily and involuntarily—or downgraded their subscriptions over time can help you figure out how to prevent other customers from doing the same in the future. You can:

  • establish historic churn rate patterns,
  • create customer segments to establish trends between similar customer use cases,
  • automate dunning messages and set a credit card re-try schedule for failed transactions,
  • and more.

These MRR reports and dunning features and functionality are important tools that, if used correctly, can really help your business lower its churn rate and ultimately scale.

If you'd like to see how Fusebill can help with all your recurring billing needs, please fill out the form below and one of our subscription experts will be in touch to learn more about your business.

Tags: SaaS Recurring Billing Churn

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