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’ processes, pushing customers away from your business. It also affects the other three 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
Why Is Customer Churn So Important?
It costs to replace those customers who have left your services and this reduces your profitability and the opportunity for lower cost expansion revenue. Therefore, if you have high churn, you will not be maximising your business’ revenue and value.
Research has found that there is a 0.92 correlation between the churn rate and the valuation of the business. This is because people leaving decrease the potential value of a recurring revenue stream and its potential. It also indicates there is something wrong with the product. Alternatively, it implies there is poor management, which can impact upon customer service, product development and staff management.
Therefore, when it comes to selling your business, having a low churn rate is paramount.
There are different average and acceptable churn rates depending on the industry; however, there is always the opportunity to diversify from the expected results and achieve better.
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CEOs Think Churn Is Nothing
Another problem is that SaaS businesses believe that churn is nothing to worry about. This is especially true if the business is replacing customers at a rate similar or greater than they are leaving. Many bosses will believe that churn is just the industry norm.
Yet customer churn has such a negative impact on your business that it should be one of your key focuses each month. Reducing it can increase revenue, grow profit margins and even attract new customers.
So How Do You Calculate Customer Churn?
Number of customers who left during a period / Number of customers at the beginning of a period
The period in this equation could be a month, a quarter or a year. It doesn’t matter as long as the two figures are consistent. You don’t include any new customers during that period either.
If a company has 500 customers and lost 25 during the year; their 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 subscriptions). The equation would look like:
Amount of lost MRR / MRR you had at the start of the period
A company’s MRR at the start of the month is $200,000 but they lose $40,000 in lost 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 company had $20,000 from customers who upgraded during the period, then the equation 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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Churn is an important metric to measure in your SaaS business. It helps to determine if there is a problem with your product and is related to your businesses valuation. To properly assess your business’ churn you must consider both customer numbers and the MRR. Otherwise you could show poor customer growth but not realise the business is growing.
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