What is Customer Churn?
Customer churn is when a customer chooses to stop using your product or service. They can churn for a number of reasons, which can include moving to a competing product, lack of training, poor UI and UX, or bad customer fit.
What is Churn Rate?
Churn rate is the number of customers that stop doing business with a company over a given period of time. It’s also known as “rate of attrition,” and is a critical customer success metric for any data-driven SaaS organization.
Why is churn rate important?
Businesses need to track their churn rates because:
1. Churn is a direct reflection of the product’s value. A high churn rate could indicate that customers aren’t getting what they need from your product.
2. Churn affects company profitability and growth. A business with high levels of churn risks turning into a leaky bucket where the profit from new sales is canceled out by the loss of revenue from churned customers.
3. Churn impacts productivity and morale. The constant cycle of customers going in and out, not to mention the negative feedback associated with unhappy customers, will be a drain on your team’s motivation and productivity.
4. Churn can harm your product’s perception in the market. According to research, customers tell an average of nine people about positive brand experiences, but tell an average of sixteen people about negative experiences.
Customer churn in SaaS and subscription-based services
Identifying customer churn in SaaS organizations and subscription-based services can be simpler than identifying churn for either freemium software products or products that are bought full-price. If a SaaS customer is no longer paying for your product, then they have churned.
Having said that, there’s still debate as to the exact point at which the customer officially churns.
- The moment a customer indicates they would like to cancel (date of cancellation)
- The moment the subscription ends or the customer does not renew
The difference between them seems minor - even pedantic - but when a customer tells the CSM to cancel their account with four months left on their annual subscription, then that difference becomes very significant indeed. Some organizations try to get the best of both worlds and track both dates.
In the end, whichever point you use depends on your SaaS organization’s process and business model.
Churn rate vs retention rate
If churn rate is defined as the percentage of customers that leave, then retention rate is defined as the percentage of customers that stay or renew.
These numbers are two sides of the same coin. If your churn rate is 10%, then your retention rate is 90%. New users are not included in this calculation.
Customer churn vs revenue churn
There are two different types of churn that you need to take into consideration:
- Customer churn is the amount of customers or accounts lost.
- Revenue churn is the amount of revenue lost due to users canceling their accounts
The two might be closely related at first glance, but in reality, they can diverge quite a bit and must be reported on separately. This is because the number of users or “seats” doesn’t automatically indicate the amount of revenue a given account is worth.
Two accounts of 100 users each might differ in terms of:
- Pricing tiers
- Training packages
- Applicable discounts
- Subscription add-ons
As you can see, it’s often necessary to track both customer churn and revenue churn to get a complete picture of churn’s impact on an organization.
You’ll never be able to totally eliminate churn, but you can reduce it to manageable levels.
What is negative churn?
Negative churn is actually the kind of churn that you do want. It’s when the amount of users/revenue you gain through expansion outpaces the amount of users/revenue you’ve lost.
Note that “expansion” here refers to the expansion of existing accounts, not net new accounts.
Churn rate formula
The customer churn rate formula is:
So if you lost 7 customers by the end of 2022, and you had 100 customers at the start of 2022, your churn rate for that year would be 7%.
The revenue churn rate formula is:
In revenue churn rate, “lost contracts” refers to the dollar value of any fully-churned/lost customers. Lost revenue on contracted/down-sell contracts refers to the dollar value of any losses on contracts that are still in place but at a lower amount (for example, if a customer reduced their licenses from 80 to 50).
Here’s an example. Let’s say the total dollar value of churned customers in June was $5,200. Total value of downsold customers is $400. Your formula is going to look like this:
(($5,200 + $400) ÷ Total $ Amt. of Contracts at Start of Period) x 100
Let’s also say that our total MRR at the start of June was $82,000.
(($5,200 + $400) ÷ $82,000) x 100
Now that all of our numbers are plugged in, we can calculate that our revenue churn for June is:
(($5,200 + $400) ÷ $82,000) x 100 = 6.83%
Churn rate by industry
According to research by Recurly, the average annual churn rate across SaaS companies appears to be 4.79%. Other tech-related industries such as IoT and Media & Entertainment seem to have similar numbers, polling at 5.88% and 5.23% respectively.
Also note that different companies and industries have different standards of what constitutes “good” and “bad” churn rates, and so churn numbers can be all over the scale depending on the companies being surveyed and their industry, location, and maturity level.
For instance, a survey of over 300 founders conducted by Nathan Latka resulted in an average gross annual churn rate of 16.8%.
A 2016 survey by Pacific Crest noted that the median annual churn rate for SaaS companies leveled out at around 10%.
What is “Acceptable” churn?
It depends on who you talk to. Industry wisdom currently places the acceptable annual customer churn rates for a SaaS company at about 5%.
But really, the definition of a truly ideal churn rate is as low as possible.
That sounds flippant, but consider that every company will differ in the following ways:
All of this affects how high or low your threshold will be for what constitutes “good churn.” While it’s okay to accept the 5% benchmark as a baseline goal, you should really be looking internally and calculating your own ideal churn rate.
Monthly vs Annual Churn
Lincoln Murphy from Sixteen Ventures has a brilliant analysis on the crucial difference between monthly churn and annual churn.
Basically, a churn rate that sounds acceptable for annual churn would be absolutely lethal to your company as a monthly churn rate.
Let’s use the oft-quoted figure of 5% as an example. Let’s say you started off with 100 customers for the year. A 5% churn rate means that 5 customers leave every year. This is a number that most businesses can easily earn back through new sales and account expansion, so that isn’t that big of a deal.
If you have a 5% monthly churn rate, however, that means you’re losing 5 customers a month. If you don’t replace those customers with new ones, then at the end of the year, you’ll only have 40% of the customers you started out with. You will have to win 60 new customers that year just to break even.
How can a company grow in that state?
You either have to have a top-notch sales and marketing team, or you won’t grow at all.
Top 5 reasons why customers churn
Business relationships are complex, and while there are usually one or two major reasons that customers churn, they’re often driven by a collection of factors that build up.
Based on our experiences and the experiences of our own customers and community, here are some of the most common reasons why customers churn:
1. They’re not getting value out of the product
A customer pays you money because they want your product to solve their business need in a timely fashion. If your product isn’t able to do that, then the customer is going to churn.
You can avoid this type of churn by having firmly defined Ideal Customer Profiles (ICPs) and ensuring that your sales team stays within those boundaries. Your CS team should also hold regular QBRs to assess customer health and track product adoption.
Of course, they might not be getting value out of your product because they weren’t a good customer to begin with. Bad-fit customers can slip through the cracks, and when they do there’s nothing much either of you can do about it except either soldier on (not recommended) or take the loss and move away.
2. Customer needs have changed
Sometimes you and your customer will go into a partnership with the best of intentions, only for your customer to change their mind down the line. Maybe their company went through a pivot. Maybe new management wants to restructure their tech stack.
No matter the case, your customer is leaving. All is not lost, though. You can still try to convince them that you can provide value. This would involve understanding their new requirements and adapting your platform to fit. In essence, you’d be onboarding them all over again.
This may not necessarily be a bad thing, as your customer may end up becoming more impressed by your product’s depth and flexibility.
3. Financial concerns
As much as we try to teach ourselves and customers to shop based on value and not on price, there’s no denying the effect that a dollar figure has on a business relationship.
Customers will sometimes review their spending on technology and come to the conclusion that they can’t afford to keep using your product. If you find that a large number of accounts are dropping out for financial reasons, you may want to revisit your pricing strategy.
4. Customer service/customer experience issues
As advanced as technology is, we still run based on relationships. It’s the Project Manager who implements your product on the customer’s system. It’s the CSM who trains and onboards the customer, It’s tech support to whom the customer turns when they run into problems.
If the customer encounters a problem with any of them, whether it’s personality-related or process-related, it sours their experience and may cause them to churn. Management can try to intervene, but sometimes there’s just nothing you can do except learn from the experience.
5. The product has issues
Sometimes you just have to admit the possibility that the problem doesn’t lie with the customer, but with your product.
No matter how you package it or train people or try to match people’s needs, a bad product will still remain a bad product. People will churn because your product needs work, and the sooner you can acknowledge there’s a problem and act on people’s feedback, the sooner you can stop bleeding customers.
You may be able to retain a few customers by promising a fix, but that has to happen quickly else the customer will feel like you’re stringing them along.
How can I predict customer churn?
Churn prediction is the process of calculating which customers are more likely to stop doing business with you. When done correctly, it can help save these accounts and increase the business’ retention rate.
Churn prediction makes use of machine learning and large amounts of historical customer data in order to calculate and rank a customer’s likelihood of churning.
Most companies that utilize churn prediction have dedicated data science teams that build custom algorithms and use data unique to their own business. This can be expensive, but is the ideal solution since there is no industry consensus on how to reliably measure customer health and identify churn indicators that are universal across all companies.
How to reduce customer churn
Have an onboarding process
When a customer signs on with your company, do you just toss them into the water and see if they can swim? Or do you have a more careful, measured approach to implementation and onboarding?
According to Hubspot research, SaaS companies are likely to lose up to 75% of new users in the first week if left to themselves. Having a formal onboarding process is crucial for getting these users past the initial hump and getting them to see your product’s value as fast as possible.
Part of this process includes defining a roadmap that takes them through the implementation process all the way to onboarding, training, and beyond.
Communicate with customers regularly
Have you ever had a customer surprise you by canceling their subscription a week before they were supposed to renew?
That’s what happens when you don’t pay attention to your customers. Your customer might be struggling to adopt your software, or has mistaken assumptions about how it’s supposed to function, and you won’t ever know because nobody is talking to them.
Schedule regular EBR or QBR meetings with your customers to get a sense of where they are, and to give them an opportunity to share their concerns. Use the EBR to show off what your product has been able to accomplish for them to date.
Retrain your users
Sometimes an account that’s been around for a long time will see a drop in usage. There are a couple of reasons why this may happen:
- New users may be unfamiliar with the system and may not have been trained properly in its use
- The customer introduced a new process that could potentially make use of a different part of your platform, but have no idea how that function works.
Either way, retraining the userbase will help them see the value in the product again. It can inject life into their account and get them back on track.
Analyze your churn
A churning customer is unfortunate and a loss of potential revenue, but it’s also a golden opportunity to learn.
Pick apart the customer’s account of what happened. Don’t just take the customer’s reason for churning at face value. Analyze the chain of events leading up to the moment of churn.
Did the customer gradually use the product less over the course of the year? Did you release a new update that fundamentally changed how the system worked? What made them good customers? What made them bad ones?
This analysis doesn’t just help the CS team do a better job; it also carries over to product, marketing, and sales. By analyzing churn, you may even be able to redefine your Ideal Customer Profile (ICP).
Create a community
In 2020, over 75% of large companies had their own online community, and for good reason. Communities allow customers to support each other and build up close ties with other like-minded individuals.
Any new users with questions could address it to the community and get a response from a more senior community member, and possibly with a faster and more thorough response than an overworked customer support agent.
If done right, the community can even be a vehicle to help other aspects of business, like customer marketing, product, and sales.
Customer churn is as fundamental a statistic to the Customer Success organization as recurring revenue is to sales. Every company needs to be able to calculate and report on churn on a regular basis (monthly would be ideal) in order to respond quickly to things like:
- Bad product-market fit
- Product problems
- Outdated Ideal Customer Profiles
- Service or support issues
If you’re a fledgling business still trying to get its feet, you should begin tracking churn, like, yesterday. If you’re a mature business, you should regularly review your churn calculations and reporting process to ensure it’s robust enough to meet your needs.
You can’t totally get rid of churn, but you can totally control how you respond to it.