Put a bunch of SaaS entrepreneurs in a room and the discussion is bound to lead to “churn rate.” But before you walk out of that room all disheartened, thinking that your 7% annual churn rate is an absolute disaster and everyone is doing much better, make sure you make a fair comparison.
There are many ways to calculate the SaaS churn. While some companies prefer to stick to a formula that makes them look good, others like to brave the grim reality of their current state and face the challenge head-on.
How to calculate SaaS churn rate
Essentially, here’s how churn is calculated for SaaS companies in a given period of time:
Churn rate = Number of churned customers / total number of customers
As you delve deeper, the complexity of this seemingly simple metric can overwhelm many growth teams. It is important that your churn rate takes into account the complexities specific to your business.
The formula to calculate churn for one SaaS business might not work for another SaaS business the same way. Make sure you take this into account when calculating the churn rate for your business.
Given below are some standard ways to calculate churn that act as a good starting point.
Annual versus monthly churn
It is easy to put off churn-centric discussions, especially when your business is at an early stage. This is when the growing customer acquisition numbers give you the ego boost and satisfaction that your efforts are paying off. But don’t get carried away!
For instance, a 5% monthly churn may seem manageable or sometimes even “acceptable” to some entrepreneurs. However, this figure actually translates to over 46% of annual churn rate. This interpretation is based on a simple formula:
Annual Churn = 1 — ( 1 — monthly churn )^12.
The table shared below by Clement Vouillon of Point Nine Capital, a Berlin-based VC firm, gives a snapshot of why comparing monthly versus annual churn can be disastrous:
Customer churn vs revenue churn
Customer churn refers to the rate at which the customers are leaving your company in a given period of time. So, let’s say you had 100 subscribers, of which 10 people canceled their subscription. Your customer churn rate here would be 10%. Here’s how to calculate it:
Customer churn rate = number of customers lost in a period/total number of customers at the beginning of the period
But not all customer accounts are created equal. Thus, calculating revenue churn becomes all the more important for every SaaS business. Revenue churn probably offers the clearest picture of the state of your business.
Here’s how to calculate the revenue lost from a cohort during a specific period:
MRR (Monthly Recurring Revenue) churn rate = Churned MRR / Previous month’s MRR
You may be thinking that revenue churn makes more sense and thus you should completely do away with the idea of customer churn. I’m afraid that’s not the way it works!
Let me explain.
Imagine having 1000 subscribers – 900 on your starter plan paying you $10/month; and 100 on your premium plan paying you $200/month.
Now let’s say you lost 100 customers from your starter plan ($1000 Monthly Recurring Revenue or MRR) and gained 10 new customers for your premium plan ($2000 MRR) during the same period.
In such a case, if you are only tracking the revenue churn, this might give you an illusion that you are still growing fast. However, the fact is, there are a significant number of problem customers in your starter plan that may get overlooked.
Tomasz Tunguz, the Venture Capitalist at Red Point, points out to an interesting fact related to customer churn on his blog. He shares that SMB customers are more likely to churn faster than enterprise customers.
The table below shows his general observations with different customer segments:
He argues that the price-sensitive nature of SMB customers and the fact that many of them are more likely to go out of business than established ones, make businesses catering to them more susceptible to churn.
This is why even though the initial growth of many SaaS businesses is funded by SMBs, most of them eventually start catering to the enterprise customers to fuel their growth, as soon as their product is ready.
Gross churn vs net churn
These are the trickiest of the lot. While net churn takes into account the revenue expansion of accounts, gross churn doesn’t. Revenue expansion mainly refers to the accounts in your cohort that end up upgrading and paying you more than what they were expected to at the beginning.
So, many times, you’d see that the positive impact of your account upgrades outweigh the impact of the customers you have lost during that period. This is also referred to as “negative churn” or “net negative churn.”
While it’s great to show off negative churn to impress investors when you’re trying to raise funding, it’s highly recommended that you lead the internal score by Gross churn.
This will give a realistic picture of your company’s churn without sugarcoating the figures.
Every business is different and it’s extremely important to calculate your churn metrics accordingly. The above churn calculations are just a good baseline to start off and see what works best for your business.
Now that we’ve settled how you can calculate churn for your business, the next order of discussion is to find out why your customers are leaving.
Reasons for SaaS Churn (And How to Fix Them!)
Churn analysis can be tricky since it often puts the customer success teams under attack. Often, companies end up taking the easier route of putting the blame on factors “beyond their control.”
Before you begin drilling into the root cause of your churn, recognize and acknowledge it as a company problem.
Everyone owns the customer and failure to demonstrate the value of your product isn’t just a CS problem. With that in mind, let’s understand the top reasons for SaaS churn.
1 – Loss of champion
Champion is the person inside your customer’s organization who is most convinced about your product and lines up others to complete the purchase order for you.
Often, when a champion leaves the company, it’s a definite indicator that the customer is at the risk of churn. David Skok talks about this in one of his articles here.
While the loss of a champion may seem like the main reason for churn, the fact in many cases is it’s just a symptom, not the root cause. The actual problem here is the inability of the product to demonstrate value more broadly and penetrate the organization beyond a single champion.
Thus, your goal should be to impact a broader business process and get multiple layers of visibility in an organization – users, executives, and operators.
Proactive customer checks on a quarterly basis can curb the situation to some extent. You can also build an algorithm to set an alert for any dip in the usage trends of your champion.
This will give you get a heads up before they switch to a new role or company. As a result, you have time to identify new champions and build relationships with them and stop the problem in its tracks.
When a champion leaves, you must resell the product to the new champion as well. This is why there are companies whose sales teams have some part of their compensation tied around their retention efforts. That way, when the need arises to “re-sell” to an account, they have an incentive to take a lead on that.
Also, churn often grows as the companies grow. An effective strategy here is to have role specializations with a dedicated person taking care of your onboarding process. The goal here is to take the customer from zero to business success in the most seamless way possible.
One great way to know if your customers are achieving business success is to ask for renewals a little ahead of time. If the customer is happy, they won’t have any qualms in renewing early.
2 – Lack of engagement
Typically, customers don’t make a snap judgement to stop using a product. The decline in the activity is gradual and spread across several weeks or months until they finally decide to pull the plug.
Lack of engagement or “activity churn” as folks at Intercom like to call it, can give you a good idea about your future churn and buy you the time you need to arrest it. This is along the same lines of monitoring the usage trends of your champion that we discussed earlier.
Correlating product usage with churn is important as it can tell you when things begin to go wrong. When product engagement metrics of an account, regardless of how you choose to measure it, begin to fall below a certain average (recognized as the “danger zone” in the graphic below), you should take action to save those accounts. Intercom explains this very well with this graphic.
Many times companies send “We miss you” messages when a user has probably gone for a vacation and their activity goes down for a week. The actual worry starts when you notice a decline in activity across the company.
A personalized reach out to someone who was a previously active user can go a long way in recovering them back. Also, segmenting your customers can help you understand their problems and categorize their feedback differently.
For example, a customer who used your free trial for a month will be facing very different problems versus a paid customer who has used your product for over a year.
Sharing a glimpse of what changes are coming up in the near future can encourage old customers to stay. It could be a feature that saves time, third-party integration that improves efficiency, or anything else.
Of course, there’ll be situations where you cannot resolve some long-standing issues. In such cases, it’s better to acknowledge them upfront rather than making false promises.
In the end, it’s natural to lose some business; but make sure you part ways on good terms.
3 – Poor onboarding
Onboarding probably gets the worst backlash of all when churn is on the rise (and sometimes, rightly so!). Start with a Jobs To Be Done Framework.
People sign up for your product to solve a problem or accomplish a particular job. While this job can be something as broad as “increasing revenue” or “improving site search,” it cannot be accomplished in just a few days.
Usually, there are a series of small steps, like “sending an invoice,” or “setting up workflows” that the user must take in order to make progress and finally achieve that goal.
Identify features that would rejoice customers with these mini-steps towards the final goal. Lay a clearly defined path and help them get there. Aim to help your customers reach the “aha moment” with least number of steps and minimum friction.
Any delays in taking your users to their first success with your product will bite you later.
Also, understand that different customer segments would want to accomplish different jobs with your product. The onboarding flow should thus be customized for each customer segment.
There is definitely some merit in sharing a detailed implementation plan with the customer where he knows exactly what are the steps you will be taking.
For instance, steps like, providing login information, configuring the platform, and transferring data along with the estimated time frame for each step. This will set reasonable expectations on how long it will take to get up and running.
Managing expectations early on will also play a key role in what your customers feel about your product. Over-promising and under-delivering is not the game you want to play in SaaS.
Start with making them use your product one time. But making them complete the process one time is no guarantee that they will continue to use it in future. Once they have completed one loop, make sure they keep on realizing the value over and over again. If these small “wins” at every step dry up, it will increase your churn numbers quickly.
4 – Bad-fit customers
Startups are more likely to face this problem in the early stages than those who have matured and found their footing in the space. That’s completely understandable though.
Initially, you want to just sell your product to whosoever is ready to buy and that would inevitably lead you to attract some customers who are not the right fit for your product.
Sometimes, it can be due to wrong product messaging or information. It’s only with time that companies begin to dig deeper to understand their ideal buyer persona. After a series of customer interviews and surveys, you realize the exact pain points you are trying to address.
This will finally help you hone your product and develop the messaging that works and attracts your ideal customer.
While this solves the problem for a lot of companies, there are firms that deliberately sell their product to whoever wants to buy it. A common argument is –
“It’s the revenue we would have otherwise never earned.”
What SaaS entrepreneurs need to recognize here is that in this domain, you do not make the sale once and move on. You need to fight every day to retain the business you have earned.
When you have a recurring revenue model, customer loyalty can make your business stand tall with the strength of a mighty oak even when the winds are contrary.
For that, you must carefully target customers that you know would be able to “benefit” from your product. If you keep on adding more customers without any discretion, unhappy customers will begin to tarnish the brand image you have painstakingly built over the years.
A bad-fit customer would drain your resources and can cost you more time and money than an average customer who actually benefits from your product.
Their feature demands might seem unreasonable or their constant bickering with the support and CS team might be hard to accommodate for your employees. Your high-pressure sales tactics or over-the-top promises might have gotten them on board but has left them high and dry.
When you recognize a pattern of too many bad-fit customers reaching your onboarding funnel, it’s time to make amends. A unified approach of your marketing, customer success, and sales team will help you tackle this problem.
Your company leadership must diagnose the issue and tread carefully to find a solution. It’s easy for teams to indulge in blame games at this point. Encourage your team to be objective in their communication and focus on solving the problem at hand. Set some ground rules before you start the discussion and keep attacking individual teams or people are off the table.
Often the answer to this goes back to revising your lead-qualifying process. You may also want to make some changes to your product or onboarding process to cater to your target customer segment.
5 – Bad support
It seems like a no brainer but poor support can be a huge factor in increasing churn. Anything from frequent product bugs to an unintuitive UI you are still trying to fix can cause your customer to leave.
Even bad response time, hiring people with little technical know-how, poor communication skills and zero customer empathy can hurt your business.
On the other hand, proactive support that delights customers can get you an extended lifeline, even when the chances of redemption for your business look slim.
For example, an SEO and social media monitoring company named Unamo conducts periodic customers interviews. This includes questions about their product usage, goals they are achieving with the product, and whether there are any features they might be underperforming on or new feature addition requests.
This proactive approach helps the company gauge the overall customer sentiment about the product and gives them enough room to fix an issue.
This is more like a tweaked version of NPS (Net Promoter Score) survey that a lot of companies conduct twice a year to assess customer satisfaction.
Basically, you ask customers to rate your company on a scale of 1-10 to see where you stand. Companies often use open-ended and close-ended questions to collect customer feedback. Here’s a post that lists the top questions you can add to your NPS survey.
6 – Appropriate experience
There,s no ‘one size fits all’ approach for creating an appropriate experience for your customers, suggests Lincoln Murphy, the world-renowned SaaS growth expert and keynote speaker. The experience you create should engage your ideal customer.
If you are catering to a developer audience, for example, you can focus on features like an easily-accessible API key, some quick documentation, and a Slack channel to offer community support.
On the other hand, for business people in an enterprise set up, at the very basic level, you must offer a full-blown UI, robust customer support, SLA (Service Level Agreement) commitment, a savvy sales team and a couple of integrations in place as well.
Note that the idea of “appropriate experience” is not static for each customer segment either. Your customers evolve with time and “appropriate experience” keeps changing. Keeping pace with the evolved idea of their expected customer experience is crucial to make them feel successful.
Sometimes your product might be doing a decent job of helping customers achieve their desired goals. However, if they had to jump through a lot of hoops (read bad UI, product bugs, etc.) to get there, they will be exhausted and won’t appreciate the poor experience.
Though they will not replace you immediately, they’ll surely switch as soon as they find someone who can help them achieve the same outcome with a better experience.
7 – Product issues
Product bugs are inevitable. When you are new, your customers are surprisingly patient, especially if you have a quick turnaround time for resolving problems. A part of keeping customers happy at this time is to ask for constant feedback and attempting to fix their issues.
Some companies have a section on their website, a private customer forum, or Facebook groups that list feature requests from customers. Everyone can vote for these feature requests, allowing firms to prioritize them in the product roadmap.
But what if a small oversight may have exposed your customers to a breach? Or a glitch that may have led to complete loss of your customers’ data? Mistakes like these are unacceptable.
Optimizely faced a brutal backlash a couple of years ago when their vulnerability allowed everyone to access the experiments that were being run by customers on their websites.
While it isn’t possible to predict such scenarios, taking control of the narrative here can help ease some angry customers. If you face such a situation, issue an open apology and own responsibility for the situation. Explain your situation and the measures you are taking for damage control.
Also, share the pre-emptive steps you have planned to avoid such pitfalls in future. If required, offer short-term discounts to the affected customers. A temporary hit on the cash flow is better than a permanent one.
People like to do business with people they trust. If you are sincere and transparent, you will be able to curb some churn and restore your reputation post this unforeseen disaster.
8 – Solve Payment Issues
Failed payments or involuntary churn happens when your billing software rejects a renewal. This is a common issue with monthly subscription payments. Issues such as expired credit cards, card limits, and insufficient funds can cause this.
There are several apps that can help you solve payment issues and stop involuntary churn. Churn Buster, for example, helps resolve the payments issues shared above.
Pre-dunning software can also help. ‘Dunning’ refers to declined payments as the customers haven’t updated their card details. Pre-dunning software takes care of these issues by sending out an email, reminding the customer of credit card expiry that’s about to happen.
The email also persuades them to update their payment information to continue.
Of course, before you start working on any of the solutions listed above, remember that customers also churn because your product is not meeting their needs and expectations.
A good product solves a real problem for the customers who use it. Do this ground-level analysis before getting into analysing the reasons for the churn rate. As Steli Efti from close.io remarks in one of his posts:
“Don’t approach churn by trying to put lipstick on a pig”
Finally, you won’t be able to avoid churn completely. There will always be external factors that are beyond your control. Many refer to it as “acceptable churn.” At the same time, be careful not to start writing off avoidable issues as acceptable churn as well though. Analyze each issue carefully before you write it off.