What Is Churn Rate and How to Use It? Posted on October 11, 2019 by Dave Fowler   #business intelligence #data
This article was originally posted on Chartio Blog

According to McKinsey researchers, if a software company grows at only 20 percent, it has a 92 percent chance of ceasing to exist within a few years. For SAAS companies, competition is fierce. By 2021, 380 million SAAS workloads are expected to be installed worldwide. How do you know if your company is keeping up with the competition? Churn rate is one Key Performance Indicator (KPI) that will give you a glimpse into your SAAS company's health. Here's how.

What Is Churn?

Churn rate is essentially the rate at which users stop using an app. This is critically important to SaaS developers because this key metric reveals the percentage of how many customers cancel their monthly subscription. Consider these stats. On average, mobile apps lose 77% of their Daily Active Users (DAUs) within just three days of the app being downloaded. After 30 days, 90% of users are lost. Calculating churn, and implementing best practices to decrease it, directly affect the sustainability of a SAAS company. This important metric will help you analyze past business performance and accurately forecast future revenue.

How to Calculate Churn Rate?

For a SAAS company to grow, its number of new users must out-pace the number of users who quit. Monitoring your churn rate is a calculation that will help you keep close tabs on this ratio. On the surface, it seems like a simple equation that involves dividing the number of customers that have churned by the number of total customers within a given period of time. However, this simple equation does not always give a clear picture of fiscal health. Why not? For most SAAS companies, determining the total number of customers in one month can be a challenge. Do you use the number you had at the beginning of the month or the end of the month? These numbers can fluctuate greatly for SAAS enterprises, leading to less-than-accurate KPIs. So, how should you calculate churn rate?

Calculate

Getting an accurate glimpse of your churn involves calculating the probability based on how many customers churned and how many opportunities they had to do so. We know. "Probabilities" bring back bad memories of Statistics class. It's not that complicated, though. For an in-depth explanation of why this method works, read what Stephen Noble from Shopify says about it. If you don't have time for that, we've outlined the basic steps:

• Figure out the number of customers you had at the start of the month.
• Total how many customers you had at the end of the month.
• Subtract the number you started with from the number you ended with to find your net gain.
• Note how many days are in the month (or given period) you are calculating. In our example, let's say it's January. So, there are 31 days in your analytical period.
• Calculate the total number of customer days. Here's where we have to think a little harder. Count the number of days in the month that each customer had an active subscription. Next, total that number across your business. Here's what it will look like for our January example: (customers at the start of January * 31) + (0.5 * net gain * 31) = customer days in a month.
• Figure out your total churns. Add the number of new churns and existing customers that churned.
• Divide total churns by customer days in a month to get churns per customer day.
• Multiply churns per customer day by the number of days in a month.

Real Numbers

Let's put in some real numbers to bring the calculation to life. Let's say you started January with 2000 customers and ended with 2500, giving you a net gain of 500. In our January example, your equation for total customer days would look like this: (2000 *31) + (0.5 * 500 * 31) = 69,750. Where does the 0.5 come from? Remember, this is just a hypothetical company. We're assuming new subscriptions and churns happen at a constant rate. In other words, new subscribers and churned customers are active half the month on average. Your customer day may be slightly different. For example, you might calculate customer days by totaling the number of subscribers that were active on each day.

Now that we've calculated customer days, add up your total churns. Let's say you had 150 new churns and 50 existing churns, totaling 150. Now, divide that by customer days: 150/69,750 = 0.22 percent. Now, multiply that by the number of days in the month: (0.22 % * 31) = 6.82 percent.

Formula

In summary, your formula will look like this:

• (Customers at the end of the month) - (Customers at the start of the month) = Net gain
• (Customers at the start of the month * Number of days in the month) + (0.5 * Net gain * Days in the month) = Customer days in the month
• (New churns) + (Existing churns) = Total churns
• Total churns / Customer days in the month = Churns per customer day
• Number of days in the month / Churns per customer day = Monthly churn rate

What Is a "Normal Churn Rate"?

So, our fictional company ended up with a 6.82 percent churn rate. Is that good? Various experts have their own opinions about acceptable churn rates. Even CMSWire admits, "there's no magic number". While most agree it should be within the five to 10 percent range, some research has shown that the SMB market is as high as 31 to 58 percent for annual churn, and mid-market SAAS companies average between 11 and 22 percent. Sixteenventures says, "the very best SAAS companies keep monthly revenue churn at around 0.58%. That's about seven percent revenue churn a year". Another expert in the field, Tomasz Tunguz, thinks "the median SAAS business loses about 10 percent of its revenue to churn each year and that works out to about 0.83 percent revenue churn a month". With so many differing viewpoints, how do you know when to be alarmed? Consider these key warning signs.

• Your churn rate has increased over the last quarter or year, or continues to increase every month.
• The dollar value of churning customers is equal or greater than the dollar value of new customers.
• You have an unbalanced Lifetime Value (LTV) to Customer Acquisition Value (CAV) ratio.
• Your LTV is low.

Fortunately, you're not left to figure out churn and its relation to LTV and other metrics on your own. There are numerous tools that create powerful real-time dashboards to help you keep tabs on the health of your SAAS business. Tools, such as the software offered by Chartio, are making companies more data literate. Allen Hillery, an adjunct professor at Columbia University recently talked about how the combination of Chartio's use of visual SQL technology and its commitment to education through The Data School, has promoted data literacy through prolific, relevant and useful education. Read his comments in full in this recent blog.

Six Best Practices When Measuring Churn

So far, we've discussed churn in terms of how many customers you are losing compared to how many you are gaining. However, that is definitely an oversimplification. There are other metrics that must be included to get a full picture of your company's churn. In addition to measuring customer churn, here are six best practices to ensure you see the big picture.

Calculate Revenue Churn

The percentage of monthly recurring revenue (MRR) you are losing compared to total MRR. (Churned MRR / Total MRR). If your SAAS firm charges per user or has different pricing tiers, your revenue churn might be totally different from customer churn. Calculating revenue churn will help you put a real dollar figure on churn.

Segment Churn Based on Contract Length

Do you offer month-to-month and annual subscriptions? If so, segment churn by contract length. Including all contracts together may skew your numbers, making them look better than they actually are and disguising customer satisfaction problems that will become apparent when your annual contracts jump ship at an alarming rate. Annual subscriptions are preferable, often improving churn, giving you more predictable cash flow, reducing your CAV and increasing your LTV. For the purposes of monitoring churn, though, keep them out of the monthly churn calculation.

Analyze "Activity Churn"

Active customers rarely stop using your app overnight. There is usually a gradual slowdown in engagement. Don't just focus on inactive customers. Look for slow-down trends. Many subscribers will cancel simply because they don't use the app enough to warrant the expense. Work at re-engaging this group. Send a reminder email. Personally reach out and ask why their usage has slowed down. What can you do to help make the app more useful?

Monitor Expansion Revenue

Expansion revenue creates negative churn when your up-sells and cross-sells to existing customers exceed the revenue you are losing due to regular customer churn. Expansion revenue counteracts the effects of churn. It could be called the antidote to churn. Simply put, expansion revenue tells you how much you're bringing in from customers who love your product so much they are willing to pay more, a critical metric for predicting growth.

Look at Net Churn

Net churn is churned revenue minus expansion revenue. ((Churned MMR - expansion MMR) / Total MMR) Note net churn is all about revenue. It has nothing to do with adding customers. As noted above, negative churn is the SAAS sweet spot, and you get there when expansion revenue outweighs churn. Net churn is essential in determining if you are reaching that goal.

Incorporate Proxy Metrics

While substantiated data is always preferable, there are times when you just don't have the data to perform the needed analysis. Proxy metrics can be inserted with existing captured data to add valuable insights. How do you identify proxy metrics? Focus on usage patterns and behaviors that result in loyal customers, such as feature usage, integration installations or API call volume. You can gather this information with click-through rates, downloads, upgrades, surveys or focus groups.

Read more about these key metrics in this article from The Data School.

How to Visualize Churn

To effectively analyze churn, you must take into account the many metrics outlined above. The best way to get a full picture of the health of your company is to visualize it. Visualizations allow you to detect patterns, trends, and outliers in data sets, enabling you to make key business decisions that will fix negative patterns before they get out of control.

For example, a cohort analysis is an effective way of segmenting customers to calculate key metrics, such as CLV, retention rate and churn. Cohorts are groups of users that share a certain characteristic, such as when they signed up. A cohort chart can help you identify when users churn, enabling you to identify problems and hopefully save some customers before they reach that point.

Traditional charts, such as line, bar, and flow charts are also valuable when measuring churn and related metrics.

Get the Right Tools

All SAAS CEOs know the importance of tracking churn. However, they often use the calculation that shows the company in the most positive light, as opposed to the most realistic standing. While churn seems like a simple calculation on the surface, it requires diligent effort and comparison with other key metrics, such as LTV. Get the tools your company needs to accurately track churn. Doing so will ensure your company is among the fasting growing SAAS companies identified by InsightSquared as losing around 3.2 percent of revenue each month to churn.

Learn more about the cloud-based tools provided by Chartio. Contact our team.