The true impact of churn on your revenue5 min readReading Time: 4 minutes
The importance of preventing and fighting churn for a SaaS business cannot be overstated. It is not enough to simply react when things happen, and it certainly won’t suffice to just make a token effort to talk about issues every time you look at reports. Customer success must be written into the very fabric of your organisation, so everyone in your company should be living and breathing it. Without this, churn will grind away at your revenue and harm your potential to grow.
It is down to you to identify and measure the loss of customers and analyse the impact that is having on your growth. In the SaaS space, one of the keys to success is customer retention. The rate at which you lose subscribers over a specific period is called churn, and this is fundamental to your revenue.
What is churn?
You can define churn as the monthly or annual reduction in customer spend. It includes:
- Customers not renewing their subscription
- Customers actively cancelling subscriptions
- Customers downgrading their subscription to a lower level
In order to get a clear picture of your churn rate, you need to engage in some form of customer segmentation. For many SaaS businesses, the churn rate is higher among newer customers than it is among mature ones. So it is important to separate your customer base at the basic level to ensure the picture you get is objective.
To calculate a useful churn rate, you may want to report only on customers that have been your subscribers for 90+ days. You might even want to look into other areas for separating churn rates, such as customer demographics. It will depend on your business, and you are best placed to know what factors should be considered when assessing churn rates.
For this post, we will focus on how the top-level churn rate offers accurate and dynamic insights into how your revenue is growing or contracting. For revenue to grow, your customer acquisition rate must be higher than the churn rate. Through ongoing monitoring, you will be able to set and review targets, get accurate performance metrics and make changes when you see the need.
Essentially, there are things churn means for your business:
1. Loss of recurring revenue/reduction in monthly recurring revenue (MRR)
2. Loss of opportunities for expansion revenue
It’s important to note that preventing churn is more cost-effective than trying to acquire more new customers. The cost to acquire customers (CAC) is higher because it is complex, and customer retention comes into play with all new customers anyway. Once you have healthy levels of subscribers, you will find it more financially viable to focus on reducing churn than to emphasise winning new subscribers continually.
The Quick Ratio for tracking and measuring churn
There are various ways to measure the actual impact of churn. All these methods have their advantages and disadvantages, and once you choose one you should commit to it.
One popular option for simplifying the description and tracking of business growth is the Quick Ratio. In a nutshell, your Quick Ratio is your company’s growth divided by its churn. Growth is defined as the monthly value of any new accounts, added to the value of existing accounts that add new services to their subscription level.
For example, let’s imagine that a company has £225,000 in recurring revenue. In a single month, that company loses two customers at a value of £45,000 and a further 10 customers reduce their subscription for a total value of £20,000. Meanwhile, there are new customers acquired to the value of £15,000 per month and two other existing customers increase their monthly subscription for a combined total of £21,000. To calculate their new monthly revenue, the formula will be (£225,000 – (£65,000 – £36,000)) for a total of £196,000.
If we apply the Quick Ratio of growth against churn (65,000/36,000) the resulting figure is 0.55. If your organisation’s Quick Ratio remains at 0.55 every month, this will result in a contraction of the business over time. A Quick Ratio of 1 means the business will remain at the same size and a Quick Ratio in excess of 1 means the business is growing. The higher above 1 the Quick Ratio is, the more healthy the business growth is.
A clear picture of your business health
One of the great benefits of the Quick Ratio is that it gives a simple yet accurate picture of the health of your business. It factors in the positive impact of sales and the negative impact of churn in a single figure. It does this without over-complicating things by delving too deeply into revenue numbers and billing data. These are things you may not wish to share with the rest of the company, so the Quick Ratio keeps it simple without sacrificing accuracy.
You can communicate Quick Ratio with the wide organisation to give them some insight into how you are performing. It also enables the creation of realistic, measurable goals like doubling your business over the next 12 months. After setting a target, you can regularly review your Quick Ratio to measure your progress and look for opportunities to improve.
Of course, there are many other metrics to look at in pursuit of business goals. But the Quick Ratio provides a simple performance snapshot that can be easily understood by the whole company, and it gives a broadly accurate picture of the health of your business.
Churn is something that every SaaS business needs to constantly monitor. The higher your churn rate, the lower your revenue, and it can lead to a contraction in your business if it gets out of control.
Cultivate a culture of customer success and emphasise that churn rate is an integral part of that. Use software and other techniques to monitor churn and gather data that can help with creating churn prevention strategies. The more work you put into keeping churn low, the greater the benefits for your revenue and growth will be. With customer retention being more cost-effective than customer acquisition, the need to keep churn rates low is self-explanatory.