What is Churn Rate?

What is Churn Rate?

Churn rate measures the loss (or discontinuation) of a paying customer over a set period, usually on a monthly basis. Over the long term, a high churn rate is unsustainable for a company as the continual loss of customers negatively impacts profitability and market valuation. Continually having to advertising or running promotions to attract new customers to replace lost ones can be expensive for a business. Customer retention is critical, particularly for B2B or SaaS businesses driven by subscription sales, so tracking monthly churn is a good indication of future viability.

If a company grows slower but has negative churn (i.e. a growing customer base), it can likely survive. However, if a company is growing fast and its churn is high, it indicates that the company will need to continue spending more money to replace the ongoing lost customers.

How are Churn Rates used?

All investors are typically focused on company key metrics to help value a company’s potential growth rates. It is vital during the due diligence phase to evaluate a company’s product performance and operational efficiency before investing. Analysts and investors will continue to monitor relevant metrics and evaluate the company’s progress until the time of a successful exit – either selling shares or a stake in the company.

Key metrics need to be relevant to the company and to the sector they operate in. For example, new customer churn rates are useful for a product-led growth company, and the natural rate of growth (NRG) is more useful for a service-based company.

Churn Rate Calculation and Industry Benchmarks

Normal churn rates are typically estimated at somewhere between 7 to 10% annually for relatively mature companies. This suggests that for every 1,000 customers, 70-100 customers will drop out annually (and need replacing with new customers to maintain sales).

Software as service (SaaS) companies typically have higher churn rates than in media and e-commerce as there is greater competition and lower switching costs. This may differ depending on the business, but anything significantly higher may become problematic.

Churn Rate Formula

The churn rate formula is as follows:

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How to Calculate Churn Rate?

Using the template with the information provided below we can calculate the future unit churn rate and the gross revenue churn of a company.

These forecasts have new customer estimates and have assumptions on the percentage of customers that are generated from marketing campaigns, as well as other assumptions related to future revenue and future sales and marketing expenses.

We begin by calculating the unit churn per quarter, which is calculated as the number of customers lost, divided by the number of customers at the end of the prior period or the prior quarter. (In this case, it would be 98,500.) This can be multiplied by -1 to produce positive churn, and the number is 1.015% for Q1.

To calculate the gross recurring revenue churn, this is simply the number of customers lost multiplied by the SaaS price per customer. So, in Q1, that would be 1000 customers x $125 per customer, so the revenue churn would be $125,000.

Looking across all four quarters we can see the unit churn starts at 1.015%. It then goes up slightly over the next two quarters, and then it comes back down in Q4.

On the other hand, the revenue churn is going up across all four quarters, and that’s simply because the number of customers lost is going up by about a hundred customers each quarter.

B2B vs. B2C Customer Churn Analysis

While some key metrics for B2C businesses overlap with B2B SaaS metrics, their importance and interpretation can differ. Churn rate is a crucial metric for B2C companies due to typically higher churn rates compared to B2B businesses. B2C customers have more options and lower switching costs, leading to easier customer loss.

Churn Rate vs. Growth Rate

Churn tracks the loss of customers, while growth rate tracks new customers. The difference between the two rates shows overall growth or loss in a specific time-period. If the growth rate is higher than the churn rate, we can assume the company has grown. If the churn rate is higher than the growth rate, then the customer base has decreased.

If a company grows slower but has negative churn, it can likely survive. However, if a company is growing fast and their churn is high, it indicates that the company will need to continue spending more money to replace the lost customers.

Churn Rate vs. Retention Rate

Retention rate tracks existing customers who continue to use the product or service. It tends to reflect customer satisfaction and loyalty. A high churn rate means you are losing customers, whereas a high retention rate means that you are keeping customers.

Advantages and Disadvantages of the Churn Rate

The churn rate is a significant metric for businesses, especially for SaaS companies, as it measures the loss or discontinuation of a paying customer. Here are some advantages and disadvantages of the churn rate:

Advantages of Churn Rate

• Insight into customer retention: it provides valuable insights into how well a business retains its customers
• Predicts future viability: a low or negative churn rate can indicate a company’s potential for long-term survival
• Analyzing operational efficiency: for investors, it’s a crucial metric during the due diligence phase to evaluate a company’s operational efficiency

Disadvantages of Churn Rate (Poor Churn Rate)

• High churn can be unsustainable: a high churn rate over a long period can be volatile and impact a company’s profitability and market valuation
• Indicates customer satisfaction issues: a high churn rate might signal problems with customer satisfaction or product-market fit
• Requires more spending: if a company’s growth is fast but accompanied by high churn, it will need to continue spending more to replace lost customers

Conclusion

The churn rate is a critical metric for both B2B and B2C businesses, particularly for SaaS companies. It provides valuable insights into customer retention and the overall health of the business. A high churn rate can be a red flag, indicating potential issues with customer satisfaction or product-market fit. On the other hand, a low or negative churn rate can be a strong indicator of customer loyalty and business sustainability.

For investors, understanding a company’s churn rate, along with other key metrics, is crucial during the due diligence phase and for ongoing evaluation of the investment. These metrics provide a snapshot of the company’s operational efficiency, product performance, and growth trajectory.