The concept of churn is simple. At its core, it is the number of customers who leave your service over a certain period of time. Churn is one of the most important metrics, if not the most important one, that SaaS business track.
After all, it has been proven time after time that it is significantly less costly to retain an existing customer than it is to acquire a new one. Hence, monitoring churn rates to figure out what it is that makes customers leave is crucial to the success of any business.
However (and if you’ve been responsible for retention before you’ll know this very well), measuring churn rates effectively isn’t as easy as understanding what churn is. You see, there are several ways to measure churn and there are also various types of churn to measure.
In general, none of them are necessarily better than the other. But with this said, when it comes to your business, or some of its areas, there is probably one approach that fits your business better.
The three types of churn
Keeping churn low is essential to the success of your business. But, before knowing what actions to take to keep it low, it is crucial for you to decide which type of churn fits your situation better. There are three types of churn:
1. Customer Churn (Logo Churn)
This type is very straightforward. It looks at the number of customers who stop using or paying for a service over a set period of time. The benefit of this approach to churn is simplicity. It often works good enough from a bird’s eye view. But, if you take a closer look you’ll see that this approach likely yields misleading numbers.
For example, if a business has different customers, some of which pay much more than others, then an approach like this (which treats all customers as if they were worth the same) isn’t good enough. This brings us to the next type of churn.
2. Revenue Churn
Not all customers pay the same amount for your service, do they? In a hypothetical SaaS business that offers two paid plans, one of which is much more costly than the other, keeping a close eye on those customers who pay for the most expensive plan is key.
In this case, the issue with tracking logo churn is that it doesn’t tell you anything about your revenue, which is likely to be your business’ most important number. Thus, you must look at revenue churn.
To further explain, think about a scenario where you have 100 total customers and three of them cancel their subscription. Using the logo approach, your churn rate would be 3% (3/100). If this is close to your average rate, then everything would look normal and you would continue with your day.
But, if two of those three customers were paying for the most expensive plan, then something big must have happened so you should investigate further. But in order for you to realize that, you would have to be looking at revenue churn.
3. Discretionary Churn
This third approach is more granular, and depending on what you’re trying to accomplish or on how your service is structured, you might want to pay close attention. As you know, SaaS companies offer their services under different terms, which can have a significant effect on how you perceive churn.
You see, sometimes customers aren’t free to leave whenever they please. Maybe your service requires customers to commit to you for a year, or something along those lines. This, of course, can make your retention rates appear much healthier than they actually are. To get rid of this variable, discretionary churn looks at those customers who have the ability to churn whenever they please.
How to calculate churn
Once you have decided which of the above three types of churn fits your business better, then it is time to figure out how to go about calculating it. There are several different ways to calculate churn. In fact, there are allegedly 43 different ways to calculate it. To keep things simple, below I’ll break down a few ways to calculate customer churn.
Before we go any further, it is key to understand that to calculate churn effectively, you must first define what churn actually means for your business. For example, you can define churn as the moment your customers cancel their subscription, or as the moment your customer’s subscription period ends, which could be a few days after they’ve decided to cancel. Either way, being crystal clear about this is key.
1. The More Straightforward Approach
The simplest way to calculate customer churn is to divide the total number of customers who churn by your total number of customers. For instance, if you started the month with 100 customers, but at the end of the month you only had 98 customers, then your churn rate would be 2% ((100-98) / 100).
2. The Adjusted Approach
You might have noticed that the above approach doesn’t account for new customers. If you’re measuring churn over a 30-day period, and you acquire new customers during that period, would you like to take those customers into account in your calculations?
If so, all you have to do is divide the number of customers who churned over the midpoint of the customer count for the 30-day period. Let’s say you start the month with 100 customers and acquire 20 new customers throughout that month, taking you to a total of 120 customers. The midpoint of the customer count would be your total customers at the beginning of the 30-day period plus your total customers at the end of your 30-day period divided 2.
Once you figure out this midpoint, which in this case is 110 ((100+120) / 2), then all you have to do is divide the amount of customers who churned by 110 and you’d have a good enough churn rate that takes into account growth during the period in which you’re measuring churn.
There’s one thing to keep in mind, though. This approach to calculating churn can yield dramatically different results when changing the period of time. For example, let’s assume that instead of a 30-day period you choose to break your time period into two 15-days segments.
In this case, Even following the same steps and using the same formula, your churn rate for the first 15-day period could vary quite a bit from your churn rate for the second 15-day period. Why? Because in a matter of 1 or 2 days you could acquire tons of new customers (e.g., after a big press release).
The Bottom Line
There are many ways to look at and reduce churn rate. Ultimately, it boils down to providing customers with a product they find valuable. However, in order to know if your customers are finding your product valuable, it is essential to look at this metric the right way.
Understanding churn is easy, but if you don’t approach it in a way that makes sense for your business and calculate it properly, you might be in for a big surprise. To avoid falling for vanity metrics or skewed data, I’d suggest following these steps:
1. Analyze the three main types of churn. Then, decide which one is better for what you are trying to accomplish. For example, if you’re trying to maximize the number of users on a free trial, looking at logo churn (customer churn) can be very helpful.
2. Figure out your cohorts. It is often of very little to no use to look at things from a bird’s eye view. If you want your data to be accurate, look at it in cohorts. For example, perhaps new customers churn easier than customers who have been paying for your service for 3 months. Therefore, new customer churn and existing customer churn should be calculated separately.
3. Decide how you will calculate churn. Let’s suppose your marketing department runs a campaign offering 50% off the first 30 days to anyone who signs up within the next 24 hours.
Hundreds, perhaps thousands of people like the offer and sign up. But, it is likely that many of these new customers signed up only because of the discount and will churn after the 30 days, which could affect your numbers significantly. These type of things must be taken into account in your calculations.
Are you sure you’re approaching churn the right way? If you aren’t certain, you can get a free audit here.