How to Calculate and Reduce Churn Rate to Increase Revenue
By using the tips provided below, you will be able to understand and reduce SaaS, subscription-based, and mobile app churn.
What is Churn and Why is it Important?
Churn, or churn rate, is the percentage of customers that stop using a service in a specified period of time. Churn is a way to measure customer retention and satisfaction, most commonly for subscription and SaaS services. Analyzing the impact churn has while measuring active users is the best way to reduce it.
Churn can best be expressed as the number of customers lost during a specific period divided by the number of customers using the product at the start of the same period.
Understanding, measuring, and reducing churn is essential for customer retention, maintaining steady growth, and reaching subscription and revenue targets. Since it assesses customers lost over a specified period, it can be used by businesses to track changes annually, quarterly, when the product or service changes, during a new product launch, or to track the impact of targeted marketing campaigns.
If you’re new to the idea of churn and it’s sounding a lot like retention to you, we’ll break down the difference between churn and retention, and what their relationship to each other is.
Churn vs. Retention
Churn is a measure of lost customers over a specified period. Retention is the inverse of churn, in that it expresses the number of customers who continue to use a product over a specified length of time. Both are equally important aspects of user analytics that identify what keeps and loses customers.
Customer retention is essential for any business to develop sustained growth and revenue. It is inseparable from customer acquisition, as both are essential factors for growing a customer base. Customer retention is arguably a priority over new user acquisition, because the cost of acquiring a new customer greatly exceeds the cost of retaining an existing one.
The idea that retention is important may seem like a basic concept, but focusing on churn reduction is the best way to utilize resources for many companies, especially those on a budget. If this sounds like something you need to start focusing on, let’s learn how to calculate churn.
Calculating Your Churn Rate
There are two different methods of calculating churn:
- Customer-based churn is a measure of lost customers, which is vital for maintaining a recurring customer base.
- Revenue-based churn is a measure of lost customer revenue compared to overall revenue generated by the subscription service over a specified period.
Churn is calculated using the following basic equation:
Churn (%) = Customers Lost During Period/Customers at Beginning of Period
When to use customer-based churn for your business
Both methods are often used by SaaS/subscription-based businesses simply because customer losses and revenue losses can be accurately measured by renewals and non-renewals. However, reducing customer-based churn is about finding ways to retain all customers – regardless of what they are spending.
Though this model offers fewer insights as it cares less about the specific demographics of your users, it’s much easier to form solutions to reducing churn, because it helps you focus specifically on obvious weaknesses in your product that is causing large numbers of users to drop off.
When revenue-based churn is better to focus on
Eliminating revenue-based churn is about finding ways to retain high-paying customers. This involves understanding customer demographics and factoring that into your calculations. Unlike the customer-based churn model, the revenue-based churn model takes into account that customers spend different amounts. This model is a better way of evaluating how customer losses over a specified period affect your business’ bottom line.
As such, a churn rate of 5% for one business can be drastically different than another in terms of lost revenue. Though revenue-based models of churn can give valuable information on the impact customer loss has on your business in real dollars, it poses more challenges to reducing the impact.
How thinking about cohorts can improve your analysis
When measuring statistics and metrics related to churn, Cohorts are vital. A cohort is a group of users defined by specific traits. This can be as simple as grouping users by month or year (which we always suggest tracking as base lines), or they can be as specific as tracking mobile subscribers between the ages of 30 and 40 that have liked 10 or more posts related to tennis in the past month.
Tracking monthly and annual cohorts is a great way to measure consistent and stable growth of your product. By creating customer personas and identifying variables related to your business, product, service, and industry, you can begin to identify areas of success, as well as weakness you need to address immediately.
Focusing on weaknesses and areas with high rates of churn helps you better understand which types of people are leaving your service, and why. By developing cohorts, tracking their information and the change in their behavior, and consistently reevaluating, you will be able to reduce customer loss and increase the lifespan of your clients. In turn, this will increase each customer’s lifetime value to your business.
How to apply churn rate calculations to your business
When it comes to the relationship between churn, behavioral cohorts, and understanding the balance between customer and revenue losses, there are a few metrics you will need to understand, measure, and compare to better understand your business and know where to improve.
Here are some basic churn metrics you can apply to your product today:
CAC — Cost to Acquire a Customer, Sum of all Sales & Marketing Expenses/# of New Customers Added
- Customer Lifetime – How long on average a customer will use your product, 1/Customer Churn Rate
- ARPA – Average MRR (Monthly Recurring Revenue) per Account
- LTV – Lifetime Value of Customer
Simplified churn: LTV = ARPA x Customer Lifetime or LTV = ARPA/Churn
For revenue Churn: ARPA x Gross margin (%) / Churn
What is the Optimal Target Churn Rate?
A churn rate of 5% annually is often considered low, while anything over 20% is high. An acceptable rate of customer loss is dependent on various factors including the value the retained customers bring in contrast to lost customers, new acquisitions over the same period of time, and the lifetime of your customers.
Ideally, the lowest possible churn rate is the best rate, and what you should aim to achieve. When discussing whether the losses are acceptable in relation to your business, it is important to consider the period of time you’re assessing, not to conflate the results of your annual and monthly churn rates, and not to confuse causation and correlation in your analytics.
An annual churn of 5%, though good, can often be a result of various other areas of growth or success within your company; if you acquired new users, if the customers you retained pay more for your service, or if you upsell or cross-sell similar products. In contrast, a monthly churn rate of 2% may not seem high, but it will result in significantly higher total customer losses over the course of a year.
Understanding the effect churn has on revenue is also important for knowing whether the losses you have are sustainable. When assessing churn rates in relation to a specific change to the business (such as a technical update, a product change, or a marketing campaign), it is important to understand these are more isolated and subject to a range of factors; they are harder to measure year over year and month over month growth rates. That being said, they are great ways of measuring the impact these campaigns have on your businesses growth and retention.
5 Strategies to Reduce Churn
If you’re looking for concrete ways to reduce the rate you’re losing users, check out these five strategies you can start implementing today.
1. Valuable service/quality user experience
Providing a valuable service and high-quality user experience is the most important strategy to reduce churn. Before getting lost in the metrics, remember that a real person is using your product or service–keeping them happy, engaged, and interested is a priority. Providing a quality product or service, ensuring a user-friendly experience, and adapting to customer feedback are all great ways of improving customer retention, and in turn, reducing your churn rate. Always keep this in mind when analyzing your data and coming up with solutions.
2. Customer engagement/audience targeting
Analyzing the source of churn is a great way to reduce it. Through customer engagement and audience targeting, you can better understand who most commonly unsubscribes to your product or service. Use complaints, survey data, and other customer analytics to find solutions to the problems expressed by users/customers in order to find ways to improve customer retention and reduce churn.
3. Create negative churn
Understand expansion revenue and how it impacts your business to develop Negative Churn–or a churn rate that is supplemented by increased revenue from your retained customers. Analyze your business using a revenue-based churn model to properly manage losses so that you can mitigate the impact on your business. This can be generated through up-selling, cross-selling, or using variable pricing models that scale the costs along with the quality of the product or service (for example, increased storage, increased users, faster speeds/performance, and so on).
4. Foster customer loyalty
Offer loyalty incentives to your customers such as rewards or bonus programs that motivate them to stay. While these sometimes require an investment, if it results in an increase to customer lifetime or what they are willing to spend on your product over time, it will be well worth it. Ensuring that your customers stay for long periods of time is essential in a subscription-based business, as you earn sustainable revenue over a long period rather than relying on an immediate product sale.
5. Offset churn with user acquisition
In truth, customer acquisition is not a direct solution to reducing churn, but it can be a short-term solution while you are struggling to reduce a high churn rate; if you need to buy yourself time while you isolate and address the source of customer turnover, this can help. When possible, it is better to directly tackle the problem itself, because customer acquisition is costlier than customer retention. Always remember that customer acquisition is costly, and your best value comes from long-lasting, high-spending customers.
It’s always best to track as much as you can. Start to track churn on a monthly and annual basis, and create cohorts for unique audiences, product changes, and marketing campaigns. Be sure to compare both customer and revenue churn metrics in order to apply both where they apply most to your business. Start to measure metrics related to churn as well; as you understand it more clearly, you’ll begin to find new ways of applying churn to improve your service and reduce the loss of customers.