They know how to calculate churn, know what it indicates about their business, and know how to use it as a tool to focus the entire business to drive top-line growth. So let’s take an in-depth look at how to calculate churn for your subscription business and the alternate formulas for calculating it.
Customer Churn Rate vs Revenue Churn Rate...What's the Deal?
The top subscription businesses understand the value of the all important metric: Churn Rate.
There are 2 main ways for businesses to measure churn: customer churn and revenue churn.
1. Customer churn rate
Customer churn rate measures how many of your customers cancel their subscriptions in a given period of time. Customer churn rate is independent of how much money each of your subscribers is paying you and is calculated as:
To figure out the number of accounts up for renewals, most businesses typically look back either one month or one year. Then, for those same customers up for renewal, they ask: how many of them have canceled?
Let’s imagine that you are a B2B SaaS company and one year ago you had 5000 subscribers. Fast forward to today and 635 of that original 5000 customer cohort have canceled or not renewed.
Annual customer churn rate = 635 / 5000 = 12.7%
Notice in the calculation that customers added over the past year are not included in the numerator or denominator of your churn calculation. This is because they were not subscribers one year ago. It is important to stick to a single list of customers when running churn calculations. There are two important decisions to make when using this formula:
Do I want to express churn or retention?
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- Some businesses prefer to track retention rate instead of churn rate. They feel it is a more positive way to frame the metric. Retention is simply defined as 1 − Churn Rate. In this example, a 12.7% churn rate corresponds to an 87.3% retention rate. It makes no di erence if you choose to calculate churn rate or retention rate, though keep in mind that most benchmarks report statistics in terms of churn.
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Is it better to look back one month or one year?
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- Base this decision on your typical customer renewal term. For example, if your customers are typically signing up for annual subscriptions, then an annual churn rate most naturally aligns with your business because it is over the course of the entire year that your business has to provide value to get your customers to renew. Alternatively, if your subscriptions have month-to-month terms, then your retention occurs each month, and so, a monthly churn rate aligns.
Customer churn rate is a useful subscription metric because you can also use it to calculate the average life expectancy of one of your subscribers since your churn rate is inversely related to the age life expectancy of your customers, as indicated by the following formula. In the prior example where the average annual churn rate was 12.7%, the average life expectancy of a customer would be: Life expectancy = 1 / 0.127 Annual churn rate = 7.9 years
2. REVENUE CHURN RATE
The other type of churn rate calculation used by subscription businesses is revenue churn rate. In contrast to customer churn rate, which looks at whether a customer is still a subscriber with you, revenue churn rate looks at whether a given cohort of recurring revenue has been retained over a given time period. It is calculated as:
Let’s imagine a company one year ago had $20M in recurring revenue up for renewal. Fast forward to today, and of that contracted $20M, let’s imagine that $4M canceled or lapsed. The annual revenue churn rate would be:
Annual revenue churn rate = $4M / $20M = 20%
Notice this formula explicitly says revenue canceled or lapsed. It does not include revenue added. The revenue churn rate equation is very closely related to another metric called “net revenue churn” (alternatively called “net revenue retention,” if expressed in terms of retention).
Net revenue churn goes a step beyond revenue churn by factoring in upsell revenue in addition to canceled and lapsed revenue. Some in the industry use the terms “revenue churn” and “net revenue churn” interchangeably, but they are slightly different. In very healthy businesses where upsell revenue outpaces churn revenue, net revenue churn rate is negative. This phenomenon is sometimes referred to as “negative churn” and is a sign that a business is doing very well at retaining and expanding the revenue earned from each customer.
WHICH SHOULD YOU USE: CUSTOMER CHURN RATE OR REVENUE CHURN RATE?
For subscription businesses where all customers pay the same amount, customer churn and revenue churn will equal each other and the distinction between customer churn rate and revenue churn rate is moot. This is the case in B2C businesses where all customers pay the same monthly fee. These companies typically choose to report customer churn rate.
Most businesses, however, do not charge all their subscribers the same amount — they offer a variety of prices and packages tailored to the unique needs and wants of target customer segments.
The distinction between revenue churn rate and customer churn rate becomes increasingly important for businesses as the revenue for each customer, or different customer segments, becomes increasingly varied. Imagine you had three primary segments in your customer base: individual, small business, and enterprise. Many companies will experience diff ering churn rates by segment, as illustrated below.
In this example, individual subscribers are churning at a much higher rate than the overall customer base, and enterprise subscribers are churning at a much lower rate.
This table offers two important takeaways:
- Track both customer and revenue churn. Notice that while customer and revenue churn rates closely approximate each other for individual segments, the overall customer and revenue churn rates are quite di fferent from one another. Picking only one of these measures would provide a misleading takeaway about the health of the overall business. Using both measures will present a more clear picture of how customers are churning.
- Track churn rate by customer segment. The heatmap highlights the variability in churn between segments. Breaking churn down by segment helps you identify if you have a challenge retaining certain types of customers, and can help you hone in on the biggest problems in your customer base.
Notice that in the above example, retaining individual subscribers is a clear area of opportunity and room for improvement.
Finally, it is important to be consistent in how you report and trend churn rate metrics. Never mix customer and revenue when reporting historical trends. Always be clear to your audience about what rate you are presenting and how it is calculated — the specifics of your numerator and denominator matter since you and others will base decisions on them.
Author:
Kevin Suer, Product Management, Zuora