What is Churn Rate?
The Churn Rate measures the percentage of a SaaS company’s existing customers that have opted to cancel their subscriptions (i.e. or otherwise discontinue being a customer) during a specified time horizon.
How to Calculate Churn Rate (Step-by-Step)
The churn rate, also known as the “attrition rate,” is the proportion of existing customers at the beginning of a period that was lost over a given period.
The question answered is, “Of our total existing customers at the beginning of the period, how many did we lose by the end of the period?”
Many modern business models are oriented around recurring revenue and subscription-based pricing models. In particular, the software-as-a-service (SaaS) model – in which companies provide cloud-based services on a subscription basis – is an integral part of practically all industries, either directly or indirectly.
Simply put, the long-term viability of SaaS companies depends not only on their capabilities in acquiring new customers but also on retaining them, which coincides with low churn rates.
The distinction from the traditional business model is that in the SaaS model, a service is provided over a prolonged period, and customers make payments periodically, such as a monthly subscription.
Calculating the customer churn is a four-step process:
- Step 1 → Select Time Metric – e.g. Monthly, Weekly, Quarterly, Annual
- Step 2 → Count the Number of Customers at Beginning of Period (BOP)
- Step 3 → Tally Number of Churned Customers that Left at End of Period (EOP)
- Step 4 → Divide Churned Customers by Number of Customers at Beginning of Period (BOP)
Churn Rate Formula
The customer churn rate formula divides the number of lost customers by the total number of customers at the beginning of the period.
The numerator, churned subscribers, can be calculated using the following formula:
In order to calculate the metric correctly, it is imperative to choose the period (e.g. quarterly, annual) and ensure consistency in all subsequent calculations, as well as explicitly state the period chosen.
SaaS Customer Churn Rate Analysis Example
For example, let’s assume that a SaaS company had 200 customers at the beginning of last year, and eight customers decided not to renew their contracts at the end of the year.
The customer churn for the year is 4.0%, which we calculated by dividing the churned customers by the beginning customer count.
- Customer Churn = 8 ÷ 200 = .04, or 4%
Churn vs. Retention Rate: What is the Difference?
Customer churn is defined as users that sign up or subscribe and then later on cancel, whereas customer retention is the percentage of customers that remain customers.
Since churn and retention are inversely related, subtracting the retention rate from one equals the churn rate.
For example, if a company’s retention rate is 60%, then its churn is 40%.
- Churn = 1 – 60% = 40%
How to Interpret Customer Attrition Rate
A recurring revenue stream can seem appealing to many – hence, there is a widespread shift toward recurring revenue as opposed to one-time sales.
The drawback to recurring revenue is the recurring responsibilities in terms of product quality and post-sale customer relationship management.
If customers are left unsatisfied, a source of income is cut off. Further, Cancellations can also now be done over the phone or by email, making it easier than ever for unsatisfied customers to discontinue.
Even though SaaS companies – particularly in the earlier stages of their lifecycle – often prioritize sales and user growth in lieu of profitability, they must not neglect their existing acquired customer base.
In the long run, customer retention determines a company’s success (or failure), as acquiring countless customers is pointless if most end up abandoning the product/service soon after.
For a company with a high churn rate to continue operating, it must continually offset those lost customers by acquiring new customers, which is not a sustainable business model.
Cancellations can be categorized as either 1) voluntary or 2) involuntary.
- Voluntary: The customer actively terminates the subscription or denies renewal.
- Involuntary: The cause of a customer cancellation was a credit card decline (e.g. expiration, insufficient funds), network failure, or internal mistake.