Churn rate is a proportion of customers who stop paying for a product or service during a given time period. It’s the complete opposite of growth rate, making it one of the most important marketing and sales metrics for subscription-based companies.
It’s a seemingly easy-to-understand metric. But the simple formula to calculate churn rate has some limitations and potential traps many marketers may not take into account. Also, contrary to popular belief, you can influence churn long before someone becomes a customer.
There’s quite a lot to explore here. In this article, you’ll learn the following:
Let’s dive into it.
There are multiple reasons why keeping track of your churn rate and working with it can help to boost your marketing performance. Well, five main reasons to be specific.
1. Direct revenue impact
Churn rate is a decelerator of your growth rate. But unlike the growth rate, a certain percentage of churn is here to stay. Many fast-growing companies may fall into the trap of ignoring high churns when their growth is much higher, but it’s not a sustainable business model.
A 15% churn rate may not seem that bad when a startup grows 200% year-over-year. But that growth rate will eventually fall, and the churn may not. Any company will sooner or later suffer from high churn rates even if they weren’t such a big problem initially.
The sooner you start tackling your churn rate, the better. It has compounding effects. Let’s consider two companies with $1M ARR (annual recurring revenue) each and a similar growth rate of 25%. But they have different churn rates (scroll horizontally to see all table columns):
|Year 0 ARR||Year 1 ARR||Year 2 ARR||Year 3 ARR||Year 4 ARR||Year 5 ARR|
That’s what a difference of 5 percentage points in churn rate can do to revenue. The higher you churn, the slower you grow. Easy as that.
2. Influence your word-of-mouth marketing
Word-of-mouth marketing (WoMM) is the process of influencing and encouraging natural discussions about a product, service, or company. I’m sure you’ve subscribed to some product or service because someone you trust told you about it. For this reason, WoMM can be one of the most powerful marketing channels.
The fact that more than 14,000 new customers in 2020 told us they were referred to Ahrefs by their friends is the best proof of WoMM’s importance:
Churn rate reflects how well you meet the expectations of people who sign up for your product or service. While we can’t directly translate high churn into dissatisfaction, we can assume it’s a signal for a need to significantly improve your WoMM.
3. Early indicator of bad news for your business
Noticed a big spike in your monthly churn rate? Chances are you did something wrong that month.
Maybe product changes got negative feedback? Increased pricing? Any bad publicity? Or it could be your competitors stepped up their game and poached a significant number of your customers.
At any rate, having such an early indicator of these changes always comes in handy.
4. Customer lifetime value variable
Customer lifetime value (LTV) is a metric that estimates how much money an individual customer will spend on your products or services. Increasing your average customer’s worth not only improves your financial metrics but also allows you to spend more on acquiring new customers.
LTV is yet another important metric, even a marketing KPI, that you should keep track of. The best way for subscription-based companies to calculate the metric is as follows:
LTV = avg. monthly revenue per customer/avg. customer monthly churn rate
The fact that churn enables calculations of other crucial marketing metrics should make it a staple in your spreadsheets and dashboards.
5. Proxy for performance forecasts
Many companies and their analysts engage in forecasting future performances. Accordingly, the churn rate is an essential variable in the calculations.
We’re not talking about in-house uses only. Churn rate is also an important indicator when it comes to investing in subscription-based companies.
So what does it take to calculate churn rate?
You might have already noticed that I talked about churn rates in relation to both customers and revenue. These are two types of churn rates, and here’s everything you need to know about calculating them.
Customer churn formula
Customer churn rate = (customers lost during period/customers at start of period) x 100
For example, on May 1, you had 1,000 active customers. And on May 31, you lost 25 of them. That means your monthly customer churn rate is 2.5%.
Easy start. Let’s move on.
Revenue churn formula
Revenue churn rate = (revenue lost during period/revenue at start of period) x 100
As you can see, it’s basically the same formula. Only the variable is different and a bit more tricky.
Here’s the thing: You should only take into account the revenue generated or lost from the customers you had at the start of the period.
Let’s say you have $100K MRR (monthly recurring revenue) at the start of the period. You manage to upgrade some of your existing customers for an additional $5K MRR, lose a few customers who contributed to $4K MRR, and notice $2K worth of downgrades.
The revenue lost during the period is $1,000. This is as you lost $6K due to churned and downgraded customers. But you made $5K from customers who decided to upgrade. Your revenue churn rate for that period is therefore 1%, as the formula is (1,000/100,000) x 100.
Sometimes, your upgrades will be worth more than the revenue lost. In that case, you’ll have a negative number in the numerator, making the overall churn for that period negative. That’s your best-case scenario, as it means growth even without taking any new customers into account.
When to use which churn rate formula?
It doesn’t take a math genius to figure out that customer and churn rates usually differ. I recommend you calculate both churns because they provide additional information.
- Customer churn rate > revenue churn rate, then your churned customers have a below-average lifetime value.
- Customer churn rate < revenue churn rate, then some of your higher-value customers churned.
Always try to put the numbers into context. For example, it’s possible to have a high revenue churn despite having done exceptionally well during a certain period.
Such a scenario happens when, for example, a business has a few percent of customers who contribute to the vast majority of revenue. If one of those huge accounts churned, it would make the revenue churn look bad.
What are the limitations of the basic churn formula?
Calculating churn rate is easy until it isn’t. I won’t dive into all the nitty-gritty, but you should be aware of the following:
- The formula works best when calculating churn rates on a monthly basis.
- For longer periods of time, newly acquired customers who churn within the given period can skew the results. You have two options here. Disregard all churns from customers acquired during that period or add up monthly data and calculate a weighted average churn.
- Consider calculating churns for some of your plans separately, especially if you target completely different market segments at the same time (e.g., SMBs vs. enterprises).
- If you’re a startup, your churn rates will likely fluctuate a lot. That’s because you experience rapid growth and new customers tend to churn more frequently than those who stick around for a while. Your likely small sample size (# of customers) is also a factor here.
- Your business may suffer from seasonal swings, so a higher churn rate may be natural during some months.
But the bottom line is that no matter how you calculate your churn, you should stick with it and work on decreasing whatever the number is.
So what’s really a bad, so-so, or good churn rate?
If you Googled this, you’d encounter anything between 2% and 8% to be an acceptable churn rate. That’s useless information for a metric where a 1% difference could mean tons of money. On top of that, some resources don’t even mention what type of churn over how long they’re referring to.
But we need a number. It’s important to have an anchor to recognize instances when churn is a minor problem and we should, thus, prioritize achieving other marketing objectives. Fortunately, all we need here is to get more specific with Google queries.
Make a list of competitors. Google their names in combination with “churn rate” or “retention rate” (the inverse metric). Voilà:
You should get some specific numbers. If you have publicly traded companies on your list, the chances of getting more numbers for your benchmarking are high.
That’s because these companies regularly publish financial reports and have their executives share metrics and data in interviews. But you can get lucky with private companies as well.
One important thing to keep in mind. You and your competitors likely target different segments of the market, and that has a huge impact on churn rates.
As you can see in the example above, Cloudflare reports 36% annual churn, while Fastly is at 0.7%. They’re both Content Delivery Network (CDN) providers, but Cloudflare caters to everyone in the market (including a free plan option). But Fastly is only targeting enterprise and high-value customers who usually sign long-term contracts.
All right. So you found out that your churn is probably too high and you should work on decreasing it. That’s what the second half of this post is all about.
Nine ways to decrease churn rate
There seems to be a misconception that churn happens after someone becomes your customer. No. You can influence your churn rate in all stages of the marketing funnel:
Let’s show you how.
1. Collect feedback from churned customers
Talking to your customers is an important part of market research. But you may learn even more when you talk to people and companies that stopped paying for your product or service.
Now don’t fall into the trap of taking action on everything you hear from those who churned. Just systematically collect the feedback to get a solid sample. Then decide if taking action on their objections and problems makes sense for your product roadmap and marketing strategy.
Since prioritization mainly revolves around two variables—effort and outcome—you’ll probably focus more on problems brought up by your most valuable customer segments.
You may also find out that a certain percentage of your customers only need to use your product for a month or two every year. You’ll get these insights after collecting such feedback for a while. Then you can account for this natural churn to help you tackle the more important churn.
2. Fix your positioning
Positioning is how your target market should perceive your brand. It’s the intended brand image that consists of associations people have of your brand and products.
Positioning allows you to differentiate from your competitors and, in some cases, even influence how the target market perceives your competitors.
Let’s give the theory a more actionable spin. Your marketing communication should consistently convey what your product does and how a potential customer can benefit from that. For example, here’s a humble brag about our homepage that does the job of providing clear communication well:
This plays a huge role in having new users who know what to expect from Ahrefs and how we can help them. We’re also confident that we can meet or, even better, exceed those expectations.
Churns often happen when you overpromise and underdeliver. Good positioning helps fix the first. So how do you figure out how to position your product?
Again, we’re back at market research that should tell you about the preferences of each of your market segments…