What is a Churn Rate?

Churn rate is a simple concept but it could completely undermine your business if it gets out of hand.

Simply put, the churn rate is the proportion of customers to an ongoing service who stop using it during a given period. That means users/visitors to a free site and customers of a subscription service.

You’ll find different people defining and calculating the churn rate in slightly different ways. That’s not a problem as long as you are measuring what’s important to you, though be sure to compare like to like when checking your performance against an “ideal” or “acceptable” churn rate. (In particular, take care comparing monthly and annual figures.)

Let’s give some very basic examples. Imagine your business has 200 subscribers at the start of the year, you pick up 10 new ones during the year, and 20 cancel during the year. The simplest churn rate definition means dividing the 20 cancellers by the 200 initial subscribers, giving an annual churn rate of 10 percent.

You can use several other methods to calculate and define churn rates. Some people compare the net gain or loss of subscribers (cancellations minus new subscribers) to the initial number of subscribers. Others will compare the number of cancellations to the total number who subscribed at any point during the period (210 in this case.) Others will take into account the revenue, meaning cancellations from people on a more expensive plan have a bigger effect on churn.

The bottom line is simple though: if your churn rate means you are losing customers at the same rate or faster than you recruit new ones, your long-term outlook is somewhere between uncertain and bleak.

In fact, churn has a more corrosive effect than you might realize. On paper, a business that loses 50 customers a month but picks up 50 new ones is doing just as well as one that neither recruits nor loses customers. In reality, the former company is in worse shape because it will have to keep spending money on marketing to attract new customers.

That’s where the math gets more subtle. What really matters is that you have a churn rate that is low enough that the average customer subscribes for at least a certain period. That period is however long it takes to make enough profit from them to cover the average cost of acquiring a customer.

So what’s a good churn rate? It depends on both the specific industry and the state of the wider economy. You’ll often hear a rule of thumb that 5 percent annual churn is a decent result with SaaS subscription businesses. What really matters is how you respond to that figure.

Remember that a business with a higher than 5 percent churn could still thrive with aggressive recruitment of new customers or increased revenue from existing ones. A business with lower than 5 percent churn could still be in deep trouble if it isn’t able to maintain the recruitment of new customers. The main takeaway from the 5 percent “rule” is that a small level of churn is almost inevitable and can be accommodated by a well-run SaaS business with strong fundamentals.

The best way to think of your churn rate is as both a quantitative and qualitative signal. If you can find out why customers are leaving you may be able to reduce the churn rate. You also need to dig below the basic numbers to find the real story, even if your churn rate seems acceptable on the surface.

For example, if you analyze your data you may discover clear signs of when and why customers leave. You might find on average somebody goes three weeks without logging in to an account before unsubscribing. In response, you could try setting a flag to highlight for any customers who haven’t logged in for two weeks and then send an email with tips and tricks for making the most of the software.

You also need to change your expectations in the long term. Another rule of thumb for SaaS is that churn should stabilize and then gradually fall as your business is more established. The stabilization comes simply because the bigger the number of customers, the less effect random variation has on the churn rate. The fall should come because–if you’re on top of your business–you’ll do a better job of finding recruiting customers who are more likely to get the most out of the service and stick with it in the long run.

However you calculate it, knowing and understanding your churn rate–and what it really means–is key to keeping control of your business.

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