A deeper understanding of churn in SaaS business
Many things were written about churn in SaaS. When working in the Growth team and doing a deep dive into our churn I remember 3 things that blew my mind. Here they are, 3 things that go beyond simple churn calculations.
The cost of lost opportunity is huge
Let’s say it is the end of January and you added $15,000 to your MRR. Because it is a recurring revenue you will be receiving this $15,000 across all months to come. The same story goes to churn. If in January your churn was $1,500 that means for all of the following months you are not receiving your $1,500. Which you could.
Let’s calculate this compound effect over the next 6 months to see how much money you will lose.
It is the beginning of January and your MRR is $100,000. It is growing 10% month over month. Your monthly churn is 5%.
So in January you will lose 5% * $100,000 = $5,000. You won't be getting this $5,000 for all months to come.
In February your MRR will be $110,000 (10% growth since the last month). A 5% churn from $110,000 gives you $5,500 MRR churned in February.
You already lost $5,000 in January and you are not getting this amount in February as well. It is $10,000 loss. Add to that February MRR churn of $5,500 and your compound loss over just two months will be $15,500
If you extrapolate this calculation for the next 6 months here is what you will get.
On month 6 your total compound loss from 5% monthly churn is $124,359! I'm sure if someone would come to you and say – can I give you $124,000 to use in your business – you would easily find ways to invest this money.
For comparison: the last row in the table above, applies the same calculation but with monthly churn 2.5%. You can see how huge the impact is in just 6 months. Any decrease in your churn saves you a lot of money in months to come.
Take a look at the interactive model to understand the compound churn effect.
You 5% monthly churn is 46% yearly churn
Your 5% monthly churn converts to 46% yearly churn. To put things in perspective if you start in January with $100,000 in your MRR and your monthly churn is 5% you will have to add $45,963 this year just to break even!
This calculation always bends my mind. $45,963 in additional MRR just to break even. All of your new business, marketing, upsells efforts will go to cover that amount and you won't be growing. Just crazy. And then ~5% of yearly churn is only ~0.4% monthly.
Here is a model you can explore and convert your monthly churn into yearly.
Calculating churn rate
Churn rate is a good metric to use if you want to understand how fast you lose your revenue. When calculating churn rate you should not be mixing monthly and yearly contracts. If you do, it will downplay the result of calculation big time.
To simplify things a bit, let's look at customers' churn rate. Let's say it is February now. There are 20 customers in total. 6 of them have paid for 12 months and their contract ends next year. 14 customers paid only for a one-month subscription. 5 out of 20 customers churned in February. Now let's calculate churn rate:
You may be tempted to do the following:
5 customers churned / 20 total = 25% churn rate
Wrong. The reality is that in February only customers that have paid for 1 month had an opportunity to churn. All of the yearly customers paid for 12 months and did not have a chance to churn just yet. Thus you should not include them into the churn rate calculation.
So if you do that correctly:
5 customers / 14 customers that could have churned = 35% churn rate
25% vs 35% is a pretty big difference. Your initial calculation is off by 42% which is huge. It will push you to underestimate churn and not to focus on it.
When learning more about churn I found that it is a somewhat less intuitive metric and one that is difficult to understand deeply. So it is worth going into all these details to get it right. Your existing customer base is a huge potential for your MRR growth. Make them stay.