Churn rate, the loss of customers over a specified period of time, is one of the most important metrics a company can track.
Churn rate has a profound impact on a company’s revenue. When most people think about losses, they’re thinking about things like overhead, ad campaigns, the marketing team’s frequent partying, that sort of thing: Looking for cash that has been spent and the investment it has (or hasn’t) returned.
Churn tends to avoid the spotlight in these discussions, but the spotlight is often exactly where it belongs.
Let’s take a closer look at what customer churn rate really means for your business, and acknowledge the negative impact it can have on your company’s bottom line. We’ll also cover customer retention rate, expose the leading factors behind both of these numbers,
What is churn?
Churn, often known as “churn rate,” is the measurement of the number of subscription customers who have canceled their subscription over a set period of time. Churn is most commonly measured as a monthly number, since most subscriptions’ payments are monthly.
Say you started May with 200 users. Your sales team added another 42 users by the end of the month, but you lost 14 existing customers along the way. Your monthly churn rate would be 14 / 242, or 5.785%.
While many variables influence customer churn rate, the leading causes of churn can be attributed to one of “the big three:”
Read on or jump ahead to the topics below:
- Average subscription length
- Customer acquisition cost
- Customer lifetime value (CLV)
- Calculating churn rate
- Why customer retention is vital
The three leading factors that impact customer churn rate:
1. Average subscription length
Subscription length is the amount of time an average customer spends paying for a company’s goods or services. Typical subscription length varies based on the type of service offered. While a mobile fitness app may offer monthly subscriptions, it is more practical for a tax preparation software company to offer annual renewals.
Having a month-to-month subscription billing model can be attractive and advantageous in initially winning over new customers, but may result in a higher churn rate when factoring these new users into the calculation, since nearly half of new month-to-month users churn in their first month.
Because the first month is so notoriously turbulent, some companies run reports that exclude customers that are still in their first month. Companies with a month-to-month model often can reduce churn by offering a small discount when customers subscribe for a longer period of time.
Numerous acquisition factors impact a company’s churn rate, and tracking those factors can lead to a substantial difference in long-term revenue. As illustrated below, two companies with identical growth but different churn rates will see drastically divergent trajectories over the course of just five years:
2. Customer acquisition cost
Another crucial factor in churn rate is customer acquisition cost, or the amount of money spent to gain one new customer. If a company has a high customer acquisition cost, it will need to maintain a high customer retention rate in order to grow efficiently. When companies have both a high customer acquisition cost and a high churn rate, they’re burning precious capital to acquire new users, only to lose those customers in a short time.
The ideal scenario is to have low customer acquisition costs and a low churn rate, which means a company is not spending tons of money to increase its customer base, while simultaneously keeping most of its users. When both these numbers are under control, it’s smooth sailing.
The list below highlights some initiatives companies can implement to ensure continued customer satisfaction, thus decreasing churn rates:
Improved onboarding experience
40 – 60% of users churn after using the product just one time. This is often because users are unable to quickly understand how a product actually adds value to their business.
Improving the onboarding process and communicating clearly with users during each stage of the sales funnel is important in mitigating this. When people understand what they’re signing up for, it makes sense that they’re not going to ditch it after only using it once.
Improved customer service
Excellent customer service should be a core component in the strategy of every company seeking to retain customers long term. Many companies think of customer service as an overhead that should be reduced as much as possible rather than an investment in customer success.
When customers are treated well, they’re more likely to remain loyal to that organization. With a rockstar customer service team, your customers will reward you by referring their peers, helping the business to grow.
Conversely, poor customer service is utterly catastrophic. Almost 9 in 10 customers have left a business due to poor customer experience. In contrast, 86% of customers are willing to pay more just for better customer experience—product aside.
One of the best ways to attract new customers is to offer exclusive discounts or free trial periods for first-time users. A period of free usage can give the customer enough time to decide—at their own pace—if your product is a good fit for them.
3. Customer lifetime value (CLV)
Customer lifetime value (CLV), measures a customer’s total value towards a business over the duration of their relationship. This metric is useful when considered alongside customer acquisition costs.
When customer acquisition cost surpasses customer lifetime value, the company is receiving a negative return on investment (ROI) on each customer. To avoid this, companies try to create ways to increase the lifetime value of their customers.
Providing additional services
Offering additional services, often ones that are complementary to a company’s core business offering can make a noticeable difference when it comes to providing more reasons for customers to stay with a company. For example, companies can host free webinars filled with valuable information, create downloadable reports, or even offer engaging and educational tutorial videos.
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Calculating churn rate
Churn rate is calculated by dividing the number of customers lost (churned customers) by the total number of customers:
Number of Churned Customers / Total Number of Customers
The total number of customers for a period can sometimes be difficult to pinpoint. Total customers for a given month, for example, are not always well-defined because the number of total customers can change throughout the month due to new customers onboarding and cancelations from the current user base.
Because of how unstable churn rates can be in the first month, subscription-based companies often define new customers as users that are coming up on their first renewal, rather than identifying them as customers in their first month of service. Calculations of churn rates that include new customers still in their first month of service (a trial period for example), cause the percentage to skew higher. For this reason, it is vital to understand exactly when a customer churns.
Defining the moment of churn
Companies can define the moment of churn in two ways:
- The moment a subscription ends/nonrenewal
- The moment of cancelation
When a subscribing customer cancels, they have not yet technically churned, as there is still time to win that customer back and evoke a renewal before their subscription ends. There are also other industry-specific factors at play, like seasonality for one.
While it is most common to measure churn using the total number of customers as a baseline, companies may also elect to measure churn based on other factors, like revenue, the number of product licenses, or even product downgrades.
Some companies calculate customer retention rate by the number of customers at the end of an arbitrary period, minus the number of new customers during the period, divided by the number of customers when the period began, times 100.
This method of measurement is actually used by 69% of SaaS companies. Nice!
Why customer retention is vital
Improving customer retention rates, even by just 5%, can increase profits by at least 25%. Increased customer retention can have a long-lasting impact on the overall success of a company.
Even if a company is gaining new customers each month, it is still missing out on tons of additional revenue if it has a low customer retention rate. Churn rate can have a significant impact on a company’s bottom line, with an estimated $1.6 trillion in revenue being lost each year due to failure to retain existing customers. Yikes.
While many companies prioritize growing their customer base and strategizing ways to lower customer acquisition expenditures, it costs 5 times more to acquire a new customer than it does to keep an existing one. Cultivating new customers should be a priority, but not at the expense of customer retention efforts.
Gaining a firm understanding of a company’s churn rate sets the stage for long-term success and can dramatically increase revenue over time.
Knowing the value of repeat customers will ensure retention is prioritized over simply gaining new customers at a continuous rate. While companies will inevitably face some degree of churn, smart businesses can persevere by reducing the impact churn has on their bottom line and increasing revenue by actively working towards a negative churn rate.
Reducing churn begins with listening to customers and understanding what they desire. With the right systems in place to gather and analyze this knowledge, companies can gain sales opportunities, add value to their customer experience, and increase revenue as well as customer loyalty.
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