SaaS Churn Rate: Essential Aspects Business Should Know
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How many times you've heard: "Churn is bad for business"? Of course, it hurts when customers leave your product. But well, nothing remains unchanged, neither in life nor in business. No need to panic. Let's better make it clear how to deal with the churn and benefit from it.
What is churn rate?
In essence, the SaaS churn definition is pretty simple. It means the percentage of customers who left your product over a certain period. Customer churn is a crucial indicator to understand if your business faces problems that threaten its growth. Churn rate directly influences financial metrics, such as recurring revenue, lifetime value, and customer acquisition cost.
Let's see how these metrics are all connected.
Monthly recurring revenue (MRR): when customers leave, they take your income with them. In this metric, "recurring" is a key – a SaaS company needs to have a stable and predictable cash flow for constant business growth. We dedicated a separate article to MRR metric, so take a look to learn more.
Customer lifetime value (LTV): the longer a user stays with a company, the more money they can bring. Customer churn impacts LTV as it naturally decreases possible revenue that could have been earned.
Customer acquisition costs (CAC): if customers churn before you get back expenses spent on their acquisition, your loss will exceed the gain in the long perspective. By the way, if you want to know more about CAC, check CAC SaaS metric article on our blog.
OK, now we know the churn rate basics, so it's time to move to its calculation.
How to calculate churn rate
Here is the simplest way you can calculate the churn rate:
Number of churned users / Total number of users
In this SaaS churn rate formula, the number of churned users means how many people left your service within a certain period, whereas the total number of users implies all customers you had during this period.
At first glance, this exercise may seem as easy as pie. In reality, though, you need to consider lots of nuances making your calculation show a real picture.
Firstly, you need to define what you will take as the moment of churn.
It can be either:
- The moment a customer doesn't renew the subscription, or
- The moment of the cancellation (in this case, there is always a chance to get customers back before their subscription ends)
Also, before the analysis starts, it will be useful to decide:
- Exact time frames – a month, a quarter, or a year
- Sample size (so-called cohort) – it defines how representative and predictive the results will be
- Customer segment – low-tier and high-tier plan segments may have different churn numbers.
Thus, an aggregated figure will lack accuracy and lead you in the wrong direction.
Imagine, you did all the homework well. And now you're looking at the final churn rate number with a few questions on your mind: "What on earth does this percentage mean? Is it low, high, or normal? And what is a good churn rate for SaaS?"
Keep calm. The truly awesome story begins!
SaaS churn rate benchmarks
Though there are lots of opinions about the average churn rate for SaaS companies, most experts support the idea of the 5% - 7% range ANNUALLY as a benchmark. I will explain a bit later why the word "annually" is capitalized. Just note that this is important.
Whereas you can take this range as a reference, the churn rate "norm" depends much on a company's revenue growth.
Here is a graph to see the correlation between the churn rate and the revenue increase.
In this research, high growth companies are those that increase revenue by 75% year-to-year. Medium growth and low growth are businesses with 25% - 75% and less than 25% increase correspondently.
The percentage of each pie shows how many companies in a particular growth segment have a churn rate of less than 5%, from 5% to 10%, and greater than 10%. According to these graphs, the larger companies occur to be much closer to the desired 5% - 7% SaaS annual churn rate. This observation seems reasonable. Big SaaS companies usually focus more on enterprise customers with annual billings, high yearly contract value, and long-term contracts, making it more complicated to churn.
For the smaller businesses, the much higher rate is typical. Unlike the large companies, the earlier-stage companies target SMBs with monthly billings, shorter contacts, and, overall, lower contract value.
Do you remember I emphasized the word "annual" talking about the SaaS churn rate benchmarks?
You will get it right away.
Monthly vs. annual churn rate
The trickiest thing in the churn rate calculation is whether to stick to the annual or monthly churn rate numbers.
Let's see the difference in calculation.
For example, we assume that a startup has 1000 customers. A 5% annual churn will result in the loss of 50 customers within a year, which is not so dramatic, right? At least, this loss is easy to recoup with new customers.
But what's happening with a 5% monthly churn rate? Our startup will lose 460 customers in one year because the monthly churn compounds over time and reduces the number of customers by 5% every month. The loss of almost half of the customer base can be difficult to quickly compensate.
For early-stage SaaS companies or those primarily selling to SMBs, the expected churn rate will be closer to 3% - 5% monthly. However, the larger customers you target, the more your business matures, the closer you get to the "ideal" 5% - 7% annual churn rate.
Eventually, your progress should look like on this graph:
Why customers leave
Here are some possible reasons why customers decide to part ways with your product.
- Users have different expectations from your product
- Your product does not have the features or services they need
- You bring wrong customers on board (that's a question to sales and marketing teams)
- Poor onboarding and support
- Price offering doesn't fit the customers' budget
- Your product has critical bugs you fail to fix
Sometimes, everything is OK with your product and service, but the value is not fully uncovered, so customers don't comprehend why they should pay for it.
We will now get into one SaaS company churn analysis to see the real-life example.
Churn analysis example
The company is a SaaS startup that provides a subscription-based service mostly for SMB companies.
The data was gathered through a customer survey, covering recently churned users.
The graph below shows how much time the customers had spent with the company before they churned. "Fresh" customers, which were using the service less than a year, fall into the most considerable churn portion of 36,3%. Probably, they didn't feel the service satisfied their needs or didn't find the value they would be willing to pay for.
Another significant portion includes those who stayed with the company for more than two years. They had enough time to interact with the product and, chances are, were frustrated with bad customer service or switched to the competitors with a better price offering.
More than half of the churned customers - 57,2% - are small businesses with up to ten employees. As we already learned in the paragraphs above, monthly contracts, cash flow volatility, and low contract value, typical for SMBs, make it easy to churn.
Poor customer service is the top churn reason. Further go price, low service quality, sales, and implementation issues.
If we dig deeper into what poor customer service means, we see that sales process failure makes up a significant portion.
The SDRs inaccurately explained the functionality and failed to qualify the leads, which eventually led to churn. That's a widespread problem SaaS companies face. All marketing efforts and costs will be in vain if sales and support cannot qualify and retain customers.
How to reduce churn rate
To a certain extent, it is quite fair to claim that churn is inevitable. Indeed, you cannot appease everyone. However, to secure the company's profitability and revenue growth, your sacred duty is to minimize the churn rate, pursuing the target of 3% - 5% annually.
Here are a few tips to help you improve your churn rate.
Get to know your customers better
It may seem not obvious, but your "anti-churn" campaign starts long before you win a customer.
You have to know who your ideal customers are, how to reach them, what they need, and how much they are willing to pay for your product. The best way to see the total picture is by creating a customer persona based on users' characteristics such as demographics, industry, income, and jobs-to-be-done.
When your marketing team does this homework, the ball goes to sales.
Lead qualification is what your sales representatives must brilliantly perform. During a discovery call, SDRs should scan a lead and flawlessly determine if your company's service can fully satisfy a customer's needs. At every stage of the sales pipeline, you have to make sure your value proposition is exactly what the customer is looking for.
Starting from a free trial over the first six months, you should track customer engagement and make sure your product meets the customer's expectations. It is up to you whether you will build your in-house system to monitor and manage the engagement or leverage a third-party tool.
The paramount goal is to help users engage with your SaaS product by constant communication, active listening, gathering their feedback, and working on users' experience improvement. We gathered 11 user engagement strategies you can try implementing for your SaaS business.
Get user feedback
Customer feedback is the principal source of valuable information. Sometimes, it is not easy to get an honest response from a churned customer, but it is worth trying. Assign your best sales reps to contact those who left and get their feedback through specific questions.
You can also gather responses via in-built customer surveys, which answers you will later turn into actionable insights.
- Churn is inevitable, but you can control and improve it
- An average churn rate benchmark is 5% - 7% annually if you are a mature SaaS company
- You can expect around 5% monthly if your business is young or if you target SMBs
- Poor customer service, insufficient lead qualification, and bad user experience are among the reasons why clients leave your company
- Customer satisfaction based on monitoring and analysis will help reduce your churn rate
Also, we're more than sure that customer-oriented design and great customer experience can help reduce your SaaS churn rate.
Churn is only one of the essential metrics you should monitor to ensure your business growth.
In the Best Books on SaaS Metrics article, we selected the books that share priceless advice on how to run a successful startup.