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In the world of Software as a Service (SaaS), a high churn rate is considered to be the ultimate failure. This indicates that a significant number of customers have made the decision that your product or service does not provide enough value to justify the cost.
💡 Churn is a significant issue for startups, and the key to addressing it is to be brutally honest. This guide explains the reasons behind customer churn and offers strategies to improve churn rate and enhance the customer experience. It emphasizes that while achieving zero churn is unrealistic, changing your perspective on churn rate can make a world of difference.
Let's explore what churn rates are, ways to measure them, and strategies for reducing them in order to keep your customers happy.
What is SaaS churn?
SaaS churn refers to the frequency at which customers terminate their recurring subscriptions for a SaaS solution.
There are various approaches to measuring SaaS churn, but the easiest way is to calculate the ratio of customers who cancel their subscription during a particular time frame to the total number of subscribers at the start of that period.
Monthly churn rate is a vital measurement for SaaS companies. It offers valuable insights into growth, revenue forecasting, ARR, MRR, and renewal rates.
Plus, it enables the identification of customer churn reasons and reveals opportunities for enhancing company processes and software functionality.
Why is SaaS churn so important?
Churn is a serious threat to any SaaS business. It directly affects revenue, profitability, and overall company success. The problem lies in the fact that churn accumulates over time. If you don't take steps to minimize or control your SaaS churn rate, it will deplete your customer base and leave you with no customers at all.
Retaining existing customers is more crucial for long-term revenue growth than acquiring new clients. Even a slight increase in customer retention can have a meaningful impact on future financial success.
For example, consider two companies that bring in new customers at a 15% rate. In just two years, the company with a 5% churn rate will outperform the company with a 10% churn rate by more than 500%.
Why do SaaS customers churn anyway?
Understanding why customers cancel their SaaS subscription is crucial for the success of any SaaS company. Luckily, most customers are asked to state the reason for their cancellation.
Here are some common reasons why SaaS customers churn:
Voluntary SaaS churn
Voluntary churn occurs when a customer intentionally cancels your product or switches to a competitor because they no longer have a need for it.
As a SaaS organization, competition is inevitable. Customers may easily switch to a better alternative if they find one, whether it's a more valuable pricing model or enhanced capabilities.
SaaS providers often charge high prices for their software services. However, if the quality of the service doesn't meet expectations or if pricing isn't strategically planned, customers may cancel their subscription.
A single negative customer experience, such as a challenging onboarding process or an unpleasant encounter with a customer service representative has the potential to cause a user to forgo renewing their SaaS subscription.
When investing in a SaaS solution, customers expect the software to simplify their processes. If the product doesn't meet their anticipated features, they may stop using it.
To prevent SaaS churn, organizations should pay attention to customer feedback and make necessary adjustments. This data analysis helps reduce monthly and annual churn rates, increasing user retention.
Involuntary SaaS churn
Involuntary churn occurs when a customer leaves due to uncontrollable circumstances like outdated payment details, server errors, or insufficient funds.
What is considered a good SaaS churn rate?
An acceptable SaaS churn rate typically ranges from 3 to 8%, depending on factors such as industry, product, market, and seasonality.
Facing reality: a certain level of churn is inevitable in the SaaS industry.
Losing a customer due to their business closure may seem unavoidable, but that doesn't mean you should do nothing about it.
While some SaaS churn is inevitable, it's still important to fight against it and minimize its impact. Taking no action to prevent churn can have dangerous consequences.
3 factors that explain why average SaaS churn varies
Churn rates for subscription companies can vary greatly due to various factors. Both external factors, such as the market and customers' willingness to pay, and internal factors, like pricing structure, contract lengths, and company age, contribute to these variations.
The churn rate differs significantly based on whether services are sold to businesses or consumers. SaaS, for instance, predominantly offers B2B products and services, resulting in lower churn rates.
On the other hand, consumer services such as subscription boxes and entertainment platforms like Netflix and YouTube have higher churn rates due to their perceived lack of necessity.
Higher ARPU = less churn
The number of customers leaving greatly depends on your pricing. Companies with low average revenue per user (ARPU) have higher customer turnover than those with higher ARPU.
If your monthly revenue per user is less than $100, your business may be experiencing high rates of gross revenue churn. These rates typically fall between 3% and 16%, with a median range of 6% to 9%. Such a level of churn can greatly affect your business.
Companies with an ARPU exceeding $500 have significantly lower revenue churn, typically ranging from 2-6% with a median around 3-4%. This can have a considerable positive impact on their profits.
Longer contracts = less churn
Customers who have been with a company for a while are less likely to leave compared to new customers. Companies that have more customers on annual or longer contracts have lower rates of customer churn and higher lifetime value compared to companies that mainly offer monthly contracts.
Longer contracts result in decreased churn for two main reasons. Firstly, annual contracts provide new customers with fewer opportunities to cancel their subscription and, consequently, fewer chances to churn. Unlike monthly contracts, where there are 12 potential moments for customers to churn out, an annual contract only offers a single opportunity for customers to do so.
Annual contracts can attract higher-value customers who have confidence in your product. When customers sign a longer contract, it shows their commitment to using your product.
Their willingness to make a significant financial investment suggests they are more dedicated to succeeding with your product and less likely to leave shortly after starting.
Older businesses have less churn
Like fine wine, SaaS churn rates tend to improve over time.
Established companies have significantly lower churn rates compared to their younger counterparts.
Companies that are less than three years old experience a wide range of churn rates, from 4% to a staggering 24%. On the other hand, companies that have been around for over 10 years see much lower churn rates, typically falling between 2% and 4%.
As companies mature, they become more adept at identifying and addressing their customers' requirements, leading to increased customer loyalty. Additionally, companies that fail to address high customer turnover are unlikely to survive in the long term.
Funded startups experience higher churn rates
Venture money may seem like a solution to many issues, but churn is not always one of them. Interestingly, companies that receive venture funding actually experience higher churn rates compared to those that are self-funded.
In fact, funded companies typically have churn rates that are 20-30% higher than companies that bootstrap.
Venture funding can give a misleading sense of security. Instead of addressing core problems, it tends to magnify them as the company expands. It's like using a sledgehammer instead of a scalpel. When founders have someone else's money to play with, they are more inclined to spend excessively to solve growth challenges.
Meal delivery services like Blue Apron illustrate a common dilemma. Despite investing heavily in acquiring customers and adding new features, their rate of customer attrition remained alarmingly high, undermining their efforts to sustain growth.
Established SaaS → prioritize maintaining a low, steady churn
For successful SaaS companies and popular products that have found a strong market, it is crucial to keep revenue churn at a minimum.
Referring back to the previous ARPU data, companies with ARPUs of $500 or more should ideally have a churn rate of 2-4%, but no more than 6%.
These findings are supported by our studies on company age, which show that companies over three years old should strive for the same range of churn.
Early-stage SaaS → prioritize improving churn over time
Early-stage SaaS companies in search of product-market fit often experience higher churn rates in the first year, typically ranging from 10-15% per month (reaching as high as 24%).
This is due to the ongoing process of adjusting product marketing and pricing strategies to align with the needs of their target customers.
As your ability to attract and keep ideal customers improves, the rate of acquiring non-ideal customers should decrease gradually. The most reliable comparison for your progress should be your own metrics from the previous week, month, or year.
To effectively manage customer loss, track your churn, and work towards reducing it over time, prioritize keeping your business on the right track as opposed to fixating on your specific churn rate or comparing it to competitors.
What churn metrics should SaaS companies track?
SaaS companies have numerous churn metrics at their disposal. However, not all metrics carry the same weight.
There are four types of churn in SaaS. They include:
Gross churn rate
Net churn rate
SaaS customer churn is the proportion of customers who terminated their subscriptions with your business during a specific timeframe.
Customer churn rate calculation
To determine the customer churn rate of a SaaS, divide the number of lost customers by the initial number of customers and multiply the outcome by 100.
In July, your customer count started at 300 but decreased by 20 by the end of the month. This results in a churn rate of 5% (20 out of 400 customers).
SaaS revenue churn, also known as MRR churn, quantifies the amount of monthly recurring revenue your business loses from current customers within a specific timeframe. This includes customers who downgrade their plans.
Revenue churn rate calculation
To measure this metric, divide the revenue lost from existing customers during a specific time period by the revenue at the beginning of that period.
For instance, if your December downgrades resulted in a loss of $3,000 and your Monthly Recurring Revenue (MRR) is $75,000, your revenue churn is 0.04.
Gross churn rate
The gross MRR churn rate of a SaaS measures the percentage of monthly revenue lost from user contract cancellations. This includes both downgrades and cancellations.
Gross churn rate calculation
The gross churn rate for a month is calculated by dividing the total monthly recurring revenue (MRR) churn by the total MRR at the start of that month, then multiplying the result by 100.
If your monthly recurring revenue (MRR) for November is $120,000 and users cancel contracts worth $15,000, your gross churn rate will be 12.5%.
Net churn rate
The net revenue churn rate of a SaaS shows the percentage of revenue lost from downgrades and cancellations, while also considering the additional revenue generated from existing customers.
Net churn rate calculation
The net churn rate formula measures the change in revenue from lost customers compared to new customers in a specific time period, relative to the total revenue at the beginning of that period.
In the previous example, imagine you begin with a monthly recurring revenue (MRR) of $80,000. Unfortunately, you experience contract losses totaling $8,000. However, there is some positive news: a few customers have upgraded to the premium plan, bringing in an extra $4,000 in revenue.
The net revenue churn is calculated by subtracting the lost revenue from the beginning revenue, then dividing by the total starting revenue. In this case, the calculation is: (8,000-4,000)/80,000 = 0.05. To convert this ratio to a percentage, multiply by 100, resulting in 5%.
Many companies attempt to reduce customer churn using random methods. They indiscriminately apply various tactics that they've heard have been successful for other companies, without a cohesive strategy.
Their approach is primarily based on luck, hoping to win the retention lottery.
Churn is a complex problem with many causes. To tackle churn, it's important to break it down into smaller parts.
1. Encourage annual pricing plans
Annual plans are crucial for reducing SaaS churn. However, according to KBCM reports, almost 20% of SaaS companies still have average contract lengths of less than one year.
It is imperative for SaaS companies to offer annual contracts, as there is no valid reason not to. Increasing the proportion of annual plans in comparison to monthly plans is an effective strategy for reducing churn in SaaS companies.
Effective strategies to incentivize customers to commit to annual contracts:
Highlight your annual plans clearly on your pricing page
Offer your customers a discount of 15-20% on monthly plans upon their first purchase
If your customers go for a monthly plan anyway, set-up email campaigns to try and get them switched to an annual plan.
2. Lower your payment failure rate
Did you know that credit card delinquencies can be a major reason why customers leave? In fact, up to 20-40% of churn can be attributed to credit card failures.
Surprisingly, many companies don't have an effective solution to tackle this issue.
3. Approach churn as multiple mini-projects
SaaS churn should be treated as a series of mini-projects, each requiring its own strategy and tactics. Use the grid below to visualize and address this issue effectively.
The quadrant diagram shows where and why churn is happening in the subscription lifecycle.
To keep subscribers engaged and prevent them from leaving your service, it is important to have a proactive strategy.
Implementing in-app messaging and walkthroughs can greatly enhance user onboarding and encourage adoption of new features.
You need to ensure that the necessary payment methods are set up to effectively process subscription renewals. This includes routing international transactions through local acquirers and intermediaries to prevent them from being flagged as suspicious. Additionally, it is important to maintain consistency in data formatting across different banking systems.
To prevent customers from canceling their subscription, respond promptly by directing them to a webpage that reinforces your value proposition, resolves their specific reasons for canceling, or presents an offer to incentivize them to stay.
To fix payment problems and keep customer’s subscription active, you can to automatically retry failed payments or remind your customers to update their payment information.
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