If we look back to our MRR Movements chart from the previous lesson, you’ll see that there are two ways in which your SaaS revenue can shrink: either through customer downgrades (contraction) or churn:
In SaaS, there are two form of churn, both of which are useful to analyze in certain scenarios. Measuring churn is all about measuring lost business, either through the loss of customers (logos) or the loss of revenue.
Customer Churn Rate
The rate at which your customers are cancelling their subscriptions.
Net MRR Churn Rate
The rate at which you are losing MRR through downgrades and cancellations, offset by account expansions.
So the two measurements above help us measure the loss of revenue in our business in two different ways. One important thing to remember: churn is always measured across a specific time period. If someone tells you their churn rate, think about what period they could be referencing — it could be the current calendar month, a 30-day rolling window, the previous quarter or even across the company’s lifetime. Churn rate is always an average across a given period.
Is my churn rate too high?
Every subscription business has churn — it’s unavoidable. There’s also no common “acceptable” level of churn as it depends on the characteristics of your business.
The Pacific Crest annual SaaS survey showed that around 70% of SaaS companies had annual customer churn <10%, of which 75% were <5%.
When looking at annual churn in SaaS, keeping under 5% is a reasonable goal. Don’t confuse this with monthly churn though! 5% annually equates to less than 1% monthly customer churn rate.
Churn rate will start to have an outsized effect on your revenue as you grow. It’s always better to tackle it before it becomes a huge problem.
Let’s listen to Freshworks on this one:
“Companies put people on to a customer when they begin to show signs of leaving. A sensible approach to staying in control, is to engage and help customers find value from the very beginning. Adopt a proactive method towards building a trustful business relationship from the start and at various touch points throughout the customer lifecycle. This presents opportunities to iron out churn indications as they emerge, rather than having to firefight and being reactive.”
Arun Mani, Freshworks
So in other words, avoid being reactive to churn before it’s too late.
Different types of churn
It’s useful to categorize churn in order to better understand what’s driving your customers to leave. In SaaS we use this common high-level categorization:
- Proactive churn: The customer actively chose to cancel their subscription.
- Passive churn: The customer didn’t update their credit card details or their account lapsed in some way.
- Happy churn: The customer cancelled, but with a positive experience, receiving full value from your product.
- Churn that isn’t really churn: In the case of money-back guarantees or refunds, it’s useful to split out these customers who are not really representative of the above categories.
While churn is definitely a bad thing, negative churn is actually the opposite! Every SaaS company should have a goal of achieving negative churn in their lifetime — the impact can be the difference between steady decline and hypergrowth.
“Combined with annual prepay contracts, negative churn is a very powerful growth mechanism. When thinking through your pricing model and your customer success strategy, it’s worth trying to engineer negative churn into your startup.”
Simply put, a company has negative churn when the revenue added from up-sells and expansion exceeds that of the revenue lost from churn and downgrades. Or in other words, your net MRR churn rate is a negative value.
Why is this so powerful? Well, just as churn compounds and becomes a bigger issue as the company grows, negative churn exhibits the same characteristics. If you manage to engineer negative churn into your product (through strong expansion and retention), the impact of this will become more significant as the company scales.
Churn with annual contracts
Our friends at Freshworks outlined a very important consideration related to annual contracts in SaaS:
“A second mistake businesses make to churn is to push for annual contracts. It gives a fallacious feeling of predictability and security. Definitely the finance department cheers for it, but it is not necessarily good for sales. A unhappy customer will in best case wait the contract out and leave when he finally is free to, meanwhile bad mouthing about your company and product. In worst case scenario, he’s going to fight against the contract in court.”
Arun Mani, Freshworks
Annual vs. monthly subscriptions is an important decisions you’ll need to make when pricing your product. Annual can make sense for more enterprise-focused businesses, but the point to highlight here is that it’s not a remedy for a high churn rate.
Monthly subscriptions can seem scary because the customer has the opportunity to cancel each month. But annual contracts can just mask this, leading to a bigger problem with a lot of negative sentiment.
Resources and Further Reading
The Ultimate SaaS Churn Cheat Sheet (ChartMogul) — Our comprehensive cheat sheet on measuring churn. Works great as a reference or jumping off point for deeper analysis.
Actionable SaaS Metrics: Customer Churn Rate (ChartMogul) — The Actionable SaaS Metrics series goes beyond measuring and calculating. It takes a deeper look at some characteristics of common subscription metrics, with the goal of identifying key actionable steps to optimize them for your business.
To predict churn is to prevent it — here’s how (ChartMogul) — If you don’t pay close attention to your customers’ behavior, you could lose them. They could slip right through your fingers. Avoid the pain of churn by watching for these red flags and acting on them fast.
Net vs. Gross Revenue Churn: Best Practices (ChartMogul) — If you’re trying to understand your churn and reduce it, then focusing too hard on net revenue churn could be a little dangerous. Net churn merges together two somewhat unrelated metrics: lost revenue from (probably unhappy) cancelling customers and gained revenue from (probably happy) customers upgrading.
SaaS Q&A: How do you deal with Happy Churn? (ChartMogul) — Happy Churn: The good kind of churn? The name would suggest so, but the reality is that Happy Churn can cause significant issues when it comes to growing your SaaS business. Consider it a red flag for some bigger underlying problems.
Unlocking the Path to Negative Churn (David Skok) — David clearly illustrates with churn is so critical for SaaS businesses to get a hold on, and the potentially huge positive impact of negative churn.
Why Negative Churn is Such a Powerful Growth Mechanism (Tomasz Tunguz) — What happens to a company’s growth when they have 5% positive churn vs. 5% negative churn?