Is Churn Always Bad?
Would You Invest in a business with 33% Monthly Churn?
In my previous posts about the importance of LTV:CAC, the one metric I haven’t yet mentioned explicitly is churn. Churn is inherently baked into the LTV:CAC ratio since LTV is equal to the average expected monthly (or annual) contribution dollars divided by the monthly (or annual) churn. So is high churn a bad thing?
Everyone in the SaaS business fears churn and it shouldn’t be ignored because it is the denominator in the LTV calculation so, the higher the churn, the lower the LTV, all other things being equal. However, consider the extreme example of a business that has a LTV:CAC ratio of 3x but only a 3 month average customer lifetime. That means monthly churn is equal to 1/3, or a whopping 33% per month! The good news is that CAC is equal to only one month worth of contribution margin so if you get the customer to pay one month in advance then you’ve already covered customer acquisition costs.
In such a theoretical scenario, any investment in CAC is returned immediately and quickly produces a self-funding annuity equal to 2x CAC.
Chart 1: Cash Flow Scenarios for this Business with 33% Churn
In other words, the more you put in, the more you get out and you very quickly get to the stage where it is self funding and you are just cashing checks. Yes, such a business likely would attract competition, the LTV would decline, the CAC would increase, and the LTV:CAC ratio would decline. The example is extreme to prove a point: once I have product market fit and a repeatable sales model it is all about the ROI on my CAC and even high churn can be overcome.
In the extreme example above, or any other example, if I could pour gasoline on the fire and still keep a 3x LTV:CAC ratio then I’d be a fool not to: instant return of capital, very short duration and high return. Sign me up!
Obviously, in real life we usually can’t jump from spending $1 million on CAC and generating a 3x LTV to sending spending $10 million on CAC the very next month and expect the same 3x ratio to hold: our sales infrastructure would be overwhelmed and our sales reps would spend all their hours in interviews and zero hours selling. However, if we can, for example, double CAC every year and maintain an attractive LTV:CAC and a short payback period then we should do exactly that, or more, while it’s working.