Churn Is The Enemy

(Originally published on December 9, 2014)

Churn is one of those business concepts that isn’t on many first time SaaS founders’ radars. I know it wasn’t on mine. It’s sort of like the concept of cash flow for first time founders of retail or manufacturing businesses. You don’t think much about it until it bites you.

The 2 Types of Churn

When I refer to a “churn” rate for my startup, MoonClerk, I’m referring to two types of attrition:

Customer Churn — Customer Churn is the percentage or number of paying customers I lose every month that signed up in a previous month (if someone signs up and cancels in the same month, I don’t count those at all.)

Revenue Churn — Revenue Churn is the increase or decrease in the revenue from my customers who have signed up in previous months. Revenue Churn doesn’t take into account any revenue I received from a brand new customer. It’s the same concept that retail chains have for “same-store sales.” If my Revenue Churn is a positive percentage, it means I’m getting more revenue per existing customer — not just more revenue globally. If I have a negative percentage, it means my customers aren’t bringing in as much money on a per-customer basis as they were previously. If my total revenue is growing but my Revenue Churn is a negative percentage, it means my growth is coming entirely from new customers I sign up. That probably isn’t sustainable.

How Churn Affects a SaaS Business

Churn makes it necessary for a SaaS business to either:

a) Constantly increase the rate at which it acquires new paying customers

b) Constantly increase the revenue it receives from its existing customer

If the business doesn’t do one of those two things, it will plateau or even decline.

For example, a while back when MoonClerk was picking up 3 new paying customers a day (for, let’s say a total of 90 in a month), I thought, “If I can get to where we pick up 6 new paying customers a day, I’ll be killing it every month! That’s 180 new customs in one month.” At the time I had a total of around 350 customers. My Customer Churn rate was something like 6.7%. So, I was losing 23 customers a month. That means, I grew by 67 customers a month. I consider myself to be at least of average intelligence but for some reason I didn’t look down the road. What I didn’t think about was what my Customer Churn would look like by the time I got to the point where I was adding 180 customers a month.

Now that I am actually picking up 180 new customers per month, I have around 1,300 paying customers. My churn rate stayed about the same. But, 6.7% of 1,300 is 87. So, while my acquisition rate has increased and my churn rate has stayed the same, in any given month, I may only pick up 83 customers in a month. Even though my customer acquisition rate doubled, I’m only adding 23% more customers per month than when I was a much smaller company.

Sometimes I’ll get all excited because I’m picking up a lot of new customers but then I’ll see the cancelations and be brought back to reality. I don’t hear a lot of SaaS founders talking about hitting equilibrium or declining but you can see how that can happened more easily than what you’d think as you grow. It puts on a lot of pressure to not just increase the number of new paying customers you pick up every month but to increase at even faster rate every month.

Using Churn to Determine Lifetime Customer Value (LCV)

One advantage of knowing your Customer Churn rate is that it helps you determine your Lifetime Customer Value (LCV), which then allows you to make better financial decisions for your business. I watched a great presentation by Gail Goodman, founder of Constant Contact. In that presentation, she talks about how to use churn to determine your Lifetime Customer Value. She says, ““How do I know my lifetime customer value?” It’s one over your retention rate. It’s that simple. So, our average monthly retention is 2.2% a month, so one over 2.2% equals 45 months…. Average revenue per user times retention gives you your lifetime revenue.”

I’ve used this formula since MoonClerk started and while it’s been helpful, I will caution that it has some drawbacks.

1) In the early days of a startup, the Customer Churn rate can vary wildly early on because there aren’t many customers and because the business is changing so quickly.

2) This formula doesn’t take into account Revenue Churn. It only takes into account Customer Churn. I’ll discuss more about that below.

3) This formula assumes all customers have the same value. As you’ll see below, that’s not always the case.

MoonClerk’s Churn Analysis

Churn isn’t necessarily an absolute. Just because one business has 5% churn and another has 10% churn doesn’t mean that the one with 5% is doing twice as well at customer retention. Let’s explore MoonClerk’s churn.

In any given month, when you look at the customers who cancel their accounts with MoonClerk, here’s what the breakdown looks like regarding how long they had been with us:

• Customers who cancel their accounts have been with MoonClerk an average of 3.5 months. That’s much, much lower than our average customer.
• Of the customers who cancel, 28% have only been with us for 1 month and 13% have only been with us for 2 months. So 41% have been with us for just 2 months. If you take these accounts out of the equation, our churn rate is only 4%, not 6.7%.

Here’s how these accounts were canceled:

• 43% were because the cards failed and the customers never updated their billing information
• 57% canceled their account manually

And of the customers who canceled manually, here’s why they canceled:

• 70% just didn’t need it anymore. There are a number of reasons — their business shut down, their fundraising timeline ended, their event was over, etc.)
• 5% said it was too expensive
• 25% went with a competitor and/or didn’t use us because we lacked a feature they needed.

Some observations:

• 43% is pretty high for failed cards but we have a good dunning system in place so it’s not like we’re not doing our best to prevent failed payments. One of the reasons this number is high is that we’re a payments company. We do get some fraudulent accounts — people trying to run stolen cards through our system. We do have safeguards in place but these accounts do get through. Usually they are using a stolen card to pay for MoonClerk’s monthly fee, so it makes sense that those cards would fail after their first month.
• 40% of cancelations come from businesses that don’t need us anymore (70% of 57%.) We can’t really do too much for the businesses that shut their accounts because they don’t need it anymore.
• We can’t (or don’t want) to do much for businesses that think we’re too expensive. We’ve made a conscious decision to not be a “freemium” service and we start at $9/month, which seems pretty reasonable. These cancelations only make up 2.85% of our total cancelations anyway.
• Only 14% of our total cancelations could be considered “preventable” — ones where we didn’t have features or they liked our competition better. (25% of 57%)
• The odds are, even by adding features, we probably couldn’t retain all of the 14% of customers who canceled. We’re always going to have some customers who go with the competition or just don’t like our service because of whatever reason. Let’s say, we could retain half. That means, we really only have control over 7% of our churn.

Of our customers who canceled, on average their monthly revenue was 25% lower than our total average monthly revenue per customer. So, given that those who cancel bring us 25% less in monthly revenue than average and they have only been with us for 3.5 months on average, they really aren’t high Lifetime Customer Value customers. If our churn were made up mostly of customers who had been with us for a long time and who bring in much higher revenue than our average revenue per customer, I’d be more worried. While we do lose high value customers, it’s few and far between.

I can make a reasonable assumption that as we add new features, we may pick up new customers or new target markets but we probably won’t reduce our Customer Churn rate that much. And even if we do, it’s probably not going to make a huge impact on our revenue.

I can’t think of many ways to reduce our Customer Churn rate. I don’t really know how to get more of our late-paying/non-paying customers to pay their invoices — our dunning process is pretty comprehensive. And, we can’t control whether our customers go out of business or have some other uncontrollable external reason for not using us due to their business. The only effort I can think of to make would be to help our customers become better business people in general. That’s really unfocused. My business isn’t about providing general business advice. There’s a ton of resources out there for that. It would also be too time and resource consuming. My customers aren’t in one niche or vertical market that I can address.

The positive is that we aren’t losing a ridiculous amount of revenue due to our churn rate and we aren’t losing a high percentage of our customers to competitors.

So, How Do We Defeat Churn?

Given that I don’t have much control over reducing my Customer Churn rate, how do I fight churn? Well, I have to focus on Revenue Churn rate. I’ve been keeping track of our Revenue Churn rate, and fortunately, on average it’s been positive each month. That means my existing customers are bringing in more revenue per month than in previous months.

What are some ways I can improve our Revenue Churn rate?

• I can make sure we add new features that will allow us to attract the types of customers who can move up the revenue chain. As our customers’ revenue increases, so does ours. In the beginning we only had a limited feature set that could only attract small businesses. Now that we’ve matured, we’ve actually become a company that medium-sized businesses can use. The more businesses we have that are larger, the better our average revenue per customer will be.
• I can make sure we add new features that will allow us to retain our high value customers. If we lose customers because they outgrow us, that causes a big hit to our Revenue Churn Rate. As we mature, we’re adding features that bring value to these higher volume customers so we don’t lose them.
• I can control our pricing. Changing my pricing deserves its own blog post. While I can’t continually raise prices in order to create positive Revenue Churn, I do have the option to raise prices for some or all customers in order to create an even more sustainable business long term. My Revenue Churn would improve in the short term with a price increase but it’s also important to look at the long-term effects of price changes.

I’m sure that, like MoonClerk, other SaaS businesses have their own unique causes for churn. Maybe they need to focus on improving their product to reduce Customer Churn. Or maybe they need to change their pricing model in order to have a chance at creating a positive Revenue Churn. I’m not the best at giving de-facto advice to startups because every business is different and every founder knows his or her business better than I ever will. But, what I do know is that churn is the enemy. And I never want to turn my back on the enemy.

Originally published at blog.doddcaldwell.com.