Should You Focus on Revenue Growth or Churn?
SaaS companies of every size face a common decision: doubling down on revenue growth or focusing on reducing churn. In the early stages, when the decision is even harder to make due to limited resources, reducing churn is almost always the right answer.
This can feel counterproductive. How can the business continue to evolve if growth is not the main priority? What will happen to fundraising efforts? How can the business continue to hire the best people when growth is secondary? These are serious objections and can feel painful in the moment, but that short-term pain will have long-term benefits.
Think about the economics of this early decision. Take two companies as examples: Company 1, which chooses to focus on churn, and Company 2, which goes after growth.
Company 1
- Revenue growth is $100k in new MRR every month
- Revenue retention rate is 90% of new MRR every month (revenue churn is 10%)
Company 2
- Revenue growth is $200k in new MRR every month from its focused growth efforts
- Revenue retention is 60% (revenue churn is 40%)
Double the revenue sounds great for Company 2, but when modeled out over time the higher churn rate becomes a serious problem:
A better way to understand the change happening for each company month over month is a waterfall graph. This graph looks at activity in a given month to see the net effects of new revenue and churned revenue. Zooming in on month 5, here’s how revenue growth looks for each company:
The thing to focus on is the grey churn bar. Company 2 loses over half its new revenue to churn by month 5, whereas Company 1 loses well under half. The difference is shocking, and helps explain why the bars end up switching after month 6 on the first bar chart.
A constant churn percentage against a growing revenue base creates a growing point of friction against the company’s growth over time. It doesn’t get better; it only gets worse.
In fact, the company that prioritizes growth early will end up reducing how much it can spend to acquire a customer later on. Let’s model this out; in order to understand how much a company can spend to acquire a customer, knowing the lifetime value (LTV) is a must. LTV has two components:
- Average Customer Lifetime
Average customer lifetime is calculated as: Lifetime = 1 / Churn Rate. - Value
How much profit does a single customer represent for the business? Let’s hold this constant for both companies as $2k/month*.
Once you have those components, LTV is calculated as: Profit / Churn Rate. Here’s how it stacks out for both companies:
Company 1
Average customer lifetime: 1 / 10% = 10 months
LTV = $2k / 10% = $20,000
Company 1 will see $20,000 in profit from each customer over the course of 10 months on average.
Company 2
Average customer lifetime: 1 / 40% = 2.5 months
LTV = $2k / 40% = $5,000
Company 2 will see $5,000 in profit from each customer over the course of 2.5 months on average.
Wow. Given the same average profit per customer, the benefits of focusing on churn become really clear: Company 1’s customers are 4x more profitable. That means that Company 1 can invest up to 4 times more to acquire each customer than Company 2, and that acquisition investment will continue paying dividends for a longer period of time.
Prioritizing growth over churn can feel like an attractive option in the early stages, but it’s a dangerous choice that will have longstanding implications in the company’s effectiveness as it scales.
* I skipped some calculations to identify profit for simplicity. For a more in-depth view that covers how to accurately calculate LTV based on profit, see this post: http://blog.mediawizardz.com/using-customer-churn-rate-to-calculate-the-lifetime-value-of-your-customers
