By Sarath C P

Sarath CP is a Business Strategy Consultant at Eqvista, a cap table management software that allows companies, investors and company shareholders to track, manage, and make intelligent decisions about their companies’ equity.

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The best way that you can continue to grow your company is by continuing to profit off the existing customers. But churn is the simplest way to lose guaranteed money. The churn rate measures the number of customers you retain and at what cost. Many entrepreneurs undervalue this sales metric. This is a key indicator of the company's overall health. As a business grows, the revenue generated by existing customers becomes a major component of the company valuation. 

As an executive, you need to focus on keeping existing customers equally as you focus on getting new customers. The churn rate should be valued as the revenue and growth of the company. This is so because the cost of obtaining a customer is much higher than retaining an existing customer. The company can have continuous revenue by keeping existing customers happy. In this article, we will learn about the ideal SaaS churn rate, how to calculate it, and why it is important to analyze the churn rate. 

What is the SaaS churn rate?

• What is the ideal SaaS churn rate?

Depending on if you measure revenue or customer, the general acceptable SaaS churn rate ranges from 5 to 7% annually. In the real world, about 70% of the SaaS companies have an annual churn of less than 10%, and about 3/4th of them are at 5% or lower. The other 30% have it worse; these companies do not lack new customers. It is the customers that they can't keep that is ruining their business. 

• Why is calculating the churn rate important for a SaaS business?

Let us take a look at the numbers and why it is vital that companies calculate them. The churn rate has a ripple effect on the business. The average cost of getting a new customer is five times the cost of retaining one. This means that the more existing customers you lose, the more your revenue drops. A high churn rate is bad for business. To reduce the churn rate, they have to play the long game and improve the service little by little, making them add up to a better performance. 

Here are the different types of churn rate that affect your SaaS business. 

#1 Monthly Recurring Revenue (MRR)

If a customer cancels their subscription with your company, it has a direct impact on the MRR. The churn MRR rate determines the percentage of the effect of churn on the company. To calculate it, add the MRR of lost customers over a specific time and divide it by the MRR of the same period. 

#2 Customer Lifetime Value (LTV)

Like we stated above, the cost to gain a new customer is higher than retaining one. Customer LTV calculates the total value of the relationship with your customers over their time with your business. Many new SaaS companies make the same mistake and focus on gaining new customers instead of retaining current ones. But it is wrong to do as a high churn rate will have the company spending more to gain the same number of customers they are losing. It will make more sense if the business deals with the churn rate. 

#3 Customer Acquisition Cost (CAC)

The CAC metric calculates the amount a business will have to spend to gain a customer. The higher the churn, the more the CAC.

#4 Net Negative MRR Churn

Unlike the regular churn of the company, the net negative MRR churn is one metric that companies aspire to. A net negative churn is when the total revenue of a business from existing customers is higher than the revenue they lost to churn. 

In other words, the existing customers in your business are spending ample extra money to counteract the loss from churn. The best way to reach a net negative churn rate is by customers upgrading plans, renewing subscriptions, and upselling your existing customers.  

How to calculate SaaS churn rate?

The formula to calculate the SaaS churn rate is not complex. It is the number of customers lost in a specific period / the number of customers at the beginning of the period. This is the basic formula, but there are many different ways to calculate SaaS churn in practice. To begin with, there is the customer churn rate. Here a customer cancels their subscriptions completely, ending the relationship with the business. 

Then, there is the subscription churn, where the customer downgrades their plans or upgrades them. Other factors also affect churn, such as certain subscriptions may retain more customers than others, a certain type of customers may regularly leave when compared to others, and it can be seasonal. It could change during specific months. Another way to calculate the churn is by taking the average churn rate for a period / average number of customers in the same period. 

How and why should we analyze the SaaS churn rate?

The churn rate affects more of the SaaS company than you think. It shows the satisfaction rate of your customers and if or not your business is providing good value service or product to your customers. Customers who churn can damage the business further by negative reviews and negative word of mouth. If your business does not calculate and analyze the churn, then the company will slowly fail. When a SaaS company prepares a churn analysis, they must look at it from both sides of the customers and the business. 

Here are some analysis methods to assist you in achieving this: 

• By cohort

A good way to start your analysis is by analyzing the churn by cohort. In the reports, the customer base is divided into different segments depending on the period. This method is beneficial as it does not determine numbers influenced by the new acquisition of customers. Also, it makes it easier to detect any pattern in the customer base. Different cohorts can be compared to see any seasonal trend. The drawback of this method is that if there are many cohorts, it may get a little complex. 

• By customer age

In this method, you divide the customers into different groups depending on the length of their relationship with your business. This can help in detecting patterns easily without having to compare different cohorts. You can separate the groups based on months. If customers churn in the first month, then there is a problem with your signing up process. If they churn after twelve months, they are leaving after their annual subscriptions. You will then have to make efforts to retain them by encouraging them to renew the subscriptions.  

• By geography

You can get a more precise picture of the issues leading to churn if you group customers according to the location. The payment gateways, tax regulations, and payment processing are different in every country. If your SaaS company has a wide range of customers from all over the world, then you can detect the issue. You might be losing customers because you lack local payment options or are not complying with regulations. 

• By customer behaviour

Analyzing the churn rate by behaviour can be revealing as well. You will be able to detect the patterns that are related to the features of your service or product. Customers may churn after using a specific feature, and your team should work on improving it. On the other side, there may be features that help you keep customers. The company should then focus on them by enhancing and promoting them. This method shows the level of customer engagement. 

• Voluntary vs involuntary churn rate

There is a difference between a voluntary churn and an involuntary churn. In a voluntary churn, the customer may leave or downgrade their subscription due to bad service, negative experience, or switching to competitors. The company should focus on decreasing voluntary churn. Then there is involuntary churn, which happens due to declined cards, wrong payment information, and poor routing for payment. The customer wanted to stay with you but could not. You can easily fix this by improving the infrastructure of your services. 

• Payment methods

This method analyzes the payment method as it is the major cause of involuntary churn. Many SaaS companies ignore this even though it is the core component. The better the payment portal and options, the easier it will be for customers to subscribe. A good payment acceptance rate is essential. 

How does a negative or low SaaS churn rate increase company value?

SaaS businesses see growth in customer revenue after incurring considerable costs to acquire them. At this point, the business can only succeed by retaining them. It must be calculated and analyzed because if the customer loses more customers than they attain, the number of customers and revenue will fall significantly. 

Let us take an example to understand how the low SaaS churn increases the SaaS company valuation. ABC Ltd and XYZ Ltd have a 10% difference in churn rate. Both companies grow during five years, both of them have the same price, number of customers, and cost of acquisition. ABC Ltd has a churn of 5%, and XYZ Ltd has a churn rate of 15%. ABC Ltd is valued at $57.4 million, and XYZ Ltd is valued at $27.4 million after five years. 

The number of customers acquired per month are 20 and 10 respectively. Over five years, ABC Ltd has lost 60 customers, and XYZ has lost 120. The run rates are $12.3m and $9 m, respectively. ABC limited invested more into retaining customers and have a longer customer lifetime value. They also brought in more customers as they have more revenue over time, resulting in accelerated growth. 

Ready to Reduce your Churn to Boost your valuation? 

SaaS churn rate is vital to calculate and analyze. Entrepreneurs should start considering it as it has an impact on the growth and value of the business. If you have a major SaaS business, you have to keep your churn between 5 and 6% yearly. If a company has a high churn rate, it will incur losses—the lower the churn rate, the better. 

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