User churn is defined as the number of users that leave your product/service on a monthly or annual basis. It is normally expressed as a percentage against your total user base.
High churn will destroy your business, there’s no way around it. Churn kills startups. As such, it is one of the most important metrics that venture capitalists analyse before committing to an investment.
A business with 100 customers and a 5% monthly churn rate (assuming no user growth) will end the year with just 54 users. This means that for a startup to show any positive annual user growth, they must first acquire replacements for the 46 customers who have churned during the year, and that’s just to get to 0% user growth.
As you can see, this becomes extremely expensive and highly unsustainable for startups that are under pressure to grow users at high double if not triple figures annually.
Bessemer Venture Partners (one of the worlds leading venture capital funds) have publicly stated that a 5-7% annual churn rate is deemed an acceptable rate for startups they look to invest in.
However, just measuring the number of users churning can create an overly simplified view of your underlying business performance. For many startups, it can be more useful to consider your monthly revenue churn.
This works best for startups with a large customer base and a consolidated pricing strategy.
Annual revenue churn is calculated as:
100% – Lost ACV/(Lost ACV + Total Renewed ACV)
Where ACV stands for average contract value.
In plain English, your annual revenue churn rate is calculated by subtracting your customer churn from 100%. Your attrition rate is equivalent to the Annual Contract Value (ACV) from lost customers, divided by the total ACV from all customers that renewed during the same time.
Here are some industry benchmarks that I can share with you:
A SaaS survey that questioned X SaaS companies found the average monthly churn figure to be 3%.
Negative revenue churn
You are probably used to hearing about user churn being a negative factor hampering your growth targets. But, there is a rather rare phenomenon called negative revenue churn. Negative revenue churn occurs when growth in revenue from your existing customers exceeds the lost revenue from customers who have churned.
Now that might seem a bit strange, so let’s look at an example.
Consider a startup that provides business credit cards to small expanding business. Over the course of the year, you can assume that these customers will grow. When this customer growth is paired with a dynamic pricing strategy such as charging a set fee per employee, the revenue from existing customers might grow by 20-100% in a year.
If this growth in revenue exceeds the lost revenue from customers who have churned, you have unlocked negative revenue churn. That is quite an achievement as you don’t need to invest a single pound acquiring new customers in order to grow your revenues next year. Once you begin marketing your product you essentially pour fuel onto the fire of growth and enable you to expand rapidly.
You can set targets for your sales team to hit negative revenue churn.
For example, if you have an annual churn rate of 5% and all your customers are on the same payment program. Charging your non-churned customers an extra 10% will mostly offset the lost revenue. 95% +10% revenue growth will leave you with 104.5% revenue over last year. Then you account for the 5% annual churn and your left at 99.5% of last year’s revenue.
If you aren’t able to increase your average contract value, due to high customer price sensitivity. There are other ways to increase revenues from existing customer like through cross selling. Find out what additional product features your customer loyal customers desire and dedicate resources to building out these features.
New Relic is a cloud software provider listed on the NASDAQ achieved a negative revenue churn rate of 14%!
Revenue churn is not an appropriate metric for all start-ups to aim for. Startups that have a power law distribution, where 80% of their revenue comes from just 20% of their customers, the average contract value can be heavily influenced by just one of two major clients.
In this scenario, it would make sense to look at revenue churn in combination with user churn to assess the underlying health of a business. I’d also suggest implementing dedicated relationship managers for the high contract value clients to ensure they feel valued and are given top priority when problems arise.
Why user retention is important
Research has found that the cost to acquire a new customer can be 5x more than the cost of retaining an existing user.
The higher your user churn rate, the less predictable your future revenues to an investor. As such, you represent a riskier investment than companies with a lower user churn rate.
Investors tend to charge a premium to be enticed into taking on more risk. As such, improving your churn metrics, should enable you to achieve a higher valuation, retain more equity and capture more value in the event of an exit.
Companies with low churn rates are also able to unlock favourable alternative sources of capital to venture capital such as venture debt. This is more attractive to founders, as debt is less expensive than equity.
Maximum viable churn rate
The maximum viable churn rate is the churn rate that enables a company to grow as fast as it can whilst simultaneously optimising it’s valuation for the next funding round. Let’s just unpack that one quickly, as there’s a lot going on.
The more you spend on marketing, the less targeted your adverts will become. This will result in naturally higher churn rates, as you inevitably convert customers who aren’t in your core target market and might use your product or service for only a couple of months.
The more ‘wasteful’ your marketing becomes, the more of these customers you will attract. This will look great in your metrics for new users, but underlying this growth will be an increasing churn rate.
As we touched on earlier, letting your churn rate get to even 5% monthly becomes extremely expensive in the long run. Especially if your customers are churning before you recover their customer acquisition cost.
Now with average funding cycles occurring every 12-24 months, speak to your existing investors and potential future investors to establish how many customers you will need by X date to be an attractive investment for them.
If you have 100k users now, and need 1m users at your next funding round, work back from your current capital. Let me walk you through a simple example to illustrate this.
The goal is to have 1 million customers in 12 months’ time. You currently have 100k users. With 0% churn, you only need to acquire 900k additional users at a CAC of £0.22
With a 3% monthly churn rate you actually need to acquire 1.2 million new customers. Let me show you how this works.
When you factor in a 3% monthly churn rate of new users and assume you spend the £200k linearly across 12 months i.e. £16.7k per month. Every month, you lose 3% of your existing customers.
If you had not factored in a 3% monthly churn rate, you would end the year with 930 customers.
To get to 1 million customers the highest CAC you can actually afford is £0.16.
Be aware that this overly simplified model assumes no revenue from your customers. If you monetised customers within this 12 month period, you could feed this income back onto your marketing budget in the 12 months.
Quick lost cost churn solutions
You need to do some analysis on your customer churn. I’d suggest that you try to answer the followingg questions:
- What kind of churn is happening?
- Which customers churn the fastest? Is it a specific demographic or geography?
- What are the most common reasons for churn?
- What users are using your product the most?
- Optimise your pricing strategy
Let’s dive a bit deeper into these questions.
1) What type of churn is happening?
We can split churn into two distinct categories, voluntary or involuntary churn. Voluntary churn occurs when customers who cancel your product intentionally. Conversely involuntary churn occurs when customers leave your product/service involuntarily. This occurs when for example a customer credit card has expired before your next payment cycle, and you are no longer able to charge said customer.
This involuntary churn is easier to fix than voluntary churn. There are multiple third party providers that provide software that prompts your customers ahead of time that their payment information is close to expiring and they need to update their details. Some banks and fintech’s do this automatically.
Voluntary churn is harder to address, and likely to be represent a significantly larger proportion of your overall customer churn. Reasons for voluntary churn are nearly endless, with some of the most common reasons including: poor user onboarding, poor customer service, poor value messaging, strong competition and wasteful marketing.
You can normally take a few steps to try and prevent a customer leaving entirely. A possible solution might be allowing a customer to ‘downgrade’ their package. Perhaps they no longer require the extra features of capacity unlocked with a premium subscription and now find your product too expensive. Allowing these customers to downsize and reduce your cost burden to them might be enough to retain the customer.
The CEO of ZenMaid spoke about his success implementing this strategy. Customers looking to cancel their subscription with Zenmaid are offered a discount of 75% off their next 3 months of use as an incentive not to cancel. In month 4, the price to these customers is put back up to 100% and this strategy results in 40% of customers who accept the discount staying with Zenmaid beyond month 4.
If downgrading is still enough to retain a customer, you might want to allow them to pause their paid subscription and become a freemium user until the customer reaches a point where it makes sense again for them to begin paying for your premium services.
Lastly you might be tempted to employ some social engineering to prevent a customer deleting an account entirely. ‘Would you like to delete al of you data?’ might make a customer rethink whether or not they want to make a permanent decisions. If they keep their account open with you, there is an opportunity to reengage with them in the future and try to get them back online.
The best companies analyse are able to identify strong predictors of voluntary churn. This might include an increase in visits a customer makes to their accounts payment’s portal or low usage of your core features. Such activity might indicate that they are unhappy with their current payment structure or usage and consequently are at high risk of churn.
If you have enough resources, this might be the perfect time for your customer success team to conduct customer outreach and learn why a customer might be at high risk of churn. Is there something you can do proactively to keep the client? This can range from educating them over a high value add service that the customer misunderstood/missed entirely to allowing them to downgrade.
2) What customers are churning the fastest?
Remember, not all churn is bad. Voluntary churn of bad fit consumers is actually a good thing. These are customers who are not long-term users of your product/service, but were convinced enough by your marketing to sign up to a premium account.
If this represents a large proportion of your customer churn it is an indicator that you have a wasteful marketing campaign. It would be worthwhile refining who you are targeting to optimise your expenditure into attracting well suited long-term product users.
You might be able to extract useful data even if this is a small proportion of your customer churn. Try to optimise your marketing campaigns to minimise attracting similar profiles to these high churn customers, or lower your CAC appetite for these groups to ensure profitable user acquisitions.
When Twitch launched, it notice quite a lot of ‘bad fit’ customers using its streaming service to stream movies illegally online. It wouldn’t have made sense for the twitch founders to build more functionality for these users specifically, as the long term success of an illegal streaming service is limited at best. Rather, the team discovered that people who were streaming their online gaming actually had remarkably high viewer watch times and this indicated good product market fit for Twitch.
Listen to Michael Seibel (Twitch Co-Founder and Y-Combinator Managing Director) describe this:
Another tactic that might help you reduce large churn customer segments is to align your sales commission with customer retention. You should test different incentives to find out what works for your team, but clawing back all commission of customers that churn within 2 months is a good start. It is good to incentives as well as, and offering a commission bonus once a customer reaches a 6 month of paid use might be a good milestone to do this, or perhaps when they renew an annual contract.
3) What are your most common reasons for churn?
You need to be strategic about when you ask churning customers for feedback. It pains hurts me to see how many companies ask a customer to give a reason for leaving during the actual process.
Just put yourself in the customers shoes, when have you ever left good feedback for a company when you are actively trying to leave? No one does it. You will only frustrate them more. Most leaving customers will simply click the first option in your dropdown menu, they are racing to leave with as few clicks as possible.
Asking for customer feedback at the wrong time can be dangerous, as it creates unhelpful even misleading data around your reasons for churn. I think it is best to let customers leave before asking for feedback. Once the customer has left, wait 24h/3 days to reach out to them.
To get good responses you need to create an outreach email/campaign that connects with your user. This could be in the form of a video from your founder saying that they are sorry to see you go, but to help the business please could they spend 2 minutes giving feedback in this form, oh and by the way filling it out automatically enters you into a raffle to win a £50 amazon voucher that is given out weekly. Perhaps you could even give an example of feedback that was given that the company has acted on since that had good results.
Storing the reasons for customer churns will enable you to target certain customers when/if you solve the reason they churned.
I really like this framework by Clientsuceess that shows how a founder can analyse the different types of user churn.
Need No Ownership is a result of wasteful marketing that attracts bad fit customers.
State Of The Business aka unavoidable and unexpected, a good example of this is a restaurant loyalty business during the covid lockdowns. It was external factors out of your control.
Product competition an example for this was the impact to Netflix subscriptions when Disney launched Disney+. In Dec 2019, equity researchers estimated that Netflix was losing 1m+ subscribers a month to their new rival; Disney+.
Poor experience/price now this is where you can make a real difference. A good user onboarding strategy is fundamental to this. It’s very difficult to onboard customers well, you need to strike a balance between training your new users and being succinct. It’s incredible how many companies fail to show customers where they can go to self-serve their problems.
A good piece of advice for user onboarding is to always show your new users the most popular features. Get users to engage with your tools and actually using your product to demonstrate the ‘ah-ha’ moment.
This ‘ah-ha’ moment is actually a well know goal when it comes to user onboarding. It occurs when users discover why your product is a good solution to their problem or the point at which the probability of early user churn is significantly lowered.
Facebook discovered their ‘ah-ha’ moments occurred once a user had connected to 7 close friends within 10 days. For Twitter this was higher at 30 accounts. These discoveries should be quickly incorporated into your onboarding process where you make it as easy as possible for users to find value in your service.
Some startups ask new users straight away what their goals are for using their product. They do this to customise the user onboarding to individual preferences.
When I downloaded the Speechify app (an app that allows you to turn articles/any words into audio and play it at very fast speeds) I was quizzed on the top reasons why I wanted to use the product. My answers influenced what features I was shown in the onboarding process.
Bonjoro is a customer engagement business and their head of growth Casey Hill said that incorporating a personalised welcome video and regular customer check-ins every month helped to decrease overall annual churn by 20%.
4) What users are using your product the most?
I love this solution, as when done well it will be very profitable. Lots of companies fail to identify their stickiest users. It is this very customer group that should be the main focus of your marketing campaigns, as they have the highest need for your product and hopefully the means to pay for it. Model these customers and go and find more of them.
What is the CAC you can afford for customers that fit this profile vs your average user? Could you increase the budget to some specific marketing campaigns to attract more of them?
The role of your product team should be to iterate on product improvements that enhance the experience of these core users. A scaleable way to do this might be to send out a feedback form to the group of your most active users. This can be done in the form of emails or a prompt when the users next log in to their account. It is a good time to thank the users and share with them that they are one of your most valued users. I’ve seen some companies try to delight their customers at this point and give users a high priority customer helpline/email address. This can be done at no cost and makes your users feel very valued.
Find out what they do and don’t like and iterate improvements based on their feedback.
How can you increase your product stickiness to these and then all customers? A booking system provider for example might include the real value in additional bookings any particular restaurant generated whilst on your system vs their old phone bookings.
Are there specific user milestones that you can engage and reward loyal customers? X many days in a row logged in. X amount of additional revenue generated. All of these are easy to code and highly scalable.
5) Moving away from monthly subscription can sometimes be successful at reducing churn.
Annual plans minimise the number of times a year a customer asks themselves whether or not your product is worth paying for. If you see the average customer churning after 4 months, moving to an annual contract charging customers what they would have paid had they used your product for 6 months of use might buy your startup some runway. Now the point of sale is a natural churn point for all businesses. It can be useful for you to create a probability tree that clearly illustrates the probability of customer churn at each touchpoint/decision they make. This is an example of such a probability tree for a mobile phone contract provider:
Drawing out the customer journey with churn probabilities mapped on top of them should help you identify holes in your systems. Modify this diagram to show how monthly contracts have a higher churn rate. And paperless billing monthly to have the highest as this demographic are young consumers with large income swings. Paper billing customers are older and less likely to churn as they are less price sensitive and less likely to shop around online for better deals.
How much should you spend on addressing churn?
Beyond the quick low cost tips outlined above, it might be worth you investing in a customer success team to try and further minimise your user churn. Before doing this though, you should get a rough idea of the ROI you expect from this team.
To calculate your anticipated ROI of a customer success team:
– Calculate how much monthly revenue you lose to churn.
– Estimate/test what % of your users can be saved from churning with active outreach from a customer success member.
– Measure how long these ‘saved’ users continue using your product for.
With this data, the value created by your customer success team is the additional monthly revenue generated beyond where a customer would have previously churned for good.
Let’s work through an example:
Say you are a B2B SAAS company charging £99/month. You have a monthly churn rate of 5%, customers stay with you for an additional 4 months after being reached out to by a customer success team member, the customer success team can rescue 20% of your churning users.
In this scenario, lets say a churning user is a customer who has not logged into their account for a month. The reason for this is that the user has not correctly completed the onboarding tutorials and has struggled to find value from your product.
If you start the year with 1,000 customers, you lose 460 users over the year, or 38 users a month.
This is worth 38*£99= £3.7k per month in churned revenue.
With your new customer success team, 20% of these churning users can be saved, i.e. 38*20% = 8 users a month.
Now, these 8 users, stay for an average of 4 additional months, so their total revenue contribution is 8*£99*4= £3.2k
Therefore, you as a founder should be comfortable spending up to £2.5k a month on your customer success team i.e. one full-time member. You can then get creative with a bonus structure that incorporates their conversion rates and the time a ‘saved’ customer stays a paying user. Perhaps another outreach to ‘saved’ users in month 3 would be a good idea in this scenario?