Did you know that it costs a business $243 to lose a customer?
Unfortunately, one of the first things you'll learn as a business owner is that customers come and go for many reasons. It may not matter that your products are great or that your customer service is extremely empathetic and professional; customers simply make choices based on their (constantly evolving) preferences and needs.
Now, it's not a question of trying to please everyone that gets in contact with your business (because you can't) but rather, knowing how to measure your efficacy at satisfying your ideal customer profile at scale. It’s a matter of critical measurement; knowing which metrics to use at what time, such as when you want to watch churn rate vs retention rate, and which ratios are influenced by each.
In this article, I’ll explain the significance of these important metrics specifically for CFOs of tech and SaaS companies, and delve into instances where you will need these KPIs to optimize your company's financial performance.
Churn Rate vs Retention Rate: How to Calculate Them
Churn and retention rates are inverse measurements that generally describe the loyalty of your customers. The churn (or attrition) rate shows the percentage of customers that your brand loses over a given period while the retention rate measures the percentage of active customers that stays loyal to a business over some time frame.
Necessary Components for Your Calculations
Before you’re able to calculate accurate ratios, you need to track and gather key data from your business. Specifically, you’ll want to know:
- The number of customers you had at the beginning of a given period (typically a month, quarter, or year)
- The number of new customers you gained or onboarded during that period of time
- The number of customers you lost during that period of time
With this information in hand, you can plug it into a simple formula to determine your churn rate.
Customer Churn Rate Calculation
Churn rate is found by subtracting customers paying you at the end of a period (CE) from customers paying you at the start of a period (CS), divided by CS, multiplied by 100. It’s important to note that you’re only including paying customers from the initial cohort in your calculations. If you gain net new customers over the given period, they are not included in this equation.
In mathematical notation, we have:
Churn rate = [(CS – CE) ÷ CS] x 100%
So, let's say a subscription-based software company had 1,000 customers at the beginning of the month (CS). However, by the end of the month, they only had 900 customers (CE).
Applying the churn rate formula, we have:
Churn rate = [(CS – CE) ÷ CS] x 100%
Churn rate = [(1000 – 900) ÷ 1000] x 100%
Churn rate = 10%
The above result means that the churn rate is calculated to be 10%, indicating that 10% of customers “churned”, ie canceled their subscriptions during the month.
Or we can define churn rate in a much simpler fashion:
Churn Rate = (Number of Customers Lost ÷ Number of Total Customers) x 100
So, if you had 1,000 customers at the start of the year, but lost 200 existing customers, your annual churn rate would be:
(200 Lost Customers ÷ 1000 Total Customers) x 100 = 20%
A low churn rate tells you that more of your customers are sticking around. A good target for SaaS businesses is 5% or less per month. If you have a high churn rate, say above 7% per month, you'll have a hard time expanding your customer base, even if you're acquiring new customers at a steady rate. The customers you gain will just replace the ones you're losing.
It's important to note that customer churn is quite distinct from revenue churn. Unlike the former, revenue churn also known as monthly recurring revenue (MRR) churn focuses on the financial impact of customer attrition by calculating the percentage of recurring revenue lost by a company due to customer cancellations, non-renewals, and account downgrades in a given period.
Customer Retention Rate Calculation
The retention rate is calculated by subtracting the number of new customers from the total number of customers, divided by the existing number of customers, multiplied by 100.
The formula looks like this:
Retention Rate = [(CE - CA) ÷ CS)] x 100%
CE = Number of customers at the end of the period
CA = Number of new customers added during the period
CS = Number of customers at the start of the period
Let's consider a gaming app that had 50,000 active users at the beginning of a quarter (CS). During the quarter, they attracted 8,000 new users (CA)and ended the quarter with 56,000 active users (CE).
Applying the retention rate formula, we have:
Retention Rate = [(CE - CA) ÷ CS)] x 100%
= [(56,000 - 8,000) ÷ 50,000] x 100% = 96%
This implies that the gaming app was able to retain 96% of its active users throughout the quarter - pretty dang good.
Industry Benchmarks for Churn Rate & Retention Rate
As a growing tech company, knowing how your churn rate and retention rate stack up against industry standards is important. According to multiple studies of SaaS and tech companies:
The average monthly churn rate is between 5-7% for most tech companies. Anything over 10% monthly is typically seen as too high and a sign of underlying issues with your product, customer experience, or pricing.
For SaaS companies in particular, a good retention rate target is 80% or higher. This means 80% of customers are still actively paying for your service after 12 months. Retention rates below 70% are not suitable and show that you have significant room for improvement.
Enterprise tech companies typically see lower churn, around 3-5% monthly, due to long-term contracts and higher switching costs for large clients. They have high retention rates, around 85-95% over 12 months.
These specific benchmarks and KPIs depend on your business model, target customers, and industry. But in general, lower churn and higher retention are always better. Even incremental improvements of 1-2% per month can have huge impacts on your revenue and growth.
Churn Rate vs Retention Rate
Churn Rate: Identifying and Maximising Opportunities for Long-Term Customer Satisfaction
It’s impossible to completely stop customers from churning. However, you can understand the rate at which you're losing customers and devise practical solutions to resolve that.
Netflix, one of the most visited streaming platforms is a good example. According to Marketsplash, the streaming giant had 232.5 million paid subscribers in Q1 2023 with an incredibly low churn rate of 2%. For context, the average churn rate for subscription services is 6-8% so how was Netflix able to achieve this?
Netflix's secret strategy involved adopting the use of ML algorithms to help users find their preferred movies and keep up their interests. These algorithms popularly known as recommendation engines analyze users' activities and behavioral patterns and create personalized suggestions to keep customers coming back.
Churn Rate: Reducing Cost of Attracting New Customers
It's well-known that it's more expensive to acquire a new customer than keep a current one happy. How do you maintain the satisfaction of existing ones? By uncovering problems such as poor customer service, bugs, or lack of product-market fit early on. Calculating the churn rate regularly and noting when large customer experience changes happen allows you to quantitatively understand the impact of those changes, without needing to set up hundreds of customer interviews.
Ignoring churn rates can effectively put you out of business. It makes no sense to gain 20 new users and lose 20 old users in a single month – your business would be like a bucket with holes that perpetually struggles to be filled, no matter how much water you pour into it. Without addressing customer churn, your growth and success will always be limited, with valuable resources and potential revenue continuously slipping away through the holes in your customer base.
Retention Rate: Increasing Customer Lifetime Value (LTV)
Churn rate vs retention rate: the time difference. Churn only provides a snapshot in time. Retention rate, on the other hand, demonstrates how well you’re keeping customers engaged over the lifetime of your product or service.
This metric is a key indicator of the overall health and sustainability of your business. If people keep using your product month after month, you must be doing something right.
IKEA is an interesting example. The world-renowned furniture retailer has successfully built a strong user base meticulously crafting the experiences of their customers. From the moment customers step foot into an IKEA store, they are greeted with a unique and immersive environment. The store layout is designed to guide customers through different room setups, inspiring them with creative ideas and showcasing the functionality and versatility of IKEA furniture. This personalized experience allows customers to visualize the products in their own homes, creating a sense of excitement and attachment. In other words, they incite an emotional response from their customers, making their store memorable.
After they’ve earned the customer and created a lasting impression, they ensure they won’t lose them. Affordable pricing is part of IKEA’s company vision of "creating a better everyday life for the many people" - in other words, they’re ensuring that their products are accessible to a wide range of customers. This affordability allows individuals and families to furnish their homes without breaking the bank, creating a sense of loyalty and gratitude towards the brand.
Finally, they take the furniture home and built it themselves. This experience is infuriating to some but memorable to all - the final piece in cementing their brand in the customers’ minds and lives.
Taken together, you can see that IKEA’s customer strategy is to lower barriers to entry, then focus on keeping those customers around. Inviting prices + memorable customer experiences = high LTV.
Retention Rate: Upselling and Cross-selling
Retention allows you to measure your upselling and cross-selling ratios to maximize revenue from current customers rather than solely relying on new customer acquisition. The upselling ratio estimates the percentage of existing customers who have upgraded to a higher-priced product or service, while the cross-selling ratio measures the percentage of existing customers who have purchased additional products or services complementary to their initial purchase.
- Upselling Ratio = (Number of customers who upgraded / Total number of existing customers) x 100
- Cross-selling Ratio = (Number of customers who made cross-purchases / Total number of existing customers) x 100
When churn rates decrease and there is an increase in up-selling and cross-selling, your customer lifetime value tends to rise. Implementing these strategies can help strengthen customer loyalty and provide you with a competitive advantage: knowing the exact spending patterns of your customers.
Customer Experience is the Major Differentiator
You need to know the key differences between churn rate vs retention rate. Though used differently, these metrics are two sides of the same coin – while churn can signal problems and dissatisfaction, retention points to solutions and content customers. When deciding which metric to go for, consider your business goals and the lifecycle stage your company is in.
For example, if you’re a startup, focusing on customer retention strategies may be more important to establish a loyal customer base. On the other hand, if you are a mature company, monitoring churn rate may be more relevant to prevent customer loss. Both metrics are important and should be used in conjunction to gain a holistic understanding of customer behavior.
Have more questions about the differences between these concepts? Feel free to share them below and subscribe to The CFO Club newsletter for actionable tips & insights directly in your inbox.