Understanding the true cost of subscriber churn is one of the most critical KPIs any SaaS business can measure. Unfortunately, it is not always easy to identify the ‘true’ cost of churn because customers churn in different ways.
Simple ‘Binary’ Churn Example
In the simplest example, Company A charges $15 per month for access to its service. If every customer of Company A’s service pays the same amount, calculating churn is easy, because subscriber churn and revenue churn move together in a parallel fashion. A 5% increase in subscriber churn corresponds directly to a 5% increase in revenue churn.
More Complex SaaS Churn
However, in most SaaS companies, billing occurs on a fixed+variable consumption basis. (Think $ per seats, licenses, units, transactions, calls, servers, bandwidth, power etc.) In this more common example, subscriber churn typically occurs over a longer period of time. To make an extreme example, a customer may reach peak levels of consumption six months prior to their final cancellation event, and spend the remaining six months of their active subscription tapering their consumption as they migrate off of your service.
When a customer has signed a more traditional, annual contract – as most enterprise SaaS companies like Salesforce require – the annual contract value (ACV) provides an easy way to ascribe a value to a non-renewing customer. Revenue churn is simply the ACV for that customer, divided by the monthly periods to determine the MRR earned over the term of the contract, which will not be contributing on a go-forward basis once the customer churns.
The Curse of the ‘Long Slow Taper’
Most subscription businesses on the web today charge an auto-renewing monthly fee. It's quite common to also provide tiers or add-ons which create a variable component to the monthly invoice. The size of the auto-renewing invoices typically grow over time until the customer decides to not renew, without dropping off immediately – often resulting in a long, slow decline of usage.
In auto-renewing subscription businesses, traditional methods of calculating revenue churn use the size of the last invoice as the measure of lost revenue. We've covered interesting ways of calculating churn in the past.
Traditional methods of calculating revenue churn in auto-renewing subscription businesses often miss the true cost of churn by looking only at the value of the final invoice.
The value of a customer that was once healthy, expanding and on a path to being a very profitable customer can easily be lost in the data if your churn calculations don’t factor in the maximum value reached before the ‘long slow taper’ set in.
An Alternative Approach – Calculate ‘Trailing Peak’ Revenue Churn
In the example of a ‘Long Slow Taper’ above, we propose taking a look at “trailing peak revenue” for your customers. Each business has different characteristics, so you’ll need to tailor the approach to suit the needs of your business.
Step #1 - Choose an appropriate ‘Trailing Peak’ period of observation
In our example, we chose a six month trailing view.
Step #2 - Identify the MAX invoice value over the prior six months
In Excel, the formula is simply: =MAX(invoice1:invoice6)
Step #3 - Calculate ‘Trailing Peak’ revenue churn
In the month being observed, list the customers who finally ‘flat-lined’ via cancellation. Identify the max invoice value from the range of their prior six months period for each churned customer. Sum the max value for each customer and evaluate the ‘Trailing Peak’ revenue churn for the period.
Step #4 - Evaluate the ‘Trailing Peak’ revenue churn over time
Step #5 - Compare your ‘Trailing Peak’ revenue churn to ‘Last Month’ revenue churn over time
If your business has characteristics of ‘long slow taper’ churn, you will see your ‘Trailing Peak’ revenue churn growing way beyond your ‘Last Month’ revenue churn. This may occur while your churn, as calcuatled by the usal ‘Last Month’ method, remains well within healthy bounds.
This simple methodology can un-mask one of the most critical, and often overlooked, types of churn. Within a few minutes, you can use this methodology to assess whether your business is suffering from ‘Long Slow Taper’ churn.
If so, you may want to invest in Customer Success efforts to help identify and influence the sources of churn before your customers make the move.
Dan Burkhart - CEO Recurly