Part 5 of 9
Simply put, the churn rate is the percentage of clients who sign up for a subscription and stop paying, for whatever reason, whether they went to a competitive product or simply didn’t find a compelling need for this type of solution. There are a number of ways to measure churn, but in its most basic form it is the inverse of your renewal rate. If 97 percent of your clients renew their subscriptions, then the churn rate is 3 percent.
There are different ways of measuring churn:
- The most common is the loss of monthly revenues, which takes the amount of the subscriptions into consideration.
- Bookings are the total contract values. For example, a 12-month contract for $1000 per month is $1,000 in monthly recurring revenues, but $12,000 in bookings.
- And some companies will also look at the customer count instead of, or in addition to, monthly recurring revenues. The customer count doesn’t factor in the revenues, so it does offer some extra insight. Let’s take an extreme example where there’s one client producing $100,000 in monthly revenues and 100 clients producing $1,000 each. If the large client leaves, you would have a 50 percent churn rate based on your revenues. If 20 of the smaller clients leave, you would have churn of 20 percent in your customer base, but only 10 percent in your monthly recurring revenues. In a business based on monetizing every relationship by selling more to existing clients, losing a large number of small clients will hurt you in the long run.
The graphic below shows how harmful even relatively low churn rates can be over time:
This is a chart from David Skok, a partner with Matrix Partners, one of the leading venture capital firms specializing in SaaS. In this model, he shows the net revenue loss from a 2.5 percent and a 5 percent churn rate respectively. The assumption is that you start the year with $10,000 in bookings and you add $2,000 in new bookings every month over a five-year period.
With a monthly churn rate of 5 percent, at the end of five years you would have lost $90,000 in monthly recurring revenues – revenues you would still have if your churn rate had been 0 percent. Not only is that almost $1 million in annualized revenue loss, but on a monthly basis, it offsets new bookings. So you can see how damaging churn rates can be.
There can be many things that cause churn. A study done by the Customer Success Association, a trade group specializing in customer support and retention, indicates the top four reasons clients leave:
- They just don’t see the value of the solution, at least not enough to justify continuing to pay for it. They tried most or all of the functionality and it didn’t meet their needs.
- They’re not happy with the vendor. This is something that happens quite often, signing up for a great looking technology, but not getting enough support from the vendor during the onboarding to actually make it work.
- They never fully adopt the application. There are a lot of clients who sign up, but never get around to using it, or using enough of it to make it worthwhile. As opposed to reason #1, it’s not that the product doesn’t have enough functionality, it’s that they don’t use it.
- The client’s business isn’t doing well and they get rid of all non-essential spending.
Since churn is such a critical factor, you will want to have a strategy to keep it to a minimum. We will look at two different approaches – the carrot and the stick.
The most effective way to keep clients from leaving is to split the sales roles into hunters and farmers. Farmers are often called Customer Success Managers – it is their job to maintain communications, make sure the client is using as much of the product functionality as possible, upsell additional functionality – in general keep them happy so they renew and hopefully buy more.
Building analytics into the solution can help you measure customer engagement, – low engagement is a big red flag. One of the nice things about true SaaS solutions, as opposed to hosted or VM versions of on-premise software, is that you can measure how much of the product your clients are using, where they are running into trouble or the functionality they never use. By measuring how much they use the product, you can get early warning signals on those who are most likely to leave.
An extension of this is to really understand the functionality that makes people stay. What are the features they fall in love with and can’t live without?
But there are punitive ways to keep clients from moving. For example, a lot of SaaS vendors have moved away from the traditional month-to-month billing, and are locking clients into contracts of a year or longer. They still advertise the cost per-user per-month, but they have a minimum duration on the contract.
Some vendors make it very difficult to get the data back or to migrate it to another application. They force customers to export their data into multiple csv files, making it almost unusable.
Another trick is to require a phone call. A lot of people would gladly cancel a subscription if they could do it online. They want to avoid the confrontation or sales pressure of dealing with someone on the phone.
The risk with being too heavy with the stick is that it can increase dissatisfaction, and there are many social media platforms where unhappy customers can complain about you as a vendor.
If you implement a successful strategy to reduce churn, you can actually have a negative churn rate if you sell more to existing customers. Squeezing out more revenue dollars from an existing relationship can more than offset the revenue loss from churn.
There are things you can do to achieve negative churn. One way is to increase customer usage. When you look at businesses like Dropbox, a big part of their strategy is to give you new ways to use more storage.
Another is to have products with multiple tiers, going from freemium to silver to gold to platinum.
Again, this is where the farmers are invaluable, helping customers justify using more features that will move them into a different tier. You can see why it is so important to have farmers who are working the accounts on a regular basis – something hunters are unlikely to do, regardless of the compensation structure.
Previous blogs in this series
- Every SI should be an IP company
- Repeatable IP – strategic or opportunistic?
- Overcoming the cash flow chasm
- Managing customer acquisition costs (CAC)
- How marketing changes
- Building the right sales organization
- Sales compensation
- Customer support
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