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How To Calculate SaaS Churn Rate For More Accurate Customer Acquisition

Projecting your customer acquisition rate gives you a clear picture where the business is heading. This is important so you can address potential problems before they blow up or take advantage of opportunities before they subside. Customer acquisition rate also helps you to gauge the need for further capitalization or cost-cutting.

Because it shows you the “future”, customer acquisition rate should be as close to reality when you run the numbers. Make a wrong or incomplete computation and you may be making the best decision for the wrong reason. That costs money and time.

Customer acquisition forecast depends on two things: churn rate, or how many subscribers who opted out, and customer retention rate, how many subscribers are left. The standard calculations are pretty straightforward:

No. of customers who churned ⨸ Total no. of customers = Churn Rate

100% – Churn Rate = Customer Retention Rate

But that’s not giving you the complete picture. In fact, this standard formula may lead you to think your business is healthy even if it teeters on the edge of merely breaking even, or worse, the beginning of a slide.

Lincoln Murphy of Sixteen Ventures showed us how to define who your customers are and who aren’t, which are central to calculating SaaS churn rate. Let’s discuss this insight to help you arrive at a more accurate SaaS churn rate and customer retention rate, which in turn should let you make the right decisions.

churn

How to calculate a better churn rate

It is a basic rule in ROI forecasting: over calculate costs and under calculate profits. This will give you a conservative outlook for a safer profit margin estimate. You should apply the same principle when computing churn rate, how much subscribers off your customer base are leaving you. That means, you only include customers who could churn out–but didn’t–to your actual customer base.

Assume that customers with lock-in contracts want out. How do you know? You can’t, that’s why it’s better to anticipate that these customers don’t like you. In case they really don’t at the end of the contract, even if they churn out your revenue estimates won’t take a plunge. Conversely, if they do stay, your actual margins will look better than your estimates. That’s being conservative.

For example, if you have 100 total customers and 20 of those are in a lock-in contract, don’t count them and consider your total ‘real’ customers as 80. If you lose 10 customers, divide that by 80 (not 100) to get a more conservative churn rate. So, instead of getting a 10% churn rate, your real churn rate is 12.5%! That should make you work harder to work on reducing the number of churns, right?

It seems counter intuitive to think customers will leave you when they can. But it’s not. This tactic pushes your sales to continuously set their target higher and improve on their previous quota, instead of resting on short-term laurels. Similarly, your business is better prepared to actual sudden sales dips, when you have prepared for lower revenue estimates.

Only count long-term customers

Take your conservative churn rate to a higher level by also excluding customers who are new, within a refund period or in a free trial. These people don’t know yet if they’ll fully like and upgrade your product, which means, there’s always a chance they… might… not. By taking them out of your acquisition forecast, you’re further shrinking your customer base and, consequently, shoring up customer churn rate. It’s up to you how you define a fairly new customer–one month? two months?–but he or she should be at a stage when he or she hasn’t grasped the full potential, or lack thereof, of your product yet.

Remember the nursery lesson of not counting your chickens before they hatch? You’re applying that principle here. Hatched eggs are customers who have all the means to leave you but don’t, customers who really like you, in short.  

Going back to our example, let’s drill down on the 80 customers. Let’s say, 10 of them are out of the minimum six month lock-in period, so they’re essentially on their first month of being ‘free’ customers. They have expressed their desire to continue with your product, but for how long? You’re not sure yet, so they can be classified as fairly new; hence, we deduct them from 80. Our customer base further shrinks to 70. Our churn rate is now at 14%! That’s significantly higher than 10% had we included all 100 customers in our customer acquisition forecast.

Looking ahead: will your ‘active’ customers be active for long?

Now that you have a higher but more accurate customer churn rate, you also have a lower but more accurate customer retention rate. However, are you really retaining all those customers? Possibly not for long.

Customer retention is commonly interchanged with active users. But being active doesn’t give you the right picture and, in fact, can gloss over real customers’ perception of your product. For instance, SaaS subscribers who log in and out more frequently may ring an alarm because they may be only using a basic feature of the software; hence, undervaluing your product. It’s like someone using your CRM software for its task calendar alone. He or she will soon tire out of your product or prefer a better calendar app without having understood the CRM software’s real potential, say, analytics and reporting.

Conversely, using only one feature doesn’t automatically mean you should be alarmed. If that one feature–for example, dashboard–is the only tool the customer uses and he or she is happy about it, that’s a long-term customer.  

The key is to put the situation in context. If the customer has only signed up for one or two features and is using this feature often, that’s a good sign. On the other hand, if he or she has signed up for a premium plan and is ignoring 80% of the features, that’s a churn waiting to happen. Dig deeper into the context and get a better grasp of customer retention.

Another good example of context is measuring your inactive customers. Are they inactive for good or is it seasonal? Look for patterns in their user behavior. A helpdesk app customer may scale down on features after the holidays, which is not uncommon considering sales are expected to simmer down. The same customer may scale up again leading to the peak season.

In short, your customer retention rate off the churn rate is only an indicator. Drill down to context and you’ll get the real picture of who are really being retained for the long haul.

CONCLUSION

Now that you have a better picture of your churn rate and customer retention rate, your business may look less promising. Don’t be disheartened because you’re just being conservative. That’s the difference between having an exciting idea and actually working on that idea. Your optimism is great, but let actual results run your business.

Category: B2B News

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