How to Calculate Customer Churn: The Simple Formula

At the very essence, defining and understanding your customer churn rate is actually very simple. Because any given churn rate is the percentage of your users that leave your company over a specific period of time.

However, even though this can seem like a fairly simple calculation on the surface, we have come to discover that there is a great amount of complexity behind this concept.

Various SaaS companies define and calculate their customer churn rate in different ways. Some choose to make a simple monthly or annual churn calculation, while other firms have found it necessary to break down their churn into segments, cohorts, etc.

Unfortunately, this high level of complexity can cause a great amount of wasted time and hidden opportunities for many businesses. Numerous SaaS companies simply end up spending more time trying to understand and qualify the churn metric, rather than actually using the metric to build their firm and increase revenue growth.

Most importantly, you need to know the very foundation of your customer churn rate and how you and your team can influence the different variables.

In this article, we are going to provide you with an easy and simple calculation to determine the customer churn rate in your company. Then you can focus on how to reduce your overall churn rate and grow revenue for your SaaS business.

 

1) What is churn rate?

As mentioned at the beginning of this article, your customer churn rate is the percentage of users that cancel or don’t renew their subscription plans. This can be measured during any given month, quarter, or year.

 

You need to understand and continuously calculate your customer churn. Because if you don’t, it might keep getting higher and higher and ultimately prevent the overall growth of your company.

 

When you calculate the churn rate, you will also get information about other metrics such as customer lifetime value and retention rate, which is the inverse of the churn rate.

 

Knowing all of these metrics, allows you to build more accurate forecasts for growth, revenue, and scaling efforts for your SaaS business. The numbers will show how your product or service is performing now and what you should expect for the future.

 

2) How to Calculate Customer Churn

Depending on what you what to know, you can calculate churn in a few different ways.

 

Some SaaS companies might prefer to find their monthly rates in order to better understand monthly growth and retention. Other companies might wish to calculate their annual churn rates to learn how growth is developing year by year.

 

 

2.1 Monthly Churn Rate Calculation

 

Monthly churn rate = Users lost this month / (Users at the start of the month + Users added this month)

 

Below you can find an example of a monthly churn rate:

 

Users at the start of the month: 3,000

New users added that month: 600

Users lost at the end of the month: 474

Monthly churn rate: 474/3,600 = 13.17%

 

2.2 Annual Churn Rate Calculation

 

Annual churn rate = Users lost this year / (Users at the start of the year + Users added this year)

 

Below you can find an example of an annual churn rate:

 

Users at the start of the year: 60,401

New users added during the year: 15,893

Users lost at the end of the year: 29,103

Annual churn rate: 29,103/76,294 = 38.15%

 

 

3) Cohort Analysis

So is it always a good idea to calculate your churn rate on a monthly or annual basis?

 

No, not necessarily.

 

However, these two calculations are a good starting point to gain some entry-level values.

 

Nevertheless, you need to be aware that accelerated growth can make these simple calculations less accurate. This is particularly important to remember for any new SaaS business. In these cases, you should consider using a different formula such as cohort analysis.

 

 

3.1 The importance of cohort analysis to calculate churn

So why can it be useful to use cohort analyses to calculate churn?

 

Because when you use monthly churn rate calculation, for example, there is an underlying presumption that no buyers can churn in the first month. This is based on the assumption that all your consumers pay for the first month upfront. Therefore, when you look at users at the beginning of the month and then divide that by the total number of churned consumers, you won’t have any new customers churning in that first period of time.

 

Let’s say that you used the same model to calculate churn over a quarter. That would cause some problems. Because there is a potential for some of the new customers from the first month in the quarter, to churn in the second or third month of the quarter. If those churns were included in the calculation by a mistake that would mean that you would overstate the churn rate.

 

Therefore, we suggest an alternative solution where you make sure to exclude all new customers from your churn calculations. By doing that, you will get the churn rate of a specific cohort, which represents the install base at the beginning of a quarter. When you use cohort analyses, you will be given the true churn rate, without replacement, of your customer base over a quarter.

 

Therefore, instead of looking at all your users as a whole, cohort analysis breaks them down into relevant groups.

 

 

3.2 How does cohort analysis help identify causes of churn?

When using cohort analysis to calculate customer churn for your SaaS business, you will also be able to identify causes of churn.

 

How? You might ask…

 

Because a cohort analysis will show you the most significant moments in your consumer journey and point out relevant steps where you need to take action.

 

Let’s look at an example.

 

Imagine you are offering a grocery delivery app. Over the last couple of months, you have seen that new users of your app have shown highly engaged behavior. They have typically submitted an order within the first two to three days of installing the app on their device.

 

However, then in the second week of using your app, users start to spend less time in the app and make fewer orders. This behavior seems to continue and by the end of the first month, new users have stopped opening your app completely.

 

What can the problem be?

 

When you divide your users into cohorts, you start to recognize that the majority of your retained users, who are making regular orders, launch the app between 2 pm and 3 pm. whereas, users who open the app already in the morning either close the app within one minute or leave their online cart. 99% of these users convert into inactive users or leave within the first month.

 

This is important learning, so you can start to make proactive action to boost user engagement and retention. Based on what you have learned from the cohort analyses you might want to send a customized push message to your users between 2 pm and 3 pm to remind them to purchase their groceries, together with a promo code.

 

So you see that only by breaking your users down into smaller groups can help you spot those patterns of customer churn.

 

 

4) Strategies to Reduce Churn

Now you know what churn is and how you can calculate it in different ways. So let us look at some strategies you can implement in order to reduce user churn.

 

 

Strategy 1: Implement an Annual Plan

Most SaaS firms find it very attractive to offer annual plans to their users because a customer then pays a full year of service upfront. Yet, it has also been found that annual plans have a positive impact on consumer retention as well. Several studies on SaaS churn rates indicated that a low user churn correlated with a high number of annual subscriptions.

 

This can be explain by the subtle differences that exist between the way monthly and annual plans affect firms and buyers:

  • Firms are often more committed to buyers with an annual plan. As the buyer only has one chance to churn each year, many firms are able to provide sustained customer service and build strong consumer relationships. This increases the chances of the buyer to make a renewal the next year.
  • Buyers are often more committed to a firm with an annual plan: When a user decided to sign up for your software solution for a whole year they often show a more engaged behavior. Buyers that are committing to your product for a year want your solution to work. Hence, they are invested in your success because it makes them successful, too.
 

Strategy 2: Catch Delinquents Early

Statistics have shown that between 20-40% of all churn isn’t caused by the actual product, service, or the given value. Rather, churn is often caused by failed payments. These failed payments occur because of several reasons such as:

  • Customer credit cards have expired, incorrect billing information or customer credit cards hit their limits.
  • Credit card processors have updated their processes and those updates haven’t been implemented into your systems.
  • The fraud detection systems at card companies signal false positives or flags cards that are not fraudulent by mistake.

Therefore, you need to reach out to your consumers when their credit card is about to expire. You can do this either through email, an app, or using in-app notification. By doing so, it will be easy for users to update their information, and it can save you from of big amount of otherwise churning consumers.

 

 

Strategy 3: Build a Comprehensive Churn Reduction Process

When you have defined and calculated your business’ churn rate, you are able to start a systematic reduction process, which involves: hypothesis, question, test, analyze, refine.

 

The five steps are outlined further below:

  1. Define churn goals: Create quantifiable and achievable goals, which you can measure and grow over time.
  2. Start asking questions: Data is king! Start asking questions that will provide you with great empirical data.
  3. Develop your hypothesis: When you have your questions, start to analyze their impact on your churn.
  4. Test and analyze: Once you have set your goals, ideas, and hypotheses, it’s time to test your ideas.
  1. Refine, reject, repeat: Once an experiment is completed, you can assess it in relation to your original goals and how you can refine the process.
 

5) Conclusion

Clearly, churn rate is a critical metric for any SaaS business, and as you can see, there is a variety of opinions about how to calculate it.

 

Whether you choose the monthly calculation, annual calculation or cohort analysis is up to you and your team. You just have to make sure that you choose a method that provides valuable insight and that can help you reduce your overall churn rate and grow revenue for your SaaS company.

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