Customer churn is a SaaS business metric that measures the number of customers, accounts, contracts, bookings, etc., that a business has lost over a given period of time. Also known as the rate of customer attrition or just plain “churn,” customer churn is one of the most widely tracked and heavily discussed metrics in SaaS.

Customer churn is typically expressed as a rate or a ratio (“churn rate of 12%”), but can also be expressed as a whole number (“we churned 12K of ARR” or “we churned two customers”). When discussed as a rate, customer churn is the inverse of your renewal rate. Thus, an 80% renewal rate is the equivalent of a 20% customer churn rate. Whereas a measure of customer churn captures the amount of customers that your business loses, renewal rate captures the amount that stays.

Here’s everything else you need to know about this important SaaS metric.

How is churn used?

In the financial departments of SaaS companies, it is used as a:

• Critical input to Customer Lifecycle Valuations
• Critical input of revenue, bookings, and cash flow projections

A single customer churn number is suitable for discussions with analysts, press, peers, and other interested, non-operational audiences, making this particular metric highly valuable.

However, to better inform key business decision-makers in product or service pricing, planning, packaging, and marketing (among other things), SaaS businesses employ a variety of more sophisticated churn metrics to help them understand their business’s true performance relative to their peers.

SaaS businesses should define clear terms for each of their relevant customer churn metrics and measure them consistently over a monthly or quarterly time frame. Again, this requires well-defined and agreed-upon definitions and metrics for measurement. For example, your product management team should look for potentially dramatically different customer churn numbers that have values determined by cohorts and dimensions such as:

• Marketing campaigns
• Promotions
• Products
• Length of sales cycle
• Functional usage
• Licensed modules
• Sales channels or organizations
• Industries or market segments
• Customer size or segmentation
• Total customer revenue or contract size

When do you count a customer as “churned”?

If measuring customer churn for operational performance, you are free to determine the timespan during which a customer is to be considered churned, as there are no generally accepted practices. In fact, the ways to count customer churn are similar and parallel to new customer counts, which tend to focus on either the order date or the subscription commencement date, if different.

For customer churn specifically, the common methods of determination are:

• On the date of notification of cancellation, if it is before the actual subscription end date (often called a booked cancellation)
• On the end date of the subscription, even if notice is given before such date
• On the date, you have sufficient evidence that the customer will churn, typically as evidenced by a contract breach such as failure to pay

If measuring customer churn for use in CLV calculations, the answer is much simpler. The customer is churned when the reportable recurring revenue stream from that customer goes to zero. This method counts the customer if they are contributing revenue all the way until such contribution ends, even if notice is provided well in advance of that end date.

Understanding churn benchmarks

When assessing your company’s churn rate, context is crucial, and it’s more helpful to compare it against industry benchmarks. However, “good” churn varies widely across business models, company sizes, and sectors. It’s also worth noting that all churn is bad, no matter how low the percentage. As Lincoln Murphy, Founder of Sixteen Ventures puts it, “5% monthly churn IS NOT FINE!” (Yes, he said it in all capital letters).

Why? Because a 5% MRR churn means you’re losing roughly half your customer base on an annual basis. On the other hand, a 5% annual churn rate is much easier to stomach. Rather than giving you one standard rule of thumb, here are churn benchmarks for different software markets:

SMB SaaS

Most SMB-focused SaaS companies target 5-7% annual recurring revenue (ARR) churn as a good benchmark. For example, a 150-person SaaS startup selling $50/mo subscriptions would want to keep their churn rate under 7% of ARR each year to ensure their profitability and future growth.

Enterprise software

Unlike smaller SaaS companies, large enterprise software vendors would consider 2-3% annual recurring revenue (ARR) churn as very good performance. Companies like Oracle, SAP, and Salesforce that are targeting major corporations would expect over 90%+ in revenue retention year-over-year due to their lengthy multi-year contracts and the high switching costs for their customers.

Freemium SaaS

Many freemium SaaS products convert less than 5% of their free users to paid plans on average. Because it’s so easy to downgrade a premium plan to a free plan, these companies forecast very high churn rates of 5-10% monthly for paying subscribers. However, this churn is often offset by the large customer bases of these companies. In other words, even if a freemium SaaS product is only able to acquire or retain a small number of customers, it’s still made up by the fact that their freemium offer gives them access to a large pool of ideal customers at all times.

The 5 top causes of customer churn

Understanding why your customer base is canceling their subscriptions in the first place is critical for reducing churn. Through conducting exit interviews, collecting customer feedback, and measuring the usage of their product in specific periods, SaaS companies can identify these recurring reasons for churn:

Poor product-market fit

If your product doesn’t fully meet customer needs or solve their key pain points, they will ultimately cancel on you for a better alternative. If your customer isn’t a good fit for your product, there really isn’t much you can do about it. However, you can eliminate this type of churn by getting laser-focused on who your SaaS best serves. You can do this qualitatively by conducting customer interviews, or, you could study how churn is trending across your customer cohorts and form your hypotheses from there.

Lack of value realization

Customers may also churn if they don’t achieve expected outcomes from using your product. For example, if a customer signs up for a graphic design tool but their time-to-value (TTV) is slowed by a steep learning curve, they’ll likely cancel their subscription and sign up for a simpler alternative. This is where customer success teams play a key role in your organization — if you don’t want customers to churn due to slow TTV, you’ll need to improve your customer onboarding and training (e.g. Building a knowledge base, creating a video product tutorial, hosting monthly customer training webinars).

Pricing and packaging misfits

Sometimes customers may churn due to the wrong product SKU for their usage levels or when the pricing of your SaaS becomes unaffordable as their needs scale up. However, by offering sales-negotiated pricing, tiered pricing, and add-on modules, you can meet your users’ specific pricing and packaging needs across customer segments.

Issues with user experience

As SaaS continues to become saturated with niche vertical products and services, one of the best ways to stand out is by creating a seamless user experience. Hard-to-use admin panels, confusing workflows, and a steep product learning curve are all examples of poor UX design.

Lack of support and service

Improving your customer service experience is a low-hanging fruit that significantly increases your customer retention rate. If you let bugs go unresolved for months or if customers can’t get ahold of your customer support teams within a reasonable time frame, their likely to churn. However, by creating strong SLAs, offering dedicated support to premium users, and developing help documentation, you can ensure your customer support needs are met.

Spotting at-risk customers before they churn

The best way to eliminate customer churn is to stop it at the source. This means you’ll need to identify at-risk customer wll before they actually churn. So rather than waiting for missed payments as a lagging indicator that your customer are about to say goodbye for good, you should analyze these leading signals to detect customers who are at risk of churning.

Support ticket volume increases

A spike in customer support tickets indicates that customers are dealing with bugs or experiencing problems with your product. And if these issues remain unresolved, then your customers will likely leave you for a competitor. Depending on the issue, you may want to assign a dedicated technical account managers (TAM) to provide 1:1 support to your high-level accounts. Or if, it’s a broader technical issue, then you should immediately pull in developer resources to ensure that any bugs can fixed as soon as possible.

Product usage declines

If your usage rates significantly drop month-over-month, then it’s likely that your customers are at risk of churning. And unless you have the right tools to track your usage data, then you’ll have no way of identifying this leading indicator. You should also work with your customer success team to ensure that they’re monitoring usage levels across customer cohorts and keeping tabs on any steep drops in usage.

Net promoter score (NPS) drops

Because most SaaS subscriptions are month-to-month, monitoring your customer relationships is a must. Major drops in your NPS scores or increases in detractors that show declining customer satisfaction and customer engagement are two bug warning signs that your customers are getting ready to churn.

If you’re experiencing this in your business, you need to identify what it is that’s causing the issue. Is your pricing too high? Is your support too slow? Is your product roadmap not aligned with your customers’ needs? These are all long-term solutions. In the short term, you may consider offering incentives for referrals to boost advocacy and improve your NPS.

Missed renewal notices

While this customer attrition signal comes later in the customer lifecycle, a lack of response to an upcoming renewal predicts a very high likelihood of churn. Ensure that your customer success reps or account managers are following-up these customers so they renew their subscriptions. If they don’t respond and you think they’re getting ready to cancel, then you may consider providing special pricing, support credits, or free extensions to give your at-risk customers more reason to stay.

How to reduce customer churn

Most SaaS companies focus on eliminating voluntary churn (i.e. customers who leave on their own, whether due to a poor user experience or customers outgrowing your product).

However, there are multiple ways a business can be proactive in reducing customer churn in all its forms:

1. Understanding Why You’re Losing Customers

You can’t really solve a customer churn problem until you’ve identified its source. Why your customers are leaving is an absolutely necessary precursory question to answer before you move on to ameliorating the loss you’re suffering. Try conducting interviews or sending out cancellation surveys to understand why customers aren’t staying with your company.

2. Ensure you’re providing stellar customer service

If your customers find your ramping process to be too hard (or non-existent), they might just cancel their services rather than seek out help. If that’s the case, then you need to figure out the best way to offer them help. Consider starting a blog on your web domain, auditing your customer service department, or building out a more intensive onboarding process in order to provide more thorough and straightforward services to your clients.

3. Read the room

Customers don’t usually up and disappear without a moment’s notice. Start familiarizing yourself with the qualities of accounts that might be considering cancellation— have they not logged in for weeks? Has their usual level of activity and communication been lowered? If so, consider reaching out to this customer proactively.

What is a customer churn analysis?

Customer churn analysis is the process of measuring customer or revenue churn to either 1) assess a business’s performance against operational objectives, or 2) for pure financial analysis. This analysis can either be historical or predictive in nature.

Types of customer churn analyses

A customer churn analysis of operational objectives is meant to measure the success of packaging and other go-to-market programs; or the success of processes, typical customer success, or renewal processes. This analysis is frequently done in support of and used in the determination of bonuses and incentive payments for hitting churn and retention targets. It is for this purpose that it often comes with an ever-changing array of rules and exceptions.

A classic example of a customer churn analysis can be found in the compensation plans of customer success managers who are incentivized to minimize churn and maximize ARR and revenue. Because the core objective is to motivate employees to minimize customer churn, exceptions are made for churn that is deemed “uncontrollable.” Examples of this include exceptions made for customers who went out of business or who merged with other accounts. In the same vein, the loss of the customer and ARR is an exception left out from the performance review and quota/commission computation.

Another example may be the “forgiveness” of the loss of “seats” due to a change in company pricing and packaging decisions, which might actualize as something along the lines of “It’s not our fault that we now offer 10 seats in a bundle for less than what we used to get for 5 seats….”, when in actuality, these numbers are important to consider when analyzing customer churn and contraction.

However, when you are computing churn for the purposes of pure financial analysis, there should be little to no exceptions. An error often made by SaaS and other subscription businesses is defining the rate of attrition based on their unique views and using guidelines that are acceptable and subject to stakeholders’ and potential stakeholders’ opinions. But such guidelines can corrupt the underlying math involved in understanding the single most important metric influenced by churn: enterprise value as measured by Customer Lifetime Value.

Customer Lifetime Value, or CLV, can be calculated very easily if you know the formula to do so— and it is a formula with little to no purpose in the lives of most business people. It does however help to answer the question asked by all founders, investors, and entrepreneurs: What is my business worth?

When it comes to calculating CLV (which happens to be the most objective measure of a business’s true value), there are two primary inputs that are necessary: recurring revenue and customer churn.

In the calculation of CLV that takes customer churn into account, it is important not to rule out circumstances that count as customer churn but aren’t things your business could have prevented. For example, a customer that goes out of business has churned. It’s no one’s fault, but it can’t be used as an exception to amend the equation. When two of your customers merge, you lose one. Simple math is not debatable. In this instance, your recurring revenue may have increased from the one merged customer, but the simple math prevails: you have one less customer.

Why analyzing your churn is important

Case studies over the decades have shown that it is typically far less expensive to keep your best customers than to find new ones. The fact that revenue from returning customers has a lower cost per dollar of revenue is the simple driver behind most of the focus on churn.

A “low churn rate” or an “improving churn rate” are indicators that your business is operating well or improving in its ability to use capital efficiently in order to acquire more revenue. It is for this reason that businesses analyze and report the rate of attrition to investors as a normal course of operations. Additionally, as a business matures, it measures churn performance against objectives to keep on track for various growth objectives.

How to calculate customer churn

In order to calculate your business’s average churn rate, you have to take your business’s monthly recurring revenue (MRR) at the beginning of a business month and divide it by the monthly recurring revenue you lost over the course of that month, and subtract it by any upsells or addition revenue generated from existing customers. Every time you go to calculate customer churn, your formula should be as follows:

Customer churn rate = [(customers at beginning of month – customers at end of month) / (total number of customers at beginning of month)]

This equation is designed to calculate your monthly churn rate. However, you can easily change it to find your quarterly or annual churn rate — just change “customers at beginning of the month” to “customers at beginning of the year”.

Need help collecting this customer data? Check out Maxio’s SaaS metrics reports, and how you can use them to view your churn rates by product line, customer segment, and so much more.

What is a good customer churn rate for SaaS?

Generally, the venture community has circled around a number of 10% customer churn as a bellwether number. Every point below 10% is better and better, and every point above 10% is worse. However, there is no universal average rate you can benchmark against. Customer churn rates vary widely based on target market, price, value proposition, product quality, and operational execution in customer support and service. And rates without consideration of customer acquisition costs are often meaningless metrics.

What are the most common churn metrics for subscription businesses?

• Customer churn and logo churn: Lost customers, expressed as a percentage/rate as well as an absolute count. Customer Churn, measured as a percentage, is an important part of the overall CLV calculation process.
• Recurring revenue (ARR/MRR) churn: Typically expressed as a ratio of ARR or MRR lost as a percentage of renewal candidates, but can also be expressed as the total MRR or ARR value lost to customer cancellations and attrition.
• Revenue churn: GAAP revenue, MRR or ARR churn, typically reported as a ratio. This metric has a slightly broader breadth than recurring revenue churn in that it can include lost, non-recurring revenue.
• Average recurring revenue churn: Typically expressed as the average amount of average recurring revenue or monthly recurring revenue decrease due to lost customers.
• Bookings churn: A traditional approach to measuring churn in software companies, this approach has been replaced using ARR and MRR churn ratios. It was originally a measure of the bookings, or executed contracts, between a client and a subscription company.

How churn impacts company valuation and funding

Up to this point, we’ve covered pretty much everything you need to know about churn except for it’s long-term effects. Most SaaS professionals know the short-term impacts of churn (lost customers and lost revenue), but there’s much more to it than that. While churn may seem like an operational KPI, it directly impacts the future revenue (and, therefore, valuation) of a SaaS business. As such, churn is a crucial factor VC investors consider when assessing funding deals and exit valuations.

Customer lifetime value (CLV) models are central to calculating SaaS company valuations. These models forecast the total expected revenue from a customers over their lifetime. So naturally, if your churn is high, then your average CLV, and therefore, your valuation will decrease.

For example, let’s day a SaaS startup signs up 10,000 customers at $100 annual recurring revenue (ARR) each, totaling $1 million beginning ARR. With a 5 year average customer lifetime and stellar 97% annual recurring revenue retention, the CLV model predicts over $4.5 million in subscriber revenues over 5 years.

However, if churn increases substantially to 15% ARR churn, then total revenues drop to under $3 million over 5 years — this would cut the valuation estimate by a third! Given this direct impact on valuation, VCs scrutinize churn very closely before making investments. Companies with risky churn metrics and trends also face greater dilution from the larger equity shares that are demanded by investors to make up for these risks.

The bottom line is that by obsessing over churn and improving the customer experience, SaaS startups can boost their CLV and their chances of achieving a valuation that offers them sizable returns upon exit.

How does Maxio help track churn?

Maxio measures churn by interpreting your subscription financial records and thus provides the most accurate measurement of customer churn, including logo churn and recurring revenue churn. Maxio doesn’t rely on user transaction “tagging” because user tagging is error-prone and unscalable. User-tagged records kept in a CRM or a spreadsheet do not include proper validation to ensure the tagging is correct and can lead to materially incorrect metric reporting.

Want to start tracking your key SaaS and put an end to customer churn? Schedule a demo with our team to get started.