SaaS Churn Rate: What’s Acceptable?

saas-churn-rate-what-is-acceptableIs 5% a good monthly SaaS Churn Rate? Read on to learn the answer…

As a consultant to SaaS and Cloud providers that are looking to grow, I get asked what an acceptable SaaS churn rate is all the time.

As I stated in my Sandhill.com article SaaS Providers: Growth Requires Proactive Customer Retention the answer is you want a churn rate that is “as low as possible.”

Acceptable Churn Rate

In line with my experience and as I cited in my Sandhill.com article, Bessemer Venture Partners says an acceptable churn rate is in the 5 – 7% range ANNUALLY, depending upon whether you measure customers or revenue.

And BVP’s assertion is backed up by Pacific Crest in their Private SaaS Company Survey Results that show roughly 70% of SaaS companies in their survey had annual churn in the < 10% range, with 75% of those at 5% or under.

The way I read the results of Pacific Crest’s survey is that 30% of SaaS providers surveyed have an unacceptable level of churn.

Now what about the SaaS providers that aren’t included in surveys like that one or who don’t appear in the logo list of the top investor portfolios and who are just trying to grow? Are they doing better or worse?

In my experience, it’s quite often worse… and sometimes much worse (as you’ll see in a second).

Honestly, for those companies, it isn’t a lack of customers in the front door that is stopping their growth; it’s the constant flow of customers out the back door that is killing their business!

Monthly vs. Annual Churn Rates

Now, just so we’re on the same page, 5% – 7% Annual churn – the good churn rate – translates to 0.42 – 0.58% monthly churn.

This means companies with acceptable churn only lose about 1 out of every 200 customers (or dollars) per month.

Now that’s a solid platform you can really build a high-growth company on.

On the flip side, a high churn rate is the reason you ended 2012 with a whole bunch of new customers… but had about the same amount of revenue.

Churn is the reason that – though you acquired a lot of new logos in 2012 – you had no significant year over year growth from 2011.

Is 5% Monthly Churn Good?

To really hit this point home, here’s a story from a conversation I had last week.

The CEO of a cloud provider who competes in an extremely crowded SaaS product category (and hasn’t figured out why they exist yet) contacted me.

His goal is to double his business over the next 12 months… to 2x their current revenue.

To help reach that goal, he contacted me because he knew I could help with the things he thought were key to reaching his goal.

He knew that I could help increase customer acquisition by improving the quality of traffic to their site, improving the number of prospects entering his free trial and, of course, improving the conversion rate to paying customers of those that enter the free trial.

But as part of trying to get to the bottom of things, I asked him what his churn rate was.

Since he didn’t contact me to talk about churn he wasn’t really interested in discussing this (this, by the way, is always a bad sign; as the CEO of a SaaS company you should be open to discussing ALL ASPECTS of your business when you’re looking to grow).

He reluctantly told me he had a 5% churn rate but that it is “just fine.”

I asked him if that was 5% per year or per month… one is great the other not so much.

He confirmed it was 5% per month but reiterated that “it is fine.”

No, 5% Monthly Churn is Bad!

Now, just so you and I are on the same page… 5% monthly churn IS NOT FINE!

It means that if you didn’t add any new customers (which is unlikely) or measured on a cohort basis (this is a very accurate way), you’d see that 5% per month leads to ~46% churn. Read on.

Put this in a spreadsheet cell and hit enter: =(1-.05) ^ 12

The output is something like: 0.540360087662637 (see my over-simplification disclaimer at the end)

Make it 54, subtract that – which is the retention rate – from 100 and you have the annual SaaS churn rate: 46.

Turn that into a percentage, and the annual churn rate is: 46%

A 5% monthly churn results in… a 46% annual churn rate!

Let me add some color…

Having 5% monthly churn means if you started January with 100 customers you’d have 54 customers left at the end of December.

If you started with $100 in Monthly Recurring Revenue (MRR) you’d end up with $54/MRR at the end of December.

Think about it this way… over the course of the year where you start with 100 customers or $100/MRR but have 5% monthly churn, you’d need to acquire 46 customers (or $46/MRR) just to break even with the beginning of the year.

To grow by just 1 customer you’d have to acquire 47 customers!

To grow by just $1, you’d have to acquire $47 in new business!

If you start the year off with 100 customers, and you add 100 customers per month (and depending upon where the 5% churn from; cohort or total), you’ll end up with 25-29% annual churn.

If you add 1200 customers over a 12 month period and end up with a little more than 900 over that same period, that is probably not good.

Of course there are several factors to consider here, but in B2B SaaS where we’re looking for customer lifetimes of at least 36 months (and likely spending more than in B2C to acquire customers), this is clearly working against our goals.

Okay, so…

Why Do SaaS CEOs Ignore Churn?

Why this was not shocking to him I’ll never understand, though I can assume it was for at least one of these two reasons…

  1. His company continues to acquire customers at a rate that is fast enough to break even or show some slight growth (which is why they think they just need to ramp this up)
  2. He assumes a high churn rate is the norm; it’s expected and just fine.

What this really means is that with 5% MONTHLY churn, the CEO who said “it’s fine” is running a company with a 46% annual churn rate!

It means his company, the one that is “just fine,” is losing 50% of their customers or revenue every year.

At first I was happy to hear he has no Board of Directors to report to (so we could just get to work), but after hearing him say 5% monthly churn is “fine” I wish he did have someone to hold him accountable!

Now, while it’s not impossible to double your business in a year with such a high churn rate (this isn’t unheard of in the B2C world), it is hard.

And in our world “hard” means expensive and time-consuming.

It means running backwards on a treadmill blindfolded while lighting $100 bills on fire… eventually you might reach your goal weight, but you look like an idiot and waste a lot of money in the process.

The reality for this SaaS CEO I was talking to – and anyone else with a high churn rate – is that this is not a solid foundation to build a business on.

Rather than a solid foundation, you have a super-porous, extremely brittle wafer – like a piece of shredded wheat – that you’re going to try to build a business off of.

Or a dry sea sponge. Or a structure made from dry angel hair pasta. You get the picture.

Negative Churn and Expansion Revenue

Yes, you might have “negative churn” or “expansion revenue” where you lose some customers but the ones that stay pay you more over the course of the year.

That’s awesome! Expansion revenue is the best.

Unfortunately, in my experience, SaaS providers with high churn rates often don’t know how to effectively up-sell, cross-sell, or even down-sell so their churn rate is rarely offset by expansion revenue.

And the cost of acquiring more customers – especially when accurately figuring in all sales, marketing, on-boarding, and support costs – will frequently do more to offset what expansion revenue they have than the other way around.

As well, their pricing models are usually such that they don’t effectively move customers to higher pricing tiers and, in fact, often have non-value differentiators (like storage) separating pricing tiers so that customers game the system to avoid paying more (a major churn threat, by the way).

That said, assuming you’ve got up-sells and cross-sells that work and you have a pricing model that encourages customers to use more so they pay more to drive expansion revenue, how much better would it be if you could expand revenue over a larger customer-base by keeping more customers?

Right… so even when arguing for expansion revenue, I’m also arguing for lower churn.

Not all SaaS are created equal

Of course – like everything else in SaaS – lots of other market, category, and company-specific inputs come together to drive the churn that is outside of your control.

For instance, in the email marketing category – where I’ve worked with seven providers over the last year – there seems to be a much higher propensity for churn, especially at the lower end of the category.

However, the companies I’ve worked with – even in a market where the expectation is high customer turnover – we’ve been able to reduce the churn rate and extend customer lifetimes significantly.

How to Reduce Churn

Honestly, there’s nothing magical to reducing churn, it’s just ensuring that your customers continue to realize value from your service.

First, though, you have to get them to start using your service – either through a sale or in a free trial – but without over-promising and by otherwise managing expectations properly. I’ve actually seen a large amount of customer churn directly correlated to missteps during the sales and on-boarding phases, by the way, so keep that in mind.

Then, once the customer is up and running your only job is to ensure they keep realizing (more and more) value from your service.

While you may not add years to your customer lifetime or eliminate churn entirely, what could you do with an extra 6 months of revenue from your customers on average? What would that do to your company valuation?

A Complete Over-Simplification of Churn

Let me be clear… I’ve way over-simplified how to calculate churn for this post because I want you to start thinking about how churn can affect you and not get caught up in the details or turned off by crazy math.

The reality is that while churn is often seen as a linear function, customer retention is generally charted as a curve with actual losses – both customer and revenue – progressively decelerating.

But rather than going into how to waterfall out monthly revenue from the declining customer base, using cohort analysis, determining estimated customer lifetime, measuring revenue vs. customer (logo) churn, etc., I just wanted to present the simplest of real life examples to get you thinking.

What would you do today if you realized you had a churn rate that was too high? If you don’t know, that’s what I’m here for.

About Lincoln Murphy

I am a world-renowned Growth Architect, Consultant, Author, and Keynote Speaker and have helped drive exponential growth across the entire customer lifecycle for more than 1000 companies worldwide I wrote the Customer Success book which you can buy at Amazon. If you need help growing your company or would like me to speak at your event, please contact me. Also, connect with me on LinkedIn or follow me on Twitter or Facebook.