#28: Fixing The Deceptive Nature of The Churn Rate

Churn rate, the revered SaaS metric, can be deceiving. 

Growth can hide or magnify churn patterns, distorting the true picture of retention and keeping you focused on the wrong thing.

If your churn rate is rising in 2023, you are not alone.

And chances are that you have to discuss the fluctuation on this important barometer of SaaS performance with your CFO. So it's time to dig deeper. 

Let's unveil the churn reality and empower our business. 

Here is how we calculate the Churn Rate:

Customers who churn make up the numerator and Total number of customers at the beginning of that period defines the denominator. 

That means that the churn rate is always relative to the growth of the customer base. 

This is a problem for 2 reasons:

1. When a company experiences rapid growth — as most of us did in 2020/2021 — the numerator will grow disproportionately and mask poor retention.
2. The opposite is also true, if a company experiences a slowdown in growth — as most of us are experiencing in 2023 — the churn rate might look worse than last year's, without any change in actual churn performance.

In summary, how we measure churn makes it hard to truly understand the churn patterns of our business and compare performance to previous periods.

So if you are facing increases in your churn rate this year, you are not alone.

The decline in overall growth means that most SaaS businesses are feeling the same.

And while you might be hearing from your teams that more customers are cancelling due to the macro-environment headwinds, it's worth deep diving into your churn rate to understand if:

1. The cancellation pattern is truly getting worse (ie. a higher % of customers signing are cancelling)
2. The increase in churn rate is an optical illusion due to a decline in the growth rate (ie.the same % of customers are cancelling but the install base is growing at a slower rate),
3. The churn rate of specific cohorts is poorer, thus requiring additional analysis.

How Can You Correct The Deceptive Nature Of The Churn Rate?

There are many additional cuts you can add to your churn analysis that will help you to understand whether your business is getting better or worse at preventing churn.

A simple one I recommend you start with is to Fix The Timeline.

Because a key problem with churn is the cumulative nature of the customer install base, adjusting the timeline can already help uncover hidden cancellation patterns.

Here is how you do it:

• Create time-based cohorts: That means grouping customers depending on when they signed their first contract with your business, so you can analyse the churn in a more detailed manner.

• Adjust the Churn Rate formula:
  • Numerator: Look only at the customers who churned in the selected cohort
  • Denominator: Count of customers in that time-period bucket.

The final result will be an adjusted churn rate per cohort.

While it's not as neat as one simplified number, it will help shine a light on how different cohorts are tracking. 

Your new churn report will look like this:

 If your contracts are annual, in Q2'23 you will get a view of Q2'22 churn rate.

If you want to double-click and do a deeper analysis to understand what is causing the churn issue in specific cohorts you can further segment each bucket per contract age (ie. year 1, year 2 etc).

Communicating Churn Performance To The CFO

"To a CFO, a graph is worth a thousand words!"

This data will be instrumental when your CFO asks why your churn rate is increasing this year.

The knee-jerk reaction is to say the macro-environment is causing an increase in cancellations, and you will find no shortage of examples where this is happening.  

But a closer look into the churn data might reveal a different story. 

Consider this real-life scenario from one of my consulting clients:

Through cohort analysis, we discovered an interesting trend. Customers who joined in the final month of the quarter exhibited renewal rates nearly 5 points lower than other cohorts.

When we double-clicked, we could see year 1 churn was the driving reason for the poorer retention. But the story didn't end there.

A closer look at the customer profile unveiled a clear pattern. A majority of the churned customers enjoyed hefty discounts and were exempt from professional services requirements.

Why?

Sales reps, driven by challenging quarterly targets in 2022, had been allowed to waive essential services to close new business.

While is common knowledge in CS that customers that don't have the appropriate services are more likely to churn, having the data to back up the instinct is key to securing buy-in and driving action.

This customer decided that in the future they'd offer a special price for onboarding instead of waiving it completely. 

Moral of the story: This churn wound was self-inflicted, not macro-driven. 

TL'DR:

When the question about rising churn rates comes up, go beyond the surface and examine different customer cohorts to identify the underlying dynamics that might impact customer retention.

Start by fixing the timeline of the churn rate calculation.

Armed with these insights, you can drive strategic decisions, align incentives, and pave the way for sustainable growth.Don't let churn rate fluctuations obscure the full narrative. Remember, knowledge is power, and in this case, it's the power to conquer churn.

See you next Friday :D