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Customer Renewal Rate

If you are a SaaS business, then you must read this article for the following reasons:

  • What is Customer Renewal Rate?
  • How to calculate SaaS Customer Renewal Rate?
  • Why is there a need for your business to calculate this financial metric?

Customer Renewals are a key part of a SaaS business’ support services. Accordingly, SaaS companies must have customer renewal practices in place to proactively capture renewal revenue opportunities.

A SaaS business’s Renewal Rate helps owners and other stakeholders to undertake the cost-benefit analysis of the SaaS product’ or service’s renewal business. In addition to this, such insights help business owners contribute towards sustained revenue streams. Also, the Customer Renewal Rate helps SaaS businesses avoid a lapse in support for customers’ business-critical networks.

Furthermore, having the customer renewal practice in place requires SaaS businesses to invest in resources. It also requires them to implement processes to manage contract changes and transact renewals. 

Note that the performance metric levels of a SaaS business may decline if it fails to act proactively and pay rigorous attention to service sales. Furthermore, reduced performance metric levels may lead to reduced conversion and renewal rates. All of this means that the SaaS business will not be able to compete in the market.

To help SaaS businesses work on their renewal rate, we are going to discuss a set of guidelines and considerations related to customer renewals. We will also discuss how a SaaS business can calculate customer renewal rates in order to capture renewal opportunities.

What is the Customer Renewal Rate?

The Customer Renewal Rate is a key SaaS metric that measures the percentage of customers who renew their contracts with the SaaS firm when their contract is up for renewal. 

It is a ratio between the customers who renewed their contract at the end of a given period and customers who could have renewed their contract at the end of a given period. 

Furthermore, to evaluate this ratio, one must also take into account the competitive environment and the costs of switching to a new service.

Thus, the Customer Renewal Rate indicates the value that customers derive relative to the cost they pay for a SaaS product or service on renewing their contracts. 

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Note that customer renewal includes initiatives that a SaaS business takes to preserve the existing recurring revenue streams. These are the revenue streams that the business created in its earlier stages. 

Further, the recurring revenues that SaaS businesses generate from their ongoing licenses, support, and maintenance are extremely vital. Hence, these businesses must optimize their recurring revenue streams for their long-term health and success.

Types of Renewals

Note that a growing business may have the following types of renewals: 

i. Non-Renewal

This includes the customers who leave or abandon the SaaS product and do not contribute anything to the firm

ii. Downgrade

Downgrade includes customers who buy a different product from the same SaaS firm. But such a product contributes less revenue than their previous purchase

iii. Discounts or Price Cuts

These include the discounts or other pay cuts that are given to the customers for using the same product. That is customers pay less for using the same SaaS product.

iv. Straight Renewal

This includes the subscription renewals that customers make of the same product at the same price

v. Lower Discount or Price Increase

The lower discount or price increase renewals include the product renewals by the customers of the same product but at a higher price.  

vi. Upsell

In the case of the Upsells, the customers buy a more expensive product compared to their previous purchase of the subscription. Thus, such renewals contribute more revenue than their previous purchase.

vii. Win-Backs

Win-Backs refer to the former customers who returned.

Renewal Rate Calculation: How Do You Calculate Client Renewal Rate?

A SaaS business can use the following Renewal Rate Formula to determine its customer renewal rate:

Customer Renewal Rate % = 100% – Churn Rate

Or

Renewal Rate = Value of contracts renewed/Value of contracts up for renewal

Or 

Renewal Rate = Number of customers who renewed their contracts/Number of contracts up for renewal

From the formula above, it is clear that the customer renewal rate is the opposite of the customer churn rate

SaaS Churn Rate refers to the rate at which a SaaS business loses its customers or revenue through the cancellation of subscriptions. It measures the percentage of customers that SaaS business loses over a specific duration of time.

In simple words, SaaS churn is a consequence of “paying customers” becoming “non-paying customers”. 

Thus, a SaaS business can calculate churn rates based on either its customer count or recurring revenue. The churn rate does not include new customers or new recurring revenue brought onboard during the period. 

Calculation of Churn Rate Based on Customer Count

To calculate Churn Rate Based on Customer Count, a SaaS business can use the following formula:

Churn Rate = Number of Customers Lost in a Period/Number of Customers at the start of the Period

Let’s consider an example to understand how we can calculate Churn Rate based on customer account.

Say, IKIGAI, a SaaS-based CRM product started its business in the month of April with 1000 customers. It acquired 100 new customers in the month of April. Also, during the month of April, IKIGAI lost 50 customers out of the existing 1000 customers. 

Accordingly, IKIGAI’s monthly churn rate for April would be:

Churn Rate = Number of Customers Lost in a Period/Number of Customers at the start of the Period

Churn Rate = 50/1000 = 0.05%

Now, suppose that IKIGAI wants to calculate its yearly Churn Rate. The following are the details:

  • IKIGAI started business in April 2020 with 1000 customers
  • It acquired a total of 300 new customers during  2020
  • IKIGAI exited the CRM business in March 2021 and hence lost 200 out of the 1000 existing customers.

Accordingly, IKIGAI’s yearly churn rate for 2020 would be:

Churn Rate = Number of Customers Lost in a Period/Number of Customers at the start of the Period

Churn Rate = 200/1000 = 0.20 or 20%

Note that SaaS businesses may take into account “win-backs” or the former customers that return as customers within a time period, that is, 12 to 24 months.  These customers return as renewed customers. In such a case, it is possible that the SaaS business may have a negative churn rate.

Calculation of Churn Rate Based on Recurring Revenue

To calculate the churn rate based on Recurring Revenue, a SaaS business can use the following formula. Note that the churn rate based on recurring revenue also includes the SaaS product price changes, upsells, and downgrades.

Churn Rate = Recurring Revenue Lost in a Period/Recurring Revenue at the start of the Period

Monthly Churn Rate Based On Recurring Revenue

Let’s consider the same example to understand the churn rate based on recurring revenue. 

Say, IKIGAI, a SaaS-based CRM started business in the month of April with 1000 customers. They had an Average Revenue Per User (ARPU) of $50. This means IKIGAI started the business with a Monthly Recurring Revenue (MRR) of:

Monthly Recurring Revenue (MRR) = Number of Customers x ARPU =  $50 x 1000 = $50,000

Now suppose that IKIGAI loses 50 out of 1000 existing customers. Note that these were high-paying customers with an ARPU of $60. This means IKIGAI loses an average MRR of:

MRR Lost = Number of Customers lost x ARPU lost = 50 x $60 = $3,000

Also, IKIGAI’s monthly churn rate based on customer count is:

Churn Rate = Number of Customers Lost in a Period/Number of Customers at the start of the Period

Churn Rate = 50/1000 = 0.05 or 5%

Accordingly, the MRR Churn rate would be:

MRR Churn Rate = MRR Lost in a Period/MRR at the start of the Period

MRR Churn Rate = $3,000/$50,000 = 0.06 Or 6%

Note that the MRR churn for IKIGAI is higher than its churn rate based on customer count. This is because IKIGAI lost its higher-paying customers.

Yearly Churn Rate Based On Recurring Revenue

Let’s consider the same example to calculate the yearly churn rate based on recurring revenue. Say, IKIGAI started business in April 2020 with 1000 customers and an ARPU of $40,000. 

Thus, IKIGAI’s Annual Recurring Revenue (ARR) is:

Annual Recurring Revenue (ARR) = Number of Customers during the year x ARPU = 1000 x $40,000 = $40,000,000

Further, IKIGAI exited the CRM business in March 2021 and hence lost 200 out of the 1000 existing customers. The lost clients were low-paying customers with an average ARPU of $20,000.

Therefore, IKIGAI lost an ARR of:

ARR Lost = Number of Customers lost in a year x ARPU lost

ARR Lost = 200 x $20,000 = $4,000,000

Note that IKIGAI’s annual churn rate for 2020 is:

Churn Rate = Number of Customers Lost in a year/Number of Customers at the start of the year

Churn Rate = 200/1000 = 0.2 or 20%

Accordingly, the ARR Churn Rate of IKIGAI is:

ARR Churn Rate = ARR Lost in a Period/ARR at the start of the Period

ARR Churn Rate = 200 x $20,000 = 0.1 or 10%

It acquired a total of 300 new customers in 2020.

Note that the ARR churn of IKIGAI is much lower than its Churn Rate based on the customer count. This is because IKIGAI lost its lower-paying customers.

What Does Customer Renewal Rate Indicate?

The Customer Renewal Ratio of a SaaS business indicates the rate at which customers renew their subscriptions. It measures the percentage of customers of a SaaS business who renew their contracts when their contract is up for renewal.

Thus, customer Renewal Rate is an important customer retention SaaS metric that is used to assess the health and performance of a SaaS business. Note that both customer acquisition and customer retention are equally important for a SaaS business. 

This means the higher the customer renewal rate, the greater is the customer loyalty. 

Also, the higher the customer retention rate, the higher is the sales and marketing efficiency of a SaaS business.

Note that a SaaS business from launch through the scale phase determines financial metrics that measure its sales and marketing effectiveness. In simple words, the SaaS business measures the effectiveness of its sales team to convert a lead into a paying customer across the sales cycle.

Further, it measures the leads-to-trial conversion ratio to measure the success rate in persuading the leads to try out the SaaS product.

Then, the SaaS business also determines the trial-to-paying account ratio to measure the conversion rate to the next stage. And that is how a lead becomes a paying customer with a signed subscription contract.

What is the Difference Between Renewal Rate and Retention Rate?

The following table showcases the difference between Renewal Rate and Retention Rate:

AttributeRenewal RateRetention Rate
DefinitionCustomer Renewal Rate is a key SaaS metric that measures the percentage of customers who renew their contracts with the SaaS firm when their contract is up for renewal.  Customer retention refers to the set of customers who continue to transact with the SaaS firm. It indicates the level of success of a SaaS business in maintaining a long-term relationship with its customers.
PurposeCustomer Renewal Rate indicates the value that customers derive relative to the cost they pay for a SaaS product or service on renewing their contracts.Customer retention focuses on the continuity of transactions with the firm.
Activities IncludedCustomer renewal includes initiatives that a SaaS business takes to preserve the existing recurring revenue streams. These are the revenue streams that the business created in its earlier stages. Customer retention includes the whole set of activities that a SaaS business undertakes to nurture customers and maintain a long-term relationship with them.
Renewal and RetentionCustomer Renewal is a part of customer retention.Customer Retention includes customer renewals.
FormulaRenewal Rate = Number of customers who renewed their contracts/Number of contracts up for renewalCustomer Retention Rate = ((Number of customers at the end of period -Number of customers acquired during the period) / Number of customers at the start of period)) x 100
ImportanceAssesses the health and performance, measures sales and marketing effectiveness measures the leads-to-trial conversion ratio, determines the trial-to-paying account ratio..Increases purchases, lower price sensitivity, lower cost of customer management, gives customer referrals

How To Increase Customer Renewal Rate?

The Customer Renewal Rate formulas are simple to understand and implement tools to determine the percentage of customers who are loyal to a given SaaS business.

Good or high renewal rates can help a SaaS business in overcoming some serious challenges and create opportunities for increasing revenue.

Thus, it is important for a business to continue improving its renewal rates. A SaaS business can evaluate the following four areas in its business to optimize its renewal rates.

I. Track Renewal Performance By Customer Segment

The first step in understanding and improving customer renewal rates is to determine the factors that help in increasing such rates. Note that renewal rate is a key SaaS metric that helps a firm to determine the effectiveness of its product or service revenue performance. 

Typically, the renewal rate is based on the transaction size. However, this number alone will hardly help a business to understand the effectiveness of its product or service revenue performance by customer segment.

Thus, it is important for a SaaS business to capture renewal rates by customer segment. It will give a better snapshot of product or service revenue performance and customer retention of a business.  

Note that determining renewal performance by customer segment helps a business to identify the strengths and weaknesses of its renewal process. 

For instance, even a small decrease in annual renewals of a customer account can result in a huge decrease in business revenue over a period of time.

On the contrary, higher renewal rates indicate customer loyalty and retention which further helps in driving sales growth.

Thus, capturing renewal rates by customer segment helps a business to analyze renewal rates by customer size, geography, or industry. Further, it can also help a business in evaluating the cost-of-sale or cost of acquisition by customer segment. As a result, such insights help a business to allocate resources in a better way.

II.  Monitor The Time Period of Renewals

It is not enough for CFOs to track just the customer renewals. They also need to track the time when such contracts get renewed. This may help the CFOs in identifying the hidden challenges.

For instance, a SaaS business loses revenues immediately and increases the chances of lost renewals if many of its customers are literally waiting to pay until after expiration. That is, such customers are not aware of the upcoming expiration date and hence fail to make payments for product or service subscriptions on time.

As the time-lapse increases, these customers start considering themselves as invaluable. Hence, they do not renew their subscription.

The key to resolving such a challenge is proactively managing these customers. SaaS businesses can reach out to such customers early before the expiration. This helps them to close a contract before it expires. 

III.  Track the Renewal Size

Note that SaaS businesses may suffer a decrease in the size of the renewals from certain customers. This can be due to several reasons like product downgrades, change in the number of products covered, or discounting. 

Initially, such a decrease in the renewal size may not impact the business significantly. However, over a period of time, it may lead to significant revenue loss. 

It is important to note that once a contract expires and the customer does not renew the same, it may accelerate the erosion of renewals all the more. This may happen due to several reasons.

For instance, the longer the time-lapse between expiration and renewal, the greater is the likelihood of erosion of renewal. Then, once the contract expires, it increases the cost and difficulty of renewal. This happens because penalties after expiration make customers less likely to renew. Also, the customers may start looking for alternative SaaS solutions once the contract expires with a firm.

But, a SaaS business can take appropriate steps to fix the erosion of renewals if it knows what’s happening with each renewal. For instance, if there are more product downgrades, then the SaaS business can increase its marketing to ensure that customers realize the value of premium products.

This means that a SaaS business needs insights with regards to the reasons why product downgrades are happening. Such insights will help the business in making requisite strategic improvements.

IV.  Know the Reason For Non-Renewal

It is important for a SaaS business to understand why the customer does not renew his subscription. There can be several reasons for customers not renewing their product subscription. This may include lack of budget, product abandonment, choosing a competing product, or disliking the contract terms. 

When the time of renewal arrives and the customer chooses not to renew the product subscription, it is a great opportunity for the SaaS business to know the reasons for non-renewal.

These insights are very important for the business owner as it helps him in making improvements in product offerings. It can be the case that a customer has not renewed a given subscription plan has he has upgraded to a newer version of the product. This means that not all non-renewals are bad for the business.

Thus, tracking cancellation and its underlying reasons can help a SaaS business to win back its customers. 

What is Renewal Ratio?

As mentioned earlier, renewal ratio is the ratio of the customers who renew their contracts at the end of their subscription period to the customers who had a chance to renew their subscription.

Thus, the renewal ratio indicates the percentage of customers who renew their contracts with a SaaS business after their product subscription expires.

The Renewal Ratio is:

Renewal Ratio = Number of Customers Who Renewed Their Contracts At Expiration/Number of Customers Who Had The Chance of Renewing Their Contracts At Subscription 

Let’s consider an example. Say, IKIGAI, a cloud-based CRM solution, had in all 100 subscribers in Year 1 who had subscribed to a product plan of $100. At the end of Year 1, when the subscription of the subscribers was about to expire, only 80 customers renewed their contract. Rest 20 did not renew.

Accordingly, the Renewal Ratio for IKIGAI was:

Renewal Ratio = Number of Customers Who Renewed Their Contracts At Expiration/Number of Customers Who Had The Chance of Renewing Their Contracts At Subscription 

Renewal Ratio = 80/100 = 0.80 or 80%

What is a Good Renewal Rate for a SaaS Company?

As per Profitwell, the average churn rate for SaaS is around 5%. Also, 3% or less is considered a “good” churn rate. 

However, the churn rate figure varies across businesses and industries. This means there is no definite churn rate number for a SaaS business.

Based on the SaaS companies studied, the average churn rate (in terms of the number of customers churned) could be anywhere from 1% to 17%. Most studies reported a median monthly churn rate in the 5%-10% range.

As mentioned above, 

Customer Renewal Rate % = 100% – Churn Rate

Thus, we can say that the average renewal rate for SaaS is somewhere around 80%. The average numbers for renewal rates get better as companies get bigger. 

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