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SaaS Churn Rate: Why is it Critical in SaaS?

SaaS Churn Rate

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

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

Software-as-a-Service (SaaS) was launched to overcome the challenge of scalability that the traditional software licensing model had been facing for years. Issues like hardware requirements, manual updates, access limitations, and much more plagued the traditional on-premise software industry.

Though the SaaS model eliminated the majority of these issues, it led to a new set of challenges. These challenges were a consequence of advancements in cloud computing, diminishing capital requirements, and minimal barriers to entry.

For instance, advancements in cloud computing have led to an extremely competitive landscape across the world. Additionally,  this segment has witnessed exponential growth over the past decade and is showing no signs of slowing down.

To remain competitive, industry leaders have to be innovative in their approach. Also, they need to understand that the success of their subscription model will not depend upon the number of licenses they would sell. Rather, it would depend upon the subscriptions that the SaaS business would be able to retain for a long period of time.

In simple words, the true success of the subscription-based model business would depend upon its ability in maintaining long-lasting relationships with happy, loyal, engaged customers.

This means that one of the significant advantages of a SaaS business is its ability to grow predictable, recurring revenue. However, there is a caveat here. In case the customers of a SaaS business churn as fast as they convert, its recurring revenue will never reach its true potential.

Thus, a customer abandoning a product before the SaaS business recovers its cost of acquisition is worse than not acquiring a customer at all. Therefore, it is essential for fast-growing SaaS businesses to combat churn.

In this article, we are going to discuss what is SaaS churn rate, how to calculate SaaS churn, and what is a good churn rate for a SaaS business.

SaaS Churn Rate Meaning

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.

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In simple words, SaaS churn is a consequence of “paying customers” becoming “non-paying customers”. Thus, it’s very important for a SaaS business to understand the different types of churn, methods to evaluate churn, and steps to reduce churn.

As per research, it costs 5x more for a SaaS business to obtain a new customer than to keep an existing one. Additionally, a 5% increase in Customer Retention Rates leads to a 25% to 95% increase in profit. This does not only mean that loyal customers stick with the SaaS product. But it also means that they tend to buy more and refer more friends over time. 

Now, churn can either be active or passive in nature. The active churn is called voluntary churn and the passive churn is called involuntary churn. Note that both types of churn lead to loss of customers for a SaaS business. However,  each turn type occurs due to separate reasons. Further, a SaaS business needs to undertake different tactics to prevent the occurrence of such churn types.

Voluntary Churn Vs Involuntary Churn 

Voluntary Churn

Voluntary churn occurs when the customer of a SaaS business actively or voluntarily chooses to discontinue their service. There are many reasons why this happens. But some common ones include: 

  • The SaaS product or service did not meet customer expectations
  • Customers had a bad experience either upfront or throughout the course of their relationship with the SaaS company 
  • Misalignment of price and value where the value customers received did not justify the money they spent
  • Customers shifted to another competing product that provided a more attractive offer in terms of fulfilling customers’ needs and budget
  • The customer is going out of business and no longer needs a service 

The best solution to overcome voluntary churn is to have in place the right combination of engagement, positive customer experience, and perceived value.

Involuntary Churn

The product teams working at SaaS firms leave no stone unturned in ensuring that the customers continue to get value from their subscriptions. However, their efforts can go down the drain when a SaaS business loses a customer for reasons like payment issues such as expired, canceled, or lost cards. This is involuntary churn. 

As per research, 20-40% churn of a SaaS business is completely needless. It occurs due to failed, expired, and delinquent credit cards. This means that if a SaaS business currently has a churn rate of 5%, then one to two percentage points of that churn occurs for a needless reason. 

Involuntary churn is also called passive churn or delinquent churn. It is a critical matter of concern for subscription-based businesses. This is because such SaaS businesses usually capture a customer’s payment details at sign-up and store for processing future payments. However, over a period of time, such details become outdated. As a result, it leads to increased payment failure rates for SaaS businesses. 

Saas Churn Rate Calculation

The following section demonstrates different churn calculations to help a SaaS business have churn rate benchmarks. Such SaaS churn rate benchmarks can help a business to understand where it is now, identifies any red flag metrics, and set reasonable goals moving forward.

SaaS Churn Rate Formulas for Calculation

I. Subscriber Churn Rate

The Subscriber Churn Rate of a SaaS business is the rate at which its subscribers cancel their product or service subscriptions with the firm. The subscriber churn rate formula is:

Subscriber Churn Rate = Subscriber Churn Count / Start of Period Subscriber Count 

Let’s consider an example to understand the subscriber churn rate for a SaaS business. Say, a SaaS business ‘Y2K CRM’ had 300 subscribers at the beginning of the period. During the period that followed, it lost 15 subscribers. Thus, the Subscriber Churn Rate for ‘Y2K CRM’ during the period was equal to 5%. 

Note that the Subscriber Churn Rate is a critical financial metric, particularly for an early-stage SaaS startup. This is because it is the only metric that a SaaS startup needs to monitor in order to retain its customers in the initial phase of its business.

For large corporates, the Customer Churn Rate demonstrates the level of customer satisfaction. Furthermore, such a metric helps SaaS businesses to determine other important metrics. For instance, when a firm divides 1 by its Subscriber Churn Rate, it is able to calculate its average customer lifetime.

Note that determining and monitoring Subscriber Churn Rate is important for SaaS businesses. But, the most critical financial metric that they need to monitor is the MRR Churn Rate. 

II. MRR Churn Rate

MRR stands for Monthly Recurring Revenue. The MRR Churn Rate is the rate at which a SaaS business loses its Monthly Recurring Revenue from the canceled subscriptions of its existing paying customer base. This does not include new customer business. The MRR churn rate formula is:

MRR Churn Rate  = Churn MRR / Start of Period MRR 

Note that relative to the Subscriber Churn Rate, the MRR Churn Rate is a financial metric that indicates the impact of churn or loss of customers on revenue for a SaaS business.

Furthermore, the MRR Churn Rate also helps a SaaS business in identifying customer cohorts that are churning or abandoning their product or service subscriptions. Tomasz Tunguz, the renowned venture capitalist, has observed over the years that SMB’s churn at a much higher rate relative to larger and enterprise business customers. 

He created the table below to explain his observations on churn rate by customer segment:

SegmentMonthly Customer Churn %Annual Customer Churn %
SMB3-7%31%-58%
Mid-Market1-2%11%-22%
Enterprise0.5-1%6%-10%

The venture capitalist explains that SMB’s face such a situation because the SMB customers switch products more frequently given the switching costs are low. These customers are not as reliable as those of bigger companies. 

As a result, they churn or cease to use the product or service of a SaaS business. Such a churn inhibits the SaaS business’s growth and demands more capital investment in order to continue growing at the same rates.

This means that a SaaS business must analyze its MRR Churn Rate. This metric will help the firm in understanding whether lower MRR customers are churning or whether the SaaS business is losing high MRR customers. Note that losing high MRR customers will have a bigger impact on the revenues of the SaaS business.

In addition to this, the MRR Churn Rate can help a SaaS business in understanding it has the ability to manage such losses. This is especially important when a firm compares its MRR Churn Rate to the MRR associated with new customers that the SaaS business acquires during each period. 

Besides this, the MRR Churn Rate of a SaaS business can help the firm to forecast its future revenue performance when its scale of operations begins to expand. This means that it is important for a SaaS business to track its MRR Churn Rate quite early on in its lifecycle. It will help the firm in identifying issues that may not be visible by just tracking MRR. Thus, tracking MRR churn quite early on can give the SaaS business some time to pivot before it goes bust.

III. Gross and Net MRR Churn Rate

Gross MRR Churn Rate

The term ‘Gross MRR Churn’ is the sum of MRR lost from both canceled subscriptions and downgrades or contraction. The Gross MRR Churn formula is:

Gross MRR Churn = Churn MRR + Contraction MRR 

Likewise, the Gross MRR Churn Rate is the rate at which a SaaS business loses MRR due to both canceled subscriptions and contraction. 

Gross MRR Churn Rate = (Churn MRR + Contraction MRR) / Start of Period MRR 

It is important to note that these MRR metrics give a more in-depth look at the health of a business. This is because such a metric does not include expansion MRR. Accordingly, a low Gross MRR Churn for a SaaS business indicates that the business is healthy. 

So the question is that what is the acceptable Gross MRR Churn for a SaaS business? As per some of the renowned venture capitalists, this Gross MRR Churn for a SaaS business must remain below 2%. While others emphasize that a SaaS business must try to maintain this metric as low as possible. 

Note that a SaaS business will have a very high Gross MRR Churn Rate if it has a lot of new subscribers at the end of the year but approximately the same amount of revenue.

Net MRR Churn Rate

The term Net MRR Churn refers to the sum of MRR lost due to canceled subscriptions and contraction plus MRR gained from expansion upgrades and reactivation. Here reactivation means the customers who canceled their subscriptions previously but have come back and resubscribed the product or service. The Net MRR Churn formula is:

Net MRR Churn = (Churn MRR + Contraction MRR)+(Expansion MRR + Reactivation MRR)

Thus, Net MRR Churn Rate is the rate at which a SaaS business loses MRR from canceled subscriptions and contraction plus gains MRR from expansion and reactivation. The Net MRR Churn Rate formula is:

Net MRR Churn Rate = Net MRR Churn / Start of Period MRR 

The Net MRR Churn rate is an important financial metric that a SaaS business must monitor. It accurately represents the revenue churn of a SaaS business. In addition to this, the Net MRR Churn Rate plays a great role in determining the overall strategy of a SaaS business.

Note that the Net MRR Churn metrics combine both unhappy and happy subscribers. These metrics give a SaaS firm a complete snapshot of its business. As a result, the business is able to analyze whether it is succeeding or failing in its efforts. 

Furthermore, the Net MRR Churn metrics include cross-sells, up-sells, organic growth within a customer account, and price increases. Thus, they are important financial metrics as they help a SaaS business to understand the consequences if it is not able to acquire any new customers.

IV. Negative Churn 

The negative churn of a SaaS business indicates that the value of its existing customer base is growing without considering any business from its new customers. It is important to note that only Net MRR Churn Rate can be negative of all the Churn metrics as it is calculated using Net MRR Churn. 

The venture capitalist gives the following example of a company that has achieved 5% negative churn in one of his posts:

Negative Chrun in SaaS Churn Rate
Image Source: Tomasz Tunguz

The above graph showcases that a company may lose 5% of its customer base each month. However, the remaining 95% of the customers grow their spending with the startup by 10 percentage points. So the total revenue from the cohort is equal to 105% of the revenue from the previous month. 

Thus, there is always a scope for improvement even if a SaaS business achieves negative churn or a low net churn. This means that the gross churn can be a more accurate measurement of how a SaaS team works.

How To Reduce Churn in SaaS?

The following are the ways in which a SaaS business can reduce its churn.

I. A Good Onboarding Process

Note that significant customer takes place between customers signing up for the SaaS product and achieving their first “success” with the product. 

In the case of a SaaS-based business model, customers pay for the SaaS product because they want to resolve a problem. However,  it is going to experience churn if the firm is too slow in helping the customers to reach their first success with the product. That’s because customers start looking for alternative solutions as they want to fix their problems as early as possible. 

To overcome this issue, it is important for a SaaS business to have a great customer onboarding process in place. Such a process makes the journey of the customer between signing up and achieving their first success with the SaaS product quite seamless. That’s because the SaaS business is able to lay a definite path for its customers to follow from sign-up to first success. 

Thus, a SaaS firm must identify the first success its customers are aiming for. Further, it must create an email sequence or an in-app tutorial to help them achieve the same.

II. Consistent Customer Success With The Product 

There is no guarantee that the customers of a SaaS business would continue using the product or service of the firm even if they achieve their early success with the product. 

Note that the customers of a SaaS product or a service have immense expectations. Further, such expectations are just not restricted to a single stage of the customer journey. In order to stick to a product, they need to make consistent progress towards a series of their smaller goals.

In case they are unable to achieve those successes with the product, their chances of abandoning the product become high.

To overcome such a challenge, a SaaS business needs to help customers make continual progress with their product or service. It needs to understand customer goals and make every effort to help them move closer towards their desired outcomes.

III. Seamless Customer Support 

A SaaS business may encounter complaints from customers while using the SaaS product on a day-to-day basis. To overcome such issues, the SaaS business may have to offer fast, responsive customer support. Otherwise, the customers may shift towards alternative solutions.

This means that if it is a tough task for the customers to speak to a customer support representative of a SaaS business, their chances of churning are likely to increase. 

The SaaS business can fix this issue by making customer support a priority. It can use live chat tools and have dedicated Customer Support staff in place for its customers.

IV. Help Customers Achieve Success With the Product

At times, customers shift to alternative solutions despite a SaaS business making immense efforts to satisfy their desired outcomes and retain its customers.  This happens as the customers believe that the competitive SaaS solutions have better features and offer seamless customer support.

This means that a SaaS business has to ensure that it is helping its customers reach their first success milestone of the product quickly. If the customers reach their first success with the SaaS product quickly, their chances of churning are lower. 

The other way through which a SaaS business can resolve this issue is to differentiate the SaaS solution from other competitive solutions. Note that the product differentiation must be such that it is difficult for the end-user to compare the SaaS product with the rivals.

V. Help Customers Achieve Success With the Product

At times, there is a misalignment between customers’ expectations and the features that a SaaS product offers. Such a product will never satisfy customers as it is the wrong product for the job. 

This typically happens when a SaaS business attracts the wrong customers for its product. Note that a SaaS business reaches such a state either when there is a lack of understanding on its part regarding the ideal customers or it sends wrong product messaging.

The best way to avoid this type of churn is to understand the ideal buyer persona in as much depth as possible. A SaaS business can make use of surveys and interviews to get a deeper understanding of the customer needs. Further, such a business display clear messaging on their website to attract only the ideal buyer personas.

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