Categories Articles, SaaS

The easiest way to grow profit is to continue to profit off current customers. Churn, on the other hand, is the easiest way to lose money that is otherwise guaranteed.

Churn rate is a dangerously undervalued sales metric, especially in early-stage SaaS companies. It measures how many customers you retain and at what value – a key indicator of the overall health of your business. As a company grows, revenue from existing customers becomes a bigger and bigger part of the company’s value.

Executives need to focus on retaining customers just as much as they focus on acquiring new customers. Churn rate should be valued as much as growing the pipeline. Typically, growth and revenue are an executive’s highest priority metrics – sales, sales, sales! But the cost of retaining a current customer is lower than the cost of acquiring a new customer, and continuous revenue can be a sure thing if customers are happy.

SaaS relies on customer retention

SaaS companies have a unique revenue model because money comes in from customers continuously over the customer’s lifetime, which could be months or years. In a traditional software business, 2 sales have to be made: acquiring the customer, and then retaining that customer to maximize their lifetime value. When customers are happy, they will up-sell and the profit attained from them will increase over time. When customers are unhappy, they will churn – meaning they will not up-sell – and the company will probably lose the money they originally invested in acquiring those customers.

For a SaaS company, a continuous relationship with a customer is powerful: you can get their feedback, see which features they are using and not using, and so on. But they also have the ongoing opportunity to “break up with you” at any time, which is why investing in customer happiness is so critical in today’s business world.

Unfortunately, it’s all too common for start-up executives to disregard churn. They don’t want to spend the time or resources when their primary focus is on growth and increasing the market share. But after 2 or 3 years, this philosophy can have devastating consequences. The negative effects of churn are cumulative: the customer revenue you lost in 2013 will also be gone in 2014, and 2015, and so on.

Why a low churn rate can double your company’s value

Following heavy upfront costs to acquire new customers, SaaS businesses will eventually see growth in number of customers and revenue. When a business reaches this point, success will come from retaining these customers. Few executives acknowledge the importance of retaining their customer base because they are so focused on exciting bookings numbers. But churn rate can directly stunt or reverse that revenue growth. If your business starts losing customers faster than you are picking them up, then you will leak water out of the bottom of your bucket – it doesn’t matter how fast you pour water into the top, you could still end up with no water at all.

Analyst Mikael Blaisdell came up with a strong example, illustrated in the table below, of how a 10% difference in churn rate can double a company’s valuation after 5 years. His example tells the story of two companies as they grow over a 5-year period. Both companies share the same customer number, price, and acquisition costs, but Company A has a churn rate of 5% and Company B has a churn rate of 15%. After 5 years, Company A is valued at $28.7 million, while Company B is valued at only $13.7 million.

[styled_table]
Company A Company B
Churn rate 5% 15%
# Customers added / month 10 5
$ Customers pay / month $1,000 $1,000
CAC (Customer Acquisition Cost) $12,000 $12,000
5 YEARS LATER…
# New customers acquired 600 600
# Customers lost 30 120
Run rate $6.3 million $4.5 million
Estimated value of company $28.7 million $13.7 million
[/styled_table]

Company A probably invested more money upfront in customer happiness to drive up-sell, but because their customers have a longer lifetime value, Company A brought in a lot more revenue over time that they are able to invest back into customer acquisition. The result: accelerated growth.

How is churn prioritized in your SaaS business?

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