10 SaaS analysts walk into a bar…
They grab a table, order a variety of drinks ‒ some PBRs, a bottle of wine, a few pitchers of beer ‒ and start discussing the nuances of SaaS metrics.
As the night wears on, the analysts start to leave one by one.
First to go are the 3 analysts who ordered PBRs. “We’re all out of money,” they explain, and head into night.
The next to go is the analyst who ordered the bottle of wine, who exits in a huff: “I’ve now ordered the two most expensive bottles of wine on the menu,” she says, “and they’re both awful! I’m going to the bar across the street.” She pays, unhappily, and leaves.
Another hour passes before three of the remaining analysts finally finish their big pitcher of beer. They have a brief debate about whether to order another before ultimately deciding to get their next pitcher at another bar. “It’s been real,” they say as the head for the door.
Four quite tipsy analysts remain.
After another half an hour, three of the four decide to order another round while the fourth scrawls feverishly on a napkin with a look of complete concentration on his face.
“What are you doing?” the other three ask him.
“I’m trying to calculate the churn rate of this bar.”
The 3 Types of Churn
This is a joke (and perhaps not a very good one), but it actually sheds light on an issue that plagues SaaS companies around the world. Everyone knows that churn is incredibly important to SaaS success, but there is still no real consensus on the best way to measure it. Like the final analyst, they’re left desperately trying to compare different types of cancelled contracts.
The most fundamental definition of churn ‒ the percentage of customers lost in a given month ‒ is used in most cases, and it’s…ok. It serves a specific purpose and, in many cases, it’s a totally satisfactory way to calculate churn.
But as SaaS matures, some really smart people are starting to question the validity of using that fundamental definition of churn (often simply called “customer churn”) as a one-size-fits-all approach to calculating churn rate.
In fact, there are now 3 commonly used methods for calculating churn, each of which has a specific use-case (and each exemplified by groups of analysts in the “joke” above).
Let’s take a look at them one by one.
Customer Churn (aka “Logo Churn” or “The Boring, Traditional One”)
As discussed above, this is the most common, straightforward method for calculating churn. What percent of customers do you lose in a given month? When people refer to a “5% churn rate” this is typically what they mean: in a given month, 5% of their customers discontinued their subscription.
In the joke above, customer churn is represented by the first 3 analysts who decided to leave. Each gave a different reason for leaving, but the result is the same: 3 out of the 10 analysts didn’t even make it to the second round. In this way, you could say that during the first round of drinks, the bar had a 30% customer churn rate.
But this explanation leaves something to be desired. First, it doesn’t account for the size of their bar tabs. These three analysts ordered PBRs, meaning that the bar was losing a relatively small amount of revenue by their churning.
The second thing this churn calculation doesn’t account for is the fact that, at the time these first three left, there were other analysts locked into staying because they hadn’t yet finished their drinks.
Luckily, there are newer methods for calculating churn that take these distinctions into account.
The standard calculation for churn is simply number of customers who cancelled service divided by total number of customers.
Revenue Churn (aka “But how does it affect my bottom line?”)
In all honesty, the bar might not be all the disappointed to lose those first three analysts. They each only ordered a can of PBR, and they were taking up valuable seats and eating handfuls of the complimentary peanuts. All in all, not that big a loss.
But when the bartender saw the fourth analyst leave, his heart may have sunk. This analyst had ordered two expensive bottles of wine, and by leaving, she was reducing what was likely to have been a massive tip. This is churn that actually hurts.
For companies with different-sized customers, revenue churn is a great way to understand the true loss of a churned customer.
And because lost revenue is the main byproduct of churn, many SaaS experts are starting to emphasize the importance of calculating revenue churn, not just logo churn.
To calculate revenue churn, you divide total MRR by cancelled MRR in a given month. This means you’re not just looking at how many customers left during a given month, but how much revenue was cancelled in that month (as a percent of total revenue entering that month). In most cases, losing one huge customer is a lot more painful than losing three small fish. That’s why revenue churn has become more important over the years.
And yet…it’s still missing something.
Discretionary Churn (aka “How many of my customers that had the option to leave actually left?”)
What the first two types of churn are missing is the idea of the contract, which, after all, is what SaaS is all about. If your company loses 5 customers out of 300 during October, you may think this is a positive result. That’s less than 2%! Not bad, right?
Well, not so fast. Many SaaS companies have annual contracts, which means that not every customer even has the ability to churn during a given month. Inspect those October churn figures again. You look closer and see that only eight companies in your customer base had contracts ending in October.
Discretionary churn is the percentage of eligible customers that churned during a given period.
This means that five out of eight customers churned (not five out of 300). And five out of eight (63%) is not a good churn rate. In fact, your business may be in serious trouble.
In the joke above, the three analysts sharing a pitcher of beer represent discretionary churn. They were unlikely to leave before they finished their pitcher, but once it’s gone, it’s decision time. The completion of a pitcher serves as the end of a contract. Should the analysts re-up? Should they pay and head to another bar? This is discretionary churn, and most SaaS experts believe it is the most meaningful way to calculate your SaaS business’ churn rate.
Churn For Every Occasion
The truth is that each of these types of churn have their place; it just depends on what you’re trying to measure. In different situations, each of these is the right choice. The key is knowing how each of them work and which is best for your given situation.
If you want to learn more about the 3 types of churn, check out our new one-page primer.
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