What is Churn Rate? Definition, Calculation, and SaaS Benchmarks

Analyzing churn in your business

So why is churn rate so important for SaaS companies? Churn rates are important for SaaS companies since they are a great way to measure how secure your revenue streams are in the long run.  

Churn can influence your growth rate. The higher your churn, the more money you’ll have to spend to maintain your company’s growth. This is because for every single customer that churns, you need to attract two new customers to maintain growth (one new customer to replace the one you lost and another new customer to grow). As customer acquisition costs much more than customer retention, maintaining growth through high churn is costly.  

Churn also has a negative compounding effect, meaning that seemingly incremental changes in churn can have an outsized impact on your revenue over time. As illustrated in the figure below, if your company’s monthly churn is 3%, the negative impact on your revenue is initially relatively small but grows larger over time resulting, in our example, a loss of 31% of your customers and the revenue they bring into your business. And if your churn grows by 2%, that loss becomes 54%. Replacing the revenue lost through churn with new bookings becomes increasingly difficult over time, which is why churn remains an important metric to track.

Here are a few other useful insights churn can provide for your business:  

Churn rate is used to calculate your average customer lifetime in months – You can calculate your average customer lifetime using the formula, 1/monthly churn rate.

• The result is one of the values you’ll plug into your company’s lifetime value (LTV) formula, which determines the average revenue produced by each customer.
• Churn rate is a key part of your net revenue retention (NRR) – NRR and Rule of 40 are directly correlated to a company’s valuation. Reducing churn will increase your NRR.  
• Churn can provide insight on the pricing and packaging of your products – Looking at churn rates and the reasons it occurs in different dimensions of your business (e.g. product line, segment, or region) offers insight into whether your pricing and the packaging of your plans is affecting customer retention.

How to calculate churn rates?

There are a few different ways that the SaaS industry calculates churn rates. We recommend calculating it by considering only those customers whose contracts are coming up for renewal. This is key because if your company is not based on monthly renewals and your customers instead sign annual or multi-year contracts, calculating a churn rate that includes all your  customers (or their ARR) would result in a lower churn rate that is not representative of your business.  

You can calculate customer churn rate using this formula:  

Although “churn” in a business typically refers to customer churn, you can also calculate revenue churn rate. Customer churn rate and revenue churn rate are essentially two sides of the same coin – they tell you how much business you’re losing, either in terms of customers or revenue due to churn. The revenue churn rate formula, which also factors in the offsetting effects of upgrades, is slightly more complicated:

There is, however, a simplified way to calculate revenue churn rate if you want to look only at revenue churn without consideration of how new revenue from upgrades might be offsetting the revenue loss from churn:

Steps to calculate your churn rate:

• Choose the time period over which you want to determine your churn rate. You can use any time period that’s relevant to your business, but churn rate is typically calculated on a monthly or annual basis.

• Determine the values for the variables in the formula you’re using (either the number of customers or ARR) that you had at the beginning and end of the chosen period. Note that to get the value for Upgrades in the revenue churn rate formula, you’ll also need to calculate expansion ARR throughout the chosen period.

• Divide the amount of churn (either the number of customers or the ARR) over that time period by the value for the same variable (number of customers or ARR) at the start of the period.

• Multiply the result by 100 to get the churn rate.

Calculating churn rates - An example

Here is a simple example of calculating the annual customer churn and revenue churn rates for a SaaS company. Here are the values we have to work with:

Our example company has two SaaS product tiers:  

• Basic - 10,000 customers paying $200 a month  
• Pro - 2,000 customers paying $800 a month  
  

The ARR for each of these product lines is as follows:

• Basic - (10,000 customers * $200) $2,000,000
• Pro - (2,000 customers * $800) $1,600,000
• Total MRR -  $3.6M from 12,000 customers

Let’s assume that in one month:  

• 400 customers on the basic tier churn
• 50 customers on the pro tier churn
• None of the customers on the basic tier upgraded their subscriptions

Here’s how we can use this information to calculate the company’s monthly customer and revenue churn rates with the formulas provided above:

‍‍What affects churn rates?

Customer and revenue churn is caused by three main factors:  

• Change in ownership – For example, if a business is acquired by a new parent company using different software or business models, it can cause an increase in churn.  
• Change of sponsor – When the person who bought your product (the product champion) leaves the company, it increases the risk of the subscription getting cancelled.  
• Customer dissatisfaction – Many circumstances can cause customer dissatisfaction, including poor customer service or customer experience, slow time to value, a sub-par onboarding experience, or missing features and security requirements.

Another type of churn, known as delinquent or involuntary churn, happens regardless of your customer’s opinion of your business or product.  

Common causes of delinquent churn are when:  

• The credit card attached the account has expired.
• There are insufficient funds in the customer’s account.
• The bank prevents payment in an attempt to protect your customer from potential fraud.
• Some sort of technical glitch has prevented the payment from going through.

According to Recurly Churn Rate Benchmarks, SaaS companies lose more than 1% of their customers to delinquent churn every year. Companies can reduce this number using decline management techniques like account updater services or dynamic retry logic.  

How do you reduce churn rate?

How to reduce churn rate is a question routinely product development and customer success teams by company management. Unfortunately, there isn’t a straightforward answer.  

One way to reduce your churn rate is to regularly highlight the value your product has provided your customers over time. By illustrating how your product is helping your customers meet their objectives, you increase their confidence in the investment they have made with your company and reduce their likelihood of churning.  

Additionally, the following steps can help the relevant teams analyze and reduce churn rates:  

• Survey prospects that didn’t convert after trials  Learning why they chose not to sign up will reveal shortcomings in your products and processes that you might be able to improve on.  
• Offer incentives to existing customers – Running promotions or offering discounts to existing customers near the end of their subscription period encourages them to renew, thereby reducing customer and revenue churn.
• Increase your average subscription length – The longer a customer stays subscribed, the lower the customer and revenue churn rates. An annual subscription billing model will, therefore, result in lower churn rates compared to a month-to-month alternative.
• Experiment with longer term contracts – This can help reduce the opportunity to churn. Generally speaking, enterprises are much more willing to sign longer term contracts than small or medium sized business (SMBs).  
• Look deeper into your churn – depending on how many markets or verticals you serve, you may find that some of them are more likely to churn than others or other types of trends. By evaluating different aspects of your churn, you can uncover insights that you can act on to reduce it.  

Ideally, negative churn should be your goal. Negative churn happens when expansion ARR exceeds churn ARR. Some of the ways to achieve negative churn include:  

• Upselling by encouraging existing customers to subscribe to additional seats, or premium plans, or add-ons, or encouraging higher usage.
• Cross-selling by offering customers additional products when they subscribe to one of your services.

What is a good churn rate?

The lower your churn rate, the better. It’s a statement that really goes without saying but also leaves a lot of room for speculation. No matter how big or successful your SaaS company is, some amount of churn is inevitable. But how much is too much churn?  

Looking at churn through the lens of retention

Very few companies report their churn rates. However, there may be some insight to be gained by looking at the RevOps Square 2022 SaaS Benchmarks, where you can find some interesting information about logo retention rates (among other things). Since churn is the opposite of retention, we can use these results to get some insight as to what churn looks like for companies of different sizes and for different annual contract values (ACVs).

The problem with churn rate

Considering the variations in churn rates shown above, it’s obvious that there is no single acceptable churn rate range across the board for SaaS companies. This is because churn is affected by a few factors:  

• Contract length – Your churn rate can vary depending on the lengths of the contracts you sign. Longer contracts have fewer opportunities for cancellation compared to shorter contracts.  
• Niche-industry price benchmarks – A company offering a niche service or product at a competitive price is likely to experience lower churn rates. Because switching to a reliable competitor may be challenging and more expensive, customers are less likely to leave.  
• Insufficient reporting data – Only a few SaaS companies publish their churn rates, and when they do it’s typically only a general range. As a result, it can be difficult to compile enough data to accurately determine average and ideal churn rates.

Given these factors, how can you figure out whether your churn rate is normal or a cause for concern?

What is your ideal churn rate?

The ideal churn rate for your business depends on a variety of factors, and there’s no one-size-fits-all percentage across the board. It’s always good to look at how your direct competitors are doing, but that’s often not possible.  

According to SaaS Performance Benchmarks, the median annual ARR churn rate for a company with up to $5 million ARR is 12%. The median annual customer churn rate is 14%. If possible, Keeping these benchmarks in mind during your SaaS company’s continuous planning will let you gauge the performance of your customer retention efforts.