What is Churn Rate? How to Calculate Customer Churn (Definition + Meaning)

What is Churn Rate? How to Calculate Customer Churn (Definition + Meaning) process.st/churn-rate May 13, 2019

When it comes to running a business, particularly a SaaS company, understanding churn is vital.

There’s a lot to cover, so let’s cut straight to the chase.

In this Process Street article, we’ll look at: What is churn?

How to calculate churn rate Why do customers churn?

McKinsey’s 4 best practices to increase retention rates 15% 3 practical steps to reduce churn in your business The Harvard churn management algorithm Churn management resources to help you reduce churn Use Process Street to help you tackle churn in your business

What is churn?

Customer churn is a concept used to describe how well or poorly a company keeps hold of the customers it acquires – how many stop paying vs how many become long-term 1/12

customers.

Let’s look at that a little deeper.

Customer churn rate definition: Churn rate is the annual percentage of customers who choose to stop paying for, or using, a service.

Customer churn meaning: Customer churn is where a customer stops paying for the service you’re providing.

When you’re a startup, you can use customer churn’s relationship to customer acquisition to understand how far you are from having long-term engaged users from whom you can make a profit.

When you’re an established business, you’ll use customer churn figures to understand how much more money you could be making with improved retention, how you can improve your services to deliver that retention, and which customers are most likely to churn so that you can take preventative action.

That, broadly speaking, is what customer churn is and why it is useful.

Churn rate formula: Customers lost over the measured period divided by total customers at the beginning of that period.

But there is an alternative way…

How to calculate churn rate The basic way to understand churn rate is to take the number of customers you started with (let’s say per month) and then track how many of them you lost by the end of the month.

You also track how many new customers you gained during that month and how many of those new customers stopped paying during the month.

You add up the old customers who left with the new customers who left. This gives you the total number of customers who churned.

You then divide the number of customers who churned from the total customers at the beginning of the month. That gives you your churn rate for that month.

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You can use that principle to figure out what your average monthly churn rate was for a year, or to work out what an annual churn rate has been if you’re looking at a larger historical dataset.

However, there is a more interesting way to measure churn rate – and I think it’s better. It gives more consistency and less variable output.

Devin Brady from Recurly presents the idea of measuring churn on a daily basis.

Each day is essentially an opportunity for a customer to churn, so what you’re measuring is the probability of whether a customer churns in a month based on the number of opportunities to churn (days).

You take the same inputs as the previous method but calculate the number of days customers collectively spent active (remaining a paying customer).

You can see an image of their calculations below:

Source

The 0.5 in the calculation is the assumption that the churning customers were active for an average of half the month between them. You would replace that input based on how long churned customers were active on average before churning for the month you’re measuring. So you’ll need to add some data into there.

For a more in-depth analysis of this method and why it is useful, you can read that blog post here: A Better Way to Calculate Your Churn Rate.

To make this all a little more palatable, we can look at a few household name examples.

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These companies identified their churn and then tried to understand both the root causes and simple ways by which it could be significantly improved.

A lot of this concerns the most common aspect of churn: the churn of new customers.

This is where we see a big overlap with the typical conversations you might have about customer retention during the onboarding process.

Facebook knows that its platform is built on network effect – the more people who use it, the more content is made, the more other people use it, etc, etc.

At Facebook, the growth team split users into two categories. One category was likely to be daily active users and a benefit to the platform, the other category was likely to either be an infrequent user or churn entirely.

What was the key difference between these two categories? As I outlined in a previous article: “At Facebook, their growth team split users into two groups: those who became engaged users— using Facebook day after day—and those who didn’t, and they discovered something surprising.

Engaged users had added at minimum 7 friends within the first 10 days of signing up.”

This then informed the way the company thought about itself and designed the onboarding of its business: “In other words, they were able to predict a user’s future based on what happened within a very narrow time frame immediately after signing up. That metric became a very powerful driver in aligning everyone in the company towards getting new users to add 7 friends as quickly as possible during onboarding” Check out Facebook’s VP of growth, Chamath Palihapitiya, discussing that in more detail here:

Follow fast or churn – Twitter’s customer turnover Another example we have written about when discussing customer retention strategies is Twitter’s very similar experience.

Twitter’s Josh Elman found that there was a theme which linked active users: “It turned out that if you manually selected and followed at least 5-10 Twitter accounts in your first day on Twitter, you were much more likely to become a long term user since you had chosen things that interested you. And if we helped someone you know follow you back, then even better. As we kept tweaking the features to focus on helping users achieve these things, our retention dramatically rose.”

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This example, like the Facebook one, shows that you can track and analyze basic user data to understand what differentiates users who engage fully and keep paying, with those who slip away.

HubSpot tackled churn at the source To return to a more payment focus over the usage focus of Facebook and Twitter, HubSpot found that the best time to reduce churn was the moment the users sign up.

As AppCues describes: “In his talk at Price Intelligently’s conference entirely devoted to SaaS—SaaSFest—HubSpot product manager Dan Wolchonok described how improvements to the user onboarding in HubSpot’s Sidekick product proportionally increased the number of users using the product at every week in the customer lifecycle.”

Tackling the churn problem at its source gave proportional gains in the following weeks.

This translates to good numbers when you break them down: “User onboarding improvements drove Week 1 retention up to 75% from the 60s. Week 2 retention maintained that difference as it was up to the 60s from 50%. By Week 10, 25% of users were still using the product—rather than having only 10-15% of users actually active.”

Tackling churn before churn occurs is the best way to approach it!

Why do customers churn?

Now, sometimes customers churn for reasons that are not your fault.

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(Source)

There are loads of reasons. Perhaps those customers were looking for a product that just isn’t what you offer? Or they’re at a stage in their development where they can’t afford your price point? Or they’ve gone out of business?

Maybe some of those are your fault for misleading marketing or choosing to not offer a freemium plan, but they weren’t going to be your customers anyway. So you shouldn’t beat yourself up over them in regards to churn specifically.

You can complain to the marketing department that they’re bringing you bum leads instead.

This is why it’s very important to try to get feedback from users who cancel or leave to understand their reasons why.

If you’re a SaaS product, you might see these reasons presented:

Confusing user onboarding Onboarding is a really important stage to determine what your churn rate might be, as this is the stage where a customer learns what they can get out of your product and how to use it.

If you can’t teach them the basics here, then where and when are they going to learn it?

Short answer, a lot of them won’t – and will instead churn.

For an in-depth look at user onboarding go here: 9 User Onboarding Tools to Smash Your Revenue Targets.

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Your app needs to mature SaaS products develop and grow over time. Your product might just not be at the right stage in its development for every customer.

Take Process Street, we’re a business process management and workflow automation platform. That means people build their business processes as templates within the app and then run them as checklists to follow and get their best work done every time.

Now, we have the feature set to provide conditional logic in the execution of business processes, we can allow users to assign either whole checklists or single tasks to individuals or groups either manually or with role assignments, and we can connect with over 1,000 other apps and web apps via Zapier for you to automate activities on other platforms.

This isn’t sales copy!

These are examples of complex features which we didn’t have when we began.

They are also features we now have because customers requested them. Some customers requested new features and didn’t churn. But others did. Because for some customers, conditional logic wasn’t an added extra, it was a core need. So, of course, they churned.

As a software product in general, you need to understand what features your users want, and what features the users who churned wanted. This data can help you inform your priority development roadmap.

Then you can reduce churn gradually as these new features open up more reasons for users to stick about.

You’re charging too much Price is a tricky topic, always. Price is a common reason why someone might churn and it really comes down to how much value they’re getting from the product vs how much they’re paying you for it.

There is no perfect price point.

That said, you can do tests and analysis to figure out which price points – possibly on a leveled system – can maximize access to your product while driving the most revenue.

McKinsey’s 4 best practices to increase retention rates 15% 7/12

Churn as a concept finds its roots really in the telecoms industry. As such, McKinsey saw that as a good place to start when analyzing how companies approach the challenge of measuring, understanding, and tackling churn.

The outcome, really, was a set of business best practices which should apply to any company.

Understand your customer and their journey Like we saw with Facebook and Twitter earlier, the key to addressing churn lies in understanding your customer and their activity.

“Leading operators are structured and thorough in linking and aggregating disparate data sets to develop a full view of the customer over the entire decision journey—from acquisition and onboarding to upgrade cycles and eventual disconnect, if applicable.”

By focusing on the customer you can find ways to give them a better customer experience and impart increased value.

Use the best analytical methods you can

(Source, used under Pexels’ license)

Data, data, data.

Investing in your analytics helps you see the future. You’re able to map trends and determine predictions with varying levels of probability, including whether a customer will churn.

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For example, a leading operator used an analytical technique called “feature discovery” to identify over 50 variables that contributed to customer churn, as well as their relative importance. These variables included specific thresholds, such as combinations of phone type, data usage, and callcenter history that, once reached, reliably predicted customer attrition.

If you’re not measuring it, why aren’t you? Improving your analytics can be costly, but many companies would be surprised how much extra data they could gain overnight simply by bringing in the right tools or taking the time to set existing tools up in an optimized way.

Example: Almost everyone sleeps on Google Analytics.

Segment and microsegment your customers Through segmentation, you can create customized experiences and tailor your solutions to specific customer niches.

Such a tailored approach requires a granular micro-segmentation of the customer base which is then matched to a broad, well-classified library of offers. One leading operator, for example, developed a library of over 50 offers and then set up a mechanism for rapidly launching and measuring the related campaigns. As a result, the company was able to reduce churn by 10–15% over the following 18 months.

Customization and personalization is a growing trend, and customers are going to get more and more used to it with the proliferation of available tools.

Use agile process management techniques We love McKinsey for this one – mainly because we provide an agile process management software platform.

We find that industry leaders employ agile working methods that divide these tasks into short phases with frequent reassessments and adjustments to ensure the best results We know people can sometimes feel a bit wary or overwhelmed when first setting up their processes inside a platform designed to manage them, but it really helps in the smooth running of your business.

Don’t trust us – trust McKinsey!

Though, if you want to trust us, you’ll find a bunch of premade processes and instructional resources at the end of this article.

3 practical steps to reduce churn in your business 9/12

So, after McKinsey’s analysis of the 4 key trends across industry leaders in the sector that pioneered churn, what does the report recommend.

[W]e recommend setting a mandate for the role of analytics, establishing an analytics center of excellence, and moving from functional silos to cross-functional teams Their quote is indicative of the report, but here’s a slightly more detailed breakdown of the conclusions from me: 1. Document standard operating procedures for analytics to be incorporated and used across teams. If you build analytics into your processes then provided those are followed you will be mandating an appreciation of analytics across your organization.

2. Have a team which creates and improves analytical approaches for other teams across the organization to employ. This allows other teams to focus on their tasks and on generating value for the business.

3. Utilize teams with an array of skill-sets to increase knowledge spillover within the organization. This should allow teams to be more agile and reduce bottlenecks caused by information being transferred from department to department.

Sounds good, right?

Putting tech and cutting-edge management techniques together at the heart of your organization.

But that’s not all.

The Harvard churn management algorithm McKinsey’s research focuses on improving and structuring an organization to meet the demands of customer churn.

This Harvard research paper presents a more focused analysis of churn in organizations and enters a high level of complexity.

The paper is here: Managing Churn to Maximize Profits To note, this paper is now a few years old, so don’t let it be the end of your search for improvement. It just happens that this is the most in-depth analysis you’re likely to read.

The paper is put forward by Lemmens and Gupta and it suggests that we’re all looking at churn incorrectly.

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Sunil Gupta is the Edward W. Carter Professor of Business Administration at Harvard Business School and Aurélie Lemmens is an associate professor at the Tilburg School of Economics and Management.

Their theory is that looking at the customers you’re losing isn’t the most useful way to look at it. You should be looking at the profit you’re not making.

As in, if there are customers you haven’t upsold which you could have upsold, that could have the same impact on your business as a different customer stopping paying entirely.

You need to stop thinking only about churn and start thinking also about opportunity cost.

Traditional churn management seeks to do two things, according to Gupta and Lemmens: Identify who is going to churn Offer incentives to keep the customer “The two steps are not set up to maximize bottom-line profit of the retention campaign because they ignore a simple but important fact: Not all customers are equally important to the firm.” – Sunil Gupta, A Smarter Way to Reduce Customer Defections Adding in an interview: “You have to look at the net profitability of the retention campaign. If I offer an incentive to customers most likely to churn, they may not leave the company, but will it be profitable for me?

The traditional method is focused on reducing churn, but we contend the goal should be maximizing profits, rather than only reducing churn. People have been trying to refine and improve the method for the last 10 to 15 years, but many are missing the bigger picture.” – Sunil Gupta, The Harvard Churn Management Algorithm to Boost Profits 115% Gupta and Lemmens’ point is that not only are we missing out on retaining the right customers, but we’re also often wasting resources on retaining the wrong customers.

In sum, their model, presented in the above paper, looks like this: “To gain maximum profit from retaining customers, companies should consider not only the churn probability of customers, but also how much they spend, the likelihood that they will respond to a retention offer, and the cost of the offer itself.”

The paper is dense, but I recommend you give it a read.

Churn management resources to help you reduce churn To finish off, I thought we’d give you some extra resources to help you get started applying process management techniques to your churn management approaches.

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You can simply add any of these templates into your Process Street account to get started, edit them, and put them into practice.

Churn management resources quick links: Standard Operating Procedure (SOP) Template Structure ISO 9000 Structure Template ISO 9000 Marketing Procedures Upselling Process for SaaS Companies Churn Prevention Checklist

Use Process Street to help you tackle churn in your business If you’d like some extra resources and instructional materials to help you get started on process management, you can check out these links below:

Standard operating procedures and the basics of building processes Standard operating procedures and adherence to standards like ISO How to make the most out of Process Street for standard operating procedures

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