A recent study by Invesp found that 44% of SaaS companies are focused on customer acquisition, as opposed to just 18% that are focused on customer retention.
The focus on landing new customers makes sense to some degree. At launch, we are so focused on getting product-market fit, then gaining traction in the market and putting up good growth numbers. Before there is time for customers to churn it’s just about adding in as many new customers as you can. So, we build great sales and marketing machines.
But before we know it, if we aren’t careful, we find our growth being stunted on the top line by customer churn. And when that happens, a considerable proportion of the energy, time and money invested into growth ends up putting you on a revenue treadmill.
A SaaS company’s capital must be used wisely to maximize growth — regardless of its source or quantity. If revenue churn rate is too close to the capital burn rate, you’ve got a problem to solve. How capital is used has everything to do with how steep growth can be. Too much capital used to replace churned revenue is a recipe for a treadmill that makes it harder and harder to post strong growth numbers.
I’ve had it happen in my own SaaS business, I’ve seen it happen in my client’s businesses and I’ve heard woes of it from my friends who run SaaS businesses. It happens. But left unchecked, the growth treadmill that comes from revenue churn can burn through capital faster than you realize. You must have a solid grasp on the fundamentals of SaaS revenue metrics to understand the mechanics of why revenue churn is such an impediment to growth.
Understanding the fundamentals
You may already know this, but it never hurts to have a refresher. When you get all of these concepts, the puzzle of SaaS growth comes together.
- Customer acquisition cost (CAC): A company’s CAC is the total sales and marketing cost required to earn a new customer over a specific time period. Here’s a handy CAC calculator.
- Lifetime Value (LTV): The total revenue you can expect from a customer, on average. Here’s an LTV calculator.
- Customer churn: A customer who does not renew (a canceled customer). And yes, customer churn really sucks.
- Revenue churn: Here’s where it gets a little tricky. Gross revenue churn is:
“Gross revenue churn is the percentage of your revenue that is lost during a period due to customers canceling or downgrading.” And net revenue churn is “the percentage of revenue you have lost from existing customers in a period. To calculate net revenue churn, divide net revenue lost from existing customer in a period by total revenue at the beginning of a period. Net revenue lost is the difference of revenue lost from subscription churn minus new revenue from existing customers (i.e. upsells).” Thanks goes to Chartio for these easy-to-understand churn definitions.
Think for a moment what happens when CAC is the same, or higher, than LTV. Or what happens when customer revenue churn is simply being replaced by the revenue from new customers.
The churn rate treadmill
Revenue churn is the opposite of growth. It’s money lost period-over-period from customers that were previously acquired using precious growth capital.
Every month that monthly recurring revenue (MRR) continues or expands improves capital efficiency. But every churned or downgraded customer reduces capital efficiency. The objective is to amortize customer acquisition cost (CAC) over as long a lifetime (LTV) as possible. The higher the ratio is between CAC and LTV, the more capital efficient, sustainable and steep the growth curve can be.
When churn rate is held in check, proportionally more capital is being used to produce new revenue rather than replacement revenue. More is used to cover new ground rather than running in place.
Who contributes to reducing churn rate?
In short, everyone. Controlling customer churn starts with sales & marketing setting accurate expectations and focusing on the ideal customer profile (ICP). Those ideal customers should be on-boarded quickly and efficiently to ensure rapid adoption and realization of value. After that, customer development needs to have a path forward to upsell and deliver expansion revenue. Specific tactics vary based on sector, price point, monetization strategy and so on. But, big picture, the entire organization contributes to reducing revenue churn. It has to be a consistent focus for everyone.
What are the institutional implications of churn rate?
Institutional sources of capital really don’t like seeing their funds used to replace lost revenue. That’s considered raising execution risk which is seldom popular among banks, VCs or PEGs. In my experience churn rate is the first question asked after top-line growth, and customer acquisition are covered. If growth is offset by revenue churn, the question of why will quickly rise to the top of the list.
Every SaaS company has churn. But churn that merely is replaced by new revenue isn’t a sustainable business model, and at some point, it will catch up to you.
Churn can seriously stunt your SaaS growth
The trickle-down effects of revenue churn are widespread. They impact the P&L, the balance sheet, and company-wide morale. If you have a churn problem, you have a burn problem, and that will make it very hard to grow. I think improving customer retention and reducing revenue churn has to be any SaaS company’s number one strategic priority.