Churn rate vs. Retention rate: Understanding the metrics

Churn rate vs. Retention rate

This article delves into the specifics of churn rate and retention rate, offering actionable strategies to boost customer retention and minimize churn, thereby driving business growth.

Understanding churn rate and retention rate

Before we get into the specifics, it's crucial to recognize that not all SaaS businesses are the same. Different types of SaaS businesses may prioritize one metric over the other, depending on their goals and customer acquisition strategies.

What is churn rate?

Churn Rate is a metric that measures the percentage of customers or subscribers who stop using or cancel a product or service during a specific period. It quantifies the loss of customers, revenue, or user base, indicating the rate at which customers disengage or unsubscribe from a service.

This metric is essential for businesses with a large customer base and significant customer acquisition costs.

What is retention rate?

Retention rate is a metric that measures the percentage of customers or subscribers who continue to use a product or service over a specific period.

It quantifies customer loyalty and the ability of a business to retain its existing customers, highlighting the rate at which customers remain engaged and continue their subscriptions or usage.

Businesses focusing on long-term customer relationships and recurring revenue may prioritize this.

How to calculate revenue churn rate?

First, you need to understand what is MRR. If you’re comfortable with this metric, keep reading, if not, read this article about recurring revenue first.

Understand churn rate:

Revenue Churn Rate formula (%) = (Lost MRR / MRR at the Beginning) x 100

Example of revenue churn rate:

Suppose a SaaS company had $100,000 in MRR at the beginning of the month. By the end of the month, they lost $5,000 in MRR. Using the formula:

Revenue Churn Rate = ($5,000 / $100,000) x 100 = 5%

Causes of a high churn rate

High churn rates can be alarming for SaaS businesses as they directly impact revenue and profitability. Several factors can contribute to a high churn rate:

Persona mismatch with the product's target market:

If a project management SaaS primarily targets small businesses but acquires enterprise-level clients, it may result in a mismatch.

Analyze customer demographics and segment your user base. If a significant portion of customers falls outside your intended target market, it could be a reason for churn.

Unrealistic expectations set during sale:

For example, promising a 50% increase in productivity without clear evidence to support it during the sales pitch can lead to disappointment.

Tips: Collect feedback through surveys or interviews. If customers express feeling misled or that your product did not meet their expectations, it might be a factor in churn.

Unsuccessful onboarding process:

For example, customers could struggle to understand how to use your software due to a lack of comprehensive onboarding materials or support.

Tip by Hyperline: Monitor customer engagement during onboarding. If a significant number of customers drop off during this phase or request extensive support, it's a sign of an unsuccessful onboarding process.

Lack of engagement with key features or integrations:

For example, customers primarily use only the basic features of your CRM software and do not explore more advanced functionalities.

Tip: Analyze user data to see which features or integrations are underutilized. If core features remain untouched, it's an indication of a lack of engagement.

Limited usage to one purpose or project:

Imagine clients using your graphic design SaaS exclusively for creating logos but ignore its broader capabilities.

What you should do: Review user data and observe if customers are using your product for a narrow set of tasks. If they do not explore its versatility, this may be the reason.

Decision-makers have no interest:

In a B2B context, if decision-makers do not perceive enough value or ROI from your SaaS, they may opt not to renew.

The solution would be to maintain regular communication with key stakeholders. If they express doubts about renewal or reveal they haven't seen sufficient value, it's an indication that your product might not align with their needs.

Prices get too high:

In usage-based pricing models, like those of Stripe or Intercom, churn rates can be influenced by cost at scale. Initially, as customers pay a percentage of their transactions, this model is cost-effective for low volumes. However, as usage and associated costs rise, it can become expensive, leading to higher churn rates among larger users seeking more cost-efficient solutions.

What is a good churn rate?

The ideal churn rate varies based on factors like industry and pricing structure:

Early-Stage startups: They may have higher churn initially but should work on reducing it.

Established companies: Mature SaaS companies often strive for near-zero or negative churn.

The truth is: The best churn rate is the one you've pinpointed the reasons for and are actively improving, and the ideal rate is the one that keeps getting lower, showing your dedication to keeping customers and growing your business!

Also, each churn rate depends on the company strategy, the products and type of persona.

Exemple:

Some large SaaS companies may experience significant seasonal churn.

For example, a company specializing in tax software could have high retention most of the year but see increased churn after the tax season ends, as customers discontinue their subscriptions until the next year. These fluctuations are normal for businesses with seasonal demand, and the company's annual churn rate will be aligned with the company strategy.

How to calculate Revenue Retention Rate?

Calculate it using this formula:

Revenue Retention Rate Formula = (Total Retained Revenue / MRR at the Beginning) x 100

Example of revenue retention rate

Imagine a project management SaaS provider, starts with an initial Monthly Recurring Revenue (MRR) of $50,000. During a specific period:

They experience customer churn, resulting in a loss of $7,000 in MRR.

They also upsell additional features and services to existing customers, which brings in $9,000 in additional MRR.

To calculate the revenue retention rate for the Company:

• Start with the initial MRR: $50,000
• Subtract the lost MRR due to churn: -$7,000
• Add the gained MRR from upsells: +$9,000

Now, the total retained revenue is $50,000 - $7,000 + $9,000 = $52,000.

To calculate the revenue retention rate:

Revenue Retention Rate = (Total Retained Revenue / MRR at the Beginning) x 100

Revenue Retention Rate = ($52,000 / $50,000) x 100 = 104%

In this example, the company has achieved a revenue retention rate of 104% for that period, indicating that they not only retained their existing revenue but also gained an additional $9,000 in revenue through upsells, resulting in a net positive revenue retention rate.

What is a good retention rate?

A high revenue retention rate indicates success in retaining existing customers:

• Early-Stage Startups: Focus on steady improvement over time.
• Established Companies: Strive for retention rates above 100%.

The truth is: The higher, the better. The retention rate directly impacts a company's growth by influencing its revenue stability and reducing the need for constantly acquiring new customers to replace those lost.

A higher retention rate means more consistent revenue and often leads to increased customer lifetime value, ultimately fueling sustainable business growth.

Best practices to improve your Retention Rate

Here, we'll dive deeper into why and how each best practice can make a substantial difference, along with examples to illustrate their effectiveness.

Customer onboarding

A seamless onboarding process ensures that customers quickly understand and experience the value your SaaS product offers.

How?

• Provide clear and easy-to-follow setup instructions.
• Offer tutorials, video guides, and interactive walkthroughs.
• Assign a dedicated onboarding specialist to assist new customers.

Customer feedback

Actively seeking and responding to customer feedback allows you to address their needs and concerns, demonstrating your commitment to their satisfaction.

How?

• Implement feedback collection mechanisms within your product.
• Respond promptly to support tickets, inquiries, and feature requests.
• Conduct surveys and interviews to gather valuable insights.

Product improvements

Continuously enhancing your product based on customer feedback and market trends keeps it relevant and competitive.

How?

• Analyze customer feedback to identify pain points and opportunities.
• Prioritize feature development based on customer demand and impact.
• Release regular updates and improvements to address user needs.

Pricing strategy

A well-thought-out pricing strategy ensures you optimize revenue without alienating existing customers.

• Communicate pricing changes transparently and in advance.
• Offer tiered pricing plans to accommodate different customer segments.
• Provide options in pricing for existing customers (list of pricing methods here.)

Upsell and cross-sell

Identifying opportunities to upsell or cross-sell to existing customers can increase their lifetime value and drive revenue growth.

How?

• Analyze customer usage patterns to identify upsell opportunities.
• Offer additional features or higher-tier plans based on customer needs.
• Cross-sell complementary products or services to expand the customer relationship.

To conclude:

Churn rate and retention rate are vital metrics for SaaS businesses. Understanding and optimizing them is key to building stronger customer relationships and achieving long-term success.