The number of times I speak to $50M+ ARR companies who are just now starting to look at churn is startling. Here's why.
Imagine you're a new SaaS company that just reached your first 100 customers. You notice that in the past month, 3% of your customers have churned. You're not too phased—getting those 3 customers back might be as easy as getting on the phone or sending them a personalized email.
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This monthly customer churn rate doesn't seem so bad when you have 100 customers. But when you have 100,000 customers, your unaddressed 3% churn is a bad look. It's not as easy to win back 3,000 customers a month with nice emails.
As your customer base grows, churn becomes a bigger and bigger problem and not just because you're losing customer - it's because your CAC costs just to grow 1% is out of control, especially if the market is closing around you. Let's dig into this concept and get you on the right track.
Churn comes back to bite you
Preventing churn from destroying your company years down the line comes down to establishing good foundational business practices early on. This means measuring churn, understanding where it's coming from, and taking steps to retain those customers.
Churn compounds with growth because it is a percentage of your total customer base. This can hurt you in many ways:
The more customers churn, the more revenue you have to pour back into your company just to keep the bottom line flat.
If you've set goals to grow month-over-month or year-over-year, those goals are going to be harder to reach and will take longer.
You'll have to spend money to acquire customers and replace the ones you've lost that could have been spent on other things like product improvements or hiring.
To add insult to injury, churn reflects poorly on the health of your company. High churn will hurt you whether you're bootstrapped or venture-backed—but if you're trying to raise money, poor retention metrics are a hard sell to an investor. According to SaaS investor David Skok, growth and retention are two major factors that VCs use to determine valuations for your company. Churn sabotages both of these.
But what is the threshold for really dangerous churn? In the early days of your company, it's hard to tell. Let's model out the growth of three different companies with different user churn rates over time to demonstrate the disastrous effects of short-term thinking. Then we'll look at how you can adjust your strategy to plan for long-term success.
Churn looks different 5 years down the line
Your current churn rate won't have the same effects on your company in a few years as it does today. One of the most significant changes is financial: customer churn makes it more expensive to grow as your company gets bigger.
For example: Imagine three different SaaS companies who are all going to try to scale up in the next five years. Each company makes $500,000 in annual recurring revenue. They each have 1,000 customers that pay $500/year each, and each customer costs $625 to acquire. Each company's sales efficiency is about 0.8, meaning that 80% of the CAC is repaid within a year.
Each company plans to grow from 1,000 customers to 10,000 customers over five years. These numbers below show hypothetical growth, as each company aims to increase the size of their customer base year after year.
Company A has 1% monthly churn, Company B has 3% monthly churn, and Company C has 5% monthly churn. Even though these three companies have identical metrics except for churn, this growth is going to come at very different costs.
Company A: 1% monthly churn
Company A loses 1% of their customers each month and 12% of their customers each year. As the company grows, 12% of their customer base becomes a bigger and bigger number of customers.
Company A aims to grow from 1,000 to 10,000 customers over 5 years, despite the fact that they lose customers to churn every year.
By Year 5, losing 1% of customers a month means Company A is losing 1,200 customers in that year. In order to grow, Company A has to replace all of those lost customers and then acquire more on top. This comes at a steep cost, because each customer costs $656 to acquire.
In Year 5, Company A will have to feed 15% of the revenue they make that year into replacing churned customers.
In total, Company A will have to spend $1.8M to replace customers that churn over the course of 5 years.
This isn't to acquire customers that help them grow from 1,000 to 10,000 customers—this is just to replace the ones that are leaving each year due to 1% monthly churn.
Company B: 3% monthly churn
The churn rate for Company B is slightly higher than that for Company A. With 3% monthly churn, Company B loses 36% of their customers each year.
Company B wants to grow by the same numbers each year as Company A. In five years, they aim to grow from 1,000 to 10,000 customers.
By Year 5, when Company B is losing 3,600 customers, they'll have a huge churn problem on their hands.
The only way Company B can grow their customer base is by first replacing those churned customers.
Replacing 3,600 customers in Year 5 means spending $2.25M in CAC, which is almost half of what the company makes that year in revenue.
Over 5 years, Company B will have to spend $5.4M to replace churned customers and stay at flatline, before they spend a penny on acquiring new customers that will grow their user base.
Losing 360 customers in Year 1 probably hurt Company B, but they could afford to fix it. But it's unreasonable to think that spending half of your yearly revenue to refill your customer base and get back to flatline is sustainable for long-term growth.
Company C: 5% monthly churn
From Day 1, Company C's 5% monthly churn rate is alarming. In the first year, they'll lose 60% of their initial cohort.
Over 5 years, growth from 1,000 to 10,000 customers seems improbable. More than half of the customers from the cohort at the beginning of the year churn after 12 months.
In Year 5, Company starts with 10,000 customers and loses 6,000 of then in one year. This makes growth next to impossible.
From a market standpoint, Company C will run through much of the market trying to acquire customers to replace those who've churned. The more customers churn, the smaller their potential market gets and the harder it is to replace churned customers. From a financial standpoint, acquiring customers to refill the customer base is not a viable option.
It would cost Company C $3.75M to replace the customers that churned in Year 5 alone, in order to reach a baseline from which they could grow the next year. This is three-quarters of the revenue they'll make that year.
In total, Company C would spend $9M over five years just to refill their leaky customer bucket to baseline.
Customer churn is one of your most expensive oversights. It only gets worse with every day, month, and year that you don't address it. Even if churn isn't a huge problem today, creating a long-term retention strategy will be worth its weight in gold in one, five, or even ten years.
Shift your thinking from short-term to long-term
You can make important changes to your growth strategy by simply changing your mindset. Short-term growth goals tend to involve “growth-hacks” that prioritize aggressive acquisition above all. They aren't sustainable over time, and eventually your acquisition channels will dry up and those customers that aren't great fits will churn.
Long-term growth goals involve acquiring customers who have genuine interest in and need for your product. Then you need to figure out what they're willing to pay and create a value-metric. This ensures that customers are satisfied with the value they're paying for, and that you can grow without leaving any money on the table.
SaaS teams looking for actionable ways to stop churn and plan for long-term success need to consider:
What factors about your customers correlate with churn? Small companies tend to be bigger churn risks than larger companies because they may run out of resources more quickly or go out of business. But other factors may correlate with churn as well. For example, if customers from a certain industry tend to churn more than others, don't focus so heavily on acquiring those customers.
What features do customers with high lifetime value engage with the most? What keeps your ideal customers coming back? When during their onboarding do they first engage with this feature? If you find, for example, that customers who connect with friends through social media on your app tend to retain longer, show users where to find the social share features in their first session.
Why did customers churn? If your company is small and just starting to see customer churn, you have a great opportunity to reach out to those churned customers and personally ask them why they left. You may find ways that you can improve the product, the customer experience, or the pricing that you wouldn't have thought about otherwise.
Can you create less opportunities to churn? Customers with higher ARPU are less likely to churn—so by growing customers' accounts through up-selling and cross-selling, you're both increasing revenue and aiding long-term churn reduction. As the ARPU of your customers grows, you may also find opportunities to switch customers from monthly plans to annual plans. A higher percentage of annual plans is also correlated with lower gross churn rate.
Pull together the information you learn from talking to your customers and looking for patterns in your data. Use this to inform your customer acquisition tactics: focus your efforts on customers that really find value in your product and are willing to pay, because they will have long lifetimes at your company.
Use your findings to shape your retention strategies, too: understand what customers really want and make sure they're getting this value from day one, and look for ways to up-sell them and deliver more and more value over time.
Fixing your churn problem puts money back in your bank account
In 5 years, you don't have to be worrying about where you'll get several million dollars to replace your churned customers. You can pre-empt and prevent that problem by making customer retention a top priority.
The money that you'll save in CAC can be put towards growing your business in other ways like building out a sales team, hiring customer success team members, doing product development—the list is endless. The one place you shouldn't spend your hard-earned dollars is in fixing churn that you can prevent.