5 Ways to Calculate Customer Churn
Customer churn rates are more complicated than they may seem. Today's business environment is characterized by infinite variables and data points, as well as constant change. One-size-fits-all formulas for calculating churn don't present an accurate view of organizational health, and the perceptions that emerge as a result of skewed numbers can do serious damage.
Every marketing and customer success professional needs to know how to calculate an accurate churn rate. This remains a challenge because there is no one "best" way. Rather, the best way varies from business to business. Let's take a look at five models for calculating churn rates to help determine which is best for you.
1. The Simple Churn Model
The formula for the Simple Churn Model is this: Revenue lost divided by total revenue at the start of the period equals churn rate. For example, if you lost $50,000 in revenue, with $500,000 in revenue at the start of the period, the churn rate is 10 percent. This approach is a quick way to measure the erosion of revenue. It gives you a broad sense of how the business is doing, but is almost too broad to be genuinely useful. The Simple Churn Model leaves many questions unanswered, such as how to handle monthly and annual contract lengths, and what happens when churn rates vary over the course of a customer's life cycle.
2. The All-In Churn Model
Another approach is to calculate churn using total revenue at the end of the period, instead of at the beginning. This All-In Churn Model reflects revenue lost minus revenue gained, divided by total revenue.
This model is not recommended because it yields an artificially low churn rate due to an inflated denominator. If your business is growing fast, including new purchases or up-sells in the period will further inflate the denominator, rendering your churn metric borderline useless. In fact, if you were to add all revenue that you lost in a period minus what you gained in up-sell and new customers and divide that by your total revenue, you could very well have a negative churn rate. For example, if you have $50,000 in lost revenue, subtract $60,000 in revenue gained, and divide that number by $500,000 in total revenue, you get negative 2 percent churn.
Now you may be wondering why this is a bad thing. Industry speakers often refer to negative churn as the ultimate goal. This makes sense when you are talking about a high-level dashboard metric, which encapsulates company health in a single number, but not if your goal is to define actionable churn metrics that can be used to guide specific parts of the business. For this, you need to calculate churn separately from new revenue, expansion at existing accounts, and upsell.
3. The Annual Cohort Model
It is important to calculate churn within the context of your business mode. The Annual Cohort Model works best for most B2B companies. It provides the cleanest possible calculation of churn. To find it, calculate the number of customers that are up for renewal within a given period, and use that number as your denominator. Let's say $2 million in this case. The numerator is how many clients actually cancel. If that number is $100,000, your churn rate is 5 percent. A simple, yet effective approach.
4. The Splits Model
If you have a mix of monthly and annual contracts, you are probably walking the line between B2B and B2C. The Splits Model is the best model for B2B/B2C hybrids. Here, you have to segment your customer base by contract type. All customers are not the same; annual subscribers behave differently than monthly, with varying churn risks and up-sell potentials. The Splits Model reflects that variation. To calculate the churn rate this way, use the Annual Cohort Model from number 3 for your annual customers, and the Segmented Cohorts Churn Model below for monthly customers. Then divide by total revenue.
5. The Segmented Cohorts Churn Model
The fifth and final approach is the Segmented Cohorts Churn Model, which is most appropriate for businesses with monthly subscribers. Take the amount of revenue lost during a set period, and divide that by the total revenue due for renewal during this period. Remember to introduce a grace period of 30, 60, or 90 days before you start measuring. This gives your customer population enough time to stabilize.
Like cooking, calculating churn rate is both an art and a science. A little too much of one thing or not enough of another can throw off the entire end result. The "recipes" outlined above are just a few of the ways to look at churn. Ultimately, every business has to figure out which methods are the most reflective and useful for them. Keep in mind that these numbers are just a starting point. The next step is to turn this information into focused, coherent customer success strategies that drive real results for your business.
John Rode is the senior director of demand generation at Preact.
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