Sales Glossary / Churn Rate
The ultimate guide to churn rate measurement
In today's highly competitive business landscape, gaining insights into customer behavior and loyalty is vital for sustained growth.
One key metric that holds significant value for businesses is churn rate. Churn rate quantifies the rate at which customers stop spending money on a product, service, or organization.
This guide aims to provide a comprehensive understanding of churn rate, its relevance to businesses, how to calculate it, and the importance of measuring it over time.
What is churn rate?
Churn rate can measure several different types of churn, the main two being customer retention and revenue retention. Customer churn rate measures the percentage of customers who leave. Revenue churn rate measures the percentage of revenue lost due to customers leaving.
When customers churn, it means they've chosen to end their relationship with the company, whether by canceling a subscription, ceasing to make purchases, or switching to a competitor. Churn rate is typically expressed as a percentage and is calculated by dividing the number of customers lost during a specific period by the total number of customers at the beginning of that period.
Why does churn rate matter?
Acquiring new customers can use considerable resources.
Understanding churn rate is essential because it helps businesses evaluate the effectiveness of their customer acquisition and retention strategies. A high churn rate can be indicative of various underlying issues, such as poor ad targeting, miscommunication of the value proposition, dissatisfaction with the product or service, poor customer experiences, pricing problems, or increased competition.
By closely monitoring churn rates, businesses can identify patterns and trends, enabling them to pinpoint areas that need improvement and develop targeted initiatives to reduce customer attrition.
Churn can negatively impact a company's profitability, growth, and reputation.
How to calculate churn rate?
Calculating churn — whether for customers, revenue, or users — is simple.
For example, if a company had 100 customers at the beginning of the month and lost 10 customers during the month, the monthly customer churn rate would be 10%.
The formula for calculating revenue churn rate is:
Businesses can calculate churn rates based on any time period that's most relevant to their business.
The most common churn rates are calculated on a weekly, monthly, and yearly basis, although some products also calculate user churn daily.
How to measure churn over time?
The main method used to measure churn rate is cohort analysis.
Cohort analysis tracks the user or customer behavior of a specific group of users. A "cohort" is simply a group of people that share common characteristics. Cohorts tend to fall in two categories:
- Acquisition cohorts: these groups are divided by timing, based on when a user or customer signed up for a product or service.
- Behavioral cohorts: these groups are segmented based on the behaviors and actions they take within a product, or even based on demographic segmentation. This cohort allows businesses to find different churn rates and usage patterns based on the types of customers they are acquiring, not just the time period at which they acquired them.
Acquisition cohorts based on time period are the most common form of cohort analysis.
The period used by the business depends on the product or service.
Common time periods to analyze include days, weeks, or months. A freemium consumer app might use daily cohorts, while a paid team project management might use weeks and an enterprise software or services business may measure by months.
As an example, imagine a consultancy that works with ecommerce websites to design their websites and optimize conversion rates. They work on monthly retainers, so monthly cohort analysis makes the most sense.
They could take in all new customers in January, February, March, etc. and measure the longevity of the partnership. Over the course of a year, how many of the January customers discontinue business with this consultancy? That'd be the annual churn rate of that cohort.
The tools needed to measure churn rate depend on the business model. For an expensive product or service with relatively few customers, this is simply done in a CRM system. For products with hundreds of thousands or millions of users, it requires product analytics and a data warehouse to instrument and model out churn rate.
What's a healthy churn rate?
A healthy churn rate varies widely based on the type of business, product, or service.
For subscription services, a good goal is to keep customer churn under 5%.
For SaaS products with free users in addition to paid subscriptions, a common rule of thumb is that for every 8-10% of monthly churn, a business will need to double its acquisition rate. This, of course, is subjective, and can vary based on the individual business, pricepoint, and overall category.
Reducing churn rates, no matter the starting point, is one of the most efficient ways to grow a business.
Generally, during the early stages of building a company, churn rate will be high and as founders and executives scale the company, the goal is to reduce churn rate. The specific churn rate will vary a lot based on the business.
For example, a SaaS product targeting small to medium businesses would have a healthy business at a 90% net retention rate, but enterprise SaaS companies tend to have net retention rates above 100% (meaning they sell additional seats or products after the first deal closed).
Eight common causes of churn
A high churn rate indicates that there are issues with the product, service, or customer experience. Common causes of churn include:
1. Lack of product/market fit
At the startup stage, the most common cause of high churn is a lack of product/market fit. In fact, the easiest way to identify a lack of product/market fit is having a preternaturally high churn rate.
Product/market fit is when there's a perfect fit between the customer's needs and the product or service that a business offers. If a product is built that doesn't fulfill market demands, no matter how good the marketing or sales efforts are, churn rate will exceed new customer acquisition and ultimately lead to business failure.
2. Poor customer service or onboarding experience
If customers don't receive the customer service they expect, or if onboarding is too complicated and cumbersome, then customers are more likely to churn.
This is especially true of high-complexity purchases such as enterprise software or service businesses, but even low-touch free products require clear onboarding and obvious value to the user. If a user doesn't understand the product's value, they're likely to churn.
Additionally, poor customer service can cause frustration, leading a customer to consider alternative solutions. Poor customer service can be a result of many different factors, including timeliness, politeness, and generally, solving the customer's issue.
3. Unclear pricing model or value proposition
Another common cause of churn is an unclear pricing model or value proposition. Customers are more likely to churn if they don't understand the value they are getting from a product or service.
Even more common, the pricing model used by some companies can lead to churn. Often, this is because a customer's usage or seat count grows, and the product charges disproportionally for the usage growth. This can lead customers to find alternatives that "scale" better with their growth.
4. Lack of features or updates that customers expect
Certain features are considered standard for different product categories.
For example, an enterprise email marketing platform needs to integrate with a CRM as well as web forms to be useful.
A customer may sign up for an email marketing platform based on its price or marketing, but if these features aren't available or developed quickly, the customer may find a solution that has these in place.
5. Confusing UX/UI design
The user experience (UX) and user interface (UI) factor into the complete customer experience. If a product is difficult to use, this can cause frustration, and frustration can lead to customers giving up on the product.
This is especially true of subscription products, where users need to be able to quickly understand how to access and use their features.
6. Competition from a better product
Competition from a better product is a common cause of churn, especially in the software space.
This happens all the time. A product launches, builds a large customer base, then stagnates and stops innovating. New competitors pop up, copy the core features, and build additional functionality and lower the price, and customers, switch to the new vendor over time.
7. Poor customer segmentation or targeting
Many companies fail to recognize the difference between their target market and their current customer base, which often leads them to offer features that aren't relevant to their customers.
This is a common issue for companies that try to scale too quickly without understanding who they should be targeting. Understanding who the target customer is and creating features that they find valuable is critical to reducing churn rates.
Simply put, attracting the wrong customers or building products for the wrong customers is almost always going to lead to high churn rates.
8. Data security issues
Data security is becoming an increasingly important issue for companies to consider, both from a customer trust and legal standpoint.
If a company has experienced data leakage or other security issues, customers may be discouraged and choose not to use the product. Customers are more likely to trust companies that have invested in data privacy and security measures. This is particularly important for companies that handle sensitive customer data.
How to reduce churn rate?
There are several strategies that companies can use to reduce churn rate. The very first step is to understand the reasons for churn.
- Identifying the reasons for churn requires both quantitative and qualitative analysis.
- To perform a quantitative analysis, businesses need to track cohorts and determine churn patterns among customer segments. Generally, customer churn should be improving over time. If it's not, or if there is a sharp rise in customer churn, then there may be an issue that should be validated with qualitative research.
- Similarly, customer churn is likely not homogenous across all customer segments.
- Businesses can identify customer segments that have greater customer lifetime value and those that churn at a faster rate, and this will allow them to either fix the issues with high customer churn segments, or pivot their sales and marketing efforts to focusing on more of the high value customer segments.
- One churn rates have been identified quantitatively; qualitative research methods can help businesses identify the cause.
- NPS surveys can uncover underlying reasons for churn. Similarly, customer interviews (led by product managers, UX professionals, or marketers) are important to get the voice of the customer and uncover their needs and pain points.
- Product user experience issues can be uncovered with session replay software and user testing solutions. These allow product managers and marketers to watch users interact with products and see where they struggle and what issues to fix.
No matter what issue is causing churn in a specific business context, the three following solutions apply to almost all businesses regarding reducing churn rates:
Improve customer experience
The "customer experience," is, of course, a broad concept that includes user experience and user interface as well as customer support and onboarding.
At each step of the process, from the first marketing touchpoint all the way through customer support experiences and support document availability, attempt to drive high customer satisfaction rates and avoid frustrating valuable customers.
Improve customer targeting
Businesses often have a poor understanding of who their product is best used by, and there's a disconnect between product, sales, and marketing teams. So, marketing and sales teams target a certain customer segment, and the product is a poor fit.
This leads to customer churn, not because the product, but because the customers targeted for acquisition are a bad fit.
Consider products like LinkedIn Sales Navigator to help target the precise customers best suited for a particular business. With LinkedIn Sales Navigator, users can also manage accounts and see if any changes have occurred at a company that may make reaching out with a product or service especially ideal. LinkedIn Sales Navigator can also understand buyer intent, help map relationships for efficiency, and better help with engagement. Businesses should invest heavily in customer segmentation efforts, to make sure the product and customer are a good fit. This can be done with market research, customer surveys, interviews, and other qualitative methods.
Invest in customer feedback and analytics
Customer feedback is the breakfast of champions. Businesses can never truly know why customers are churning if they don't have analytics to track churn and customer feedback to track the reasons for churn.
At the very least, businesses need to have analytics set up to track their churn rate across time. This allows for longitudinal analysis (in other words, to see if customer churn is improving or not over time).
More importantly, businesses should keep close contact with their customers through surveys, customer interviews, and user experience research. At any point in the business's growth, there will be customer experience problems and bottlenecks. That's inevitable. But it's entirely within the control of a business to fix them, as long as they know about them. And that requires customer feedback and research.
No business can avoid churn.
However, businesses can acquire the right customers and find product market fit by targeting specific businesses, roles, and industries with LinkedIn Sales Navigator.
