Churn Might Get You Burned


A spin around the web will turn up hundreds of pages with definitions for SaaS metrics, most containing a fairly consistent set of key SaaS metric terms and definitions. “Churn” is always present and is consistently defined. Unfortunately, this important SaaS metric has been grossly simplified so it can fit easily on a list of bullets on a search engine-optimized web page or a slide deck. Hey, everyone is entitled to make a living!

Churn is all about SaaS Renewal Rates


Churn is a measure of the clients, contracts, or renewals you lose. “Churn” is expressed as a rate and is the measure of those losses. Viewed another way, churn is one minus your renewal rate, which is the rate of retention versus losses.

If you are managing a SaaS business, churn might get you burned. What experienced SaaS people know is that in many companies, churn is not a single number, but one or more “Life Cycle Renewal Rate” curves. A Life Cycle Renewal Rate Curve is the plot of the renewal rates by a dimension, typically the term number. Assuming you use a standard term length, this groups customer contracts by the period in which they were sold. When you plot the data over enough time to include the contract life cycle for a large enough sampling of customers, you may very well get a non-linear plot.

To illustrate the fundamental differences between a simple churn and life cycle renewal curves and highlight the potential problem with churn, let's produce some revenue projections that include renewals from two years of actual transactions.

First, we need a set of transactions. To simplify the example, we are using a single New Subscription transaction per quarter for a total of eight new clients over a two year period. Five of these contracts have already renewed one time. For the renewal, we’ve used a percent of the previous transaction value for the renewal transaction. In the real world, each client renews or cancels (binary), but mathematically, this example is valid for most businesses. (Alternatively, we could have used dozens of transactions per quarter and simply renewed a set of them, but again, we are using examples to make a point.) Here are the transactions:

trans2

These transactions create the following bookings:

bookings

Since these are subscription transactions, there is an associated revenue schedule. The report below shows the revenues by year for the transactions listed above. Note the Full Range values are the same but the report periods are different in keeping with basic revenue recognition models.

historic-revenues

Projections


Now, we will build two future revenue schedules based on the historical transaction plus future projected renewals.

For Projection Schedule#1, we use a churn rate of 12%, which translates to an 88% renewal rate. The projected revenues are as follows:
projectionreport-simplerate
For Projection Schedule#2, we use a life cycle renewal rate curve:
  • Renewal 1 - 70%
  • Renewal 2 - 96%
  • Renewal 3 - 93%
  • Renewal 4 - 92%
When averaged as would be done in most spreadsheets, this renewal curve would average to roughly the simple 88% renewal rate used in above. The projected revenues are as follows:
projectionreport-renewalcurve

Over a four year period, Projection Schedule#2 is almost a million dollars greater (roughly 10%).

In this simple illustration, we used only two years of new bookings transactions and the renewal projections for just those transactions. We did project renewals for those for four years, but this example assumes no new customers were added in those four years. In the real world, you are still new customers AND renewing these new customers in addition to those added in the two-year period above. In the real world, the magic of compounding can turn that $1 million difference into many millions over a four year period. That is a lot of under-forecasting or over-forecasting, depending on which method you use. (BTW - with SaaS Optics you can easily include forecasts from your sale team, making projection of future total bookings and revenue performance a piece of cake!)

So, which projection method should you use?

The one that most accurately represents the renewal patterns in your business. Your renewal rate might not be a 70%/96%/93%/92% curve, but its probably not a simple 88% either.

You are an on-demand company. You are nimble and responsive to market forces that regularly shape your pricing and packaging. So, your renewal patterns and curves are moving all the time. You may have distinct "term class of" curves, industry curves, geography curves, and other important business segmentation curves that you might not even be aware of. The only way to know is to analyze your data on an ongoing basis.

With SaaS Optics, it’s fast and easy to generate life cycle renewal rate curves by any number of dimensions - industry, geography, segment, channel, or even by sales rep or sales manager. And, its easy to use those rates to project future performance much more accurately than using a spreadsheet.

So, save the churn for butter. Start making more informed business decisions quicker and easier than ever before. Get SaaS Optics now.