Understanding Subscription Churn

What is Churn?

Next to MRR, Churn is probably the most widely discussed subscription metric. Churn has no actual agreed-upon definition. In the end, you define churn in a way that works for your business and in a way that is defensible.

While there are many variations of churn, churn is always a measure of attrition or loss, and it can be lost customers, contracts, MRR, GAAP revenue, contract value, or bookings. Churn is most frequently expressed as a rate or ratio (churn rate of 12%), but churn can also be discussed as a whole number ("churned 10K of MRR" or "churned 2 customers").

When discussed as a rate, Churn is the inverse of your renewal rate. An 80% renewal rate is the equivalent of a 20% churn rate.

Common Churn Metrics for Subscriptions Businesses

  • Customer Churn - typically expressed as a count
  • MRR Churn - typically expressed as a total of the MRR lost due to customer cancellations, but can be a ratio of MRR lost vs renewal. If a ratio, can include MRR contraction from existing customers along with MRR churned from lost customers
  • Revenue Churn - typically, this is MRR Churn versus GAAP Revenue Churn
  • Average MRR Churn - typically expressed as the average MRR of lost customers

Historically Popular Churn Metrics

  • Bookings Churn - while MRR Churn is becoming more and more popular, historically Churn was calculated using bookings numbers.
  • Revenue Churn - again, MRR Churn is the most popular way to report on revenue churn, but GAAP revenue churn has also been used extensively. The more variation in your subscription term lengths, the more difficult this number is to derive.
  • Churn by count - churn is calculated by the number of customers or subscriptions that were cancelled vs the number that were renewed. this method works for monthly subscription businesses, early stage subscription businesses, and term subscription businesses with few products.

How is Churn Used?

In the finance function, Churn is used in or to:

  • As a critical input to Customer Lifecycle Value calculations
  • As a critical input to projections of revenue, bookings, and cash flow

A single churn number is good for chats with analysts, reporters, peers and other important but non-operational discussions. To optimize pricing, product planning, packaging, marketing and other decisions to maximize revenues and business performance, use a variety of more sophisticated churn numbers to help you understand the true performance of your business.

Define clear terms for your various churn metrics and then measure them consistently from period to period. Again, this requires well-defined and agreed to definitions and formulas for churn measurement.

Product management should look for potentially dramatic different churn numbers by dimensions such as these:

  • Churn - by marketing campaign
  • Churn - by promotion
  • Churn - by product
  • Churn - by length of sales cycle
  • Churn - by functional usage
  • Churn - by licensed modules
  • Churn - by sales channel or organization
  • Churn - by industry or market segment
  • Churn - by customer size
  • Churn - by total customer revenue or contract size

Churn In Sales Performance and Compensation

Given the importance of Churn to the underlying economics of the subscription model, Churn, like MRR, is more and more a consideration in sales compensation plans. However, measurement of Churn for sales compensation often requires a set of "exception" rules that are more complicated than those for Churn measurements performed for the purpose of assessing strategic business performance.

The primary issues typically involve the inclusion or exclusion of subscription records, the value of MRR, and the timing of transactions.

Top-level MRR performance is no less likely to include ALL MRR transactions than financial statements would all transactions that impact revenue and the balance sheet. Bad AR, write-offs, refunds, and credits are always accounted for in revenue reporting and balance sheets, as they should be in some way in board-level MRR reporting.

However, the sales function is often not accountable for many post-sale financial or contractual changes, such as early cancellations, collections issues, bankruptcies, concessions, and settlements. Therefore, changes in MRR performance due to issues such as these are often excepted out of the MRR performance reporting for the sales team.

In addition to complicated "sales exception rules" that factor in or out certain transactions, significant complication can also be introduced based on significant differences in the interpretation of timing of transactions.

Just as the sales function desires to take credit at the time of the order booking, the sales team will frequently measure cancellations as of the cancellation order date. From a financial metrics perspective, MRR, revenues, and even invoicing can continue on through the end of the term, even if a cancellation order comes in well before the actual end of the term. Many calculations, including Customer Lifetime Value, should be based on the effective end date, or the date the financial transactions cease to contribute to revenue or AR, not as of an order date.

Importance of Churn Definition in Organizational Vernacular

In the subscription world, the word "churn" is an imprecise term subject to interpretation.

For most efficient business discussions, consider adopting specific and clearly defined "churn" metrics. Use terms such as MRR Churn, Churn Rate, Customer Churn rather than simply churn. Be sure everyone has a clear understanding of the definitions and methods used to calculate Churn, and encourage the organization to avoid abbreviations in written and verbal communications.

Related terms:

MRR Churn Revenue Churn
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