Churn Rate: Formula and Calculator - Wall Street Prep

The customer churn for the year is 4.0%, which we calculated by dividing the churned customers by the beginning customer count. Customer Churn = 8 ÷ 200 = .04, ... WelcometoWallStreetPrep!Usecodeatcheckoutfor15%off. 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VentureCapitalGuide(VC) VentureCapitalGuide(VC) VentureCapital(VC) VentureCapitalDueDiligencePre-Moneyvs.Post-MoneyValuationVentureCapitalValuationVentureCapitalTermSheetCapitalizationTableUnicornStartupLiquidationPreferences GrowthEquity GrowthEquityGrowthEquityInterviewGuideMinorityInvestment EquityFinancing PreferredSharesvs.CommonSharesPreferredStock SaaSMetrics LTV/CACRatioCustomerLifetimeValue(CLV)AnnualRecurringRevenue(ARR)RunRateRevenueMonthlyRecurringRevenue(MRR)NetRevenueRetention(NRR)ChurnRateRetentionRateRevenueChurnAverageRevenuePerAccount(ARPA)Ruleof40NetNegativeChurnTotalContractValue(TCV)AnnualContractValue(ACV)Bookingsvs.BillingsSaaSMagicNumberSaaSQuickRatioSalesCapacityPlanningCommittedMonthlyRecurringRevenue(CMRR)ActivationRateBessemerEfficiencyScoreRenewalRateCACPaybackPeriod StartupMetrics BurnRateCashRunwayBurnMultipleRevenuePerEmployeeMarketPenetrationAttritionRate eCommerceMetrics GrossMerchandiseValue(GMV)Click-ThroughRate(CTR)AverageOrderValue(AOV)ConversionRateTakeRateRepeatPurchaseRate UserEngagementMetrics DailyActiveUsers(DAU)MonthlyActiveUsers(MAU)DAU/MAURatioNetPromoterScore(NPS) WhatistheChurnRate? TheChurnRatemeasuresthepercentageofaSaaScompany’sexistingcustomersthathaveoptedtocanceltheirsubscriptions(i.e.orotherwisediscontinuebeingacustomer)duringaspecifiedtimehorizon. TableofContentsHowtoCalculateChurnRate(Step-by-Step)ChurnRateFormulaCustomerChurnRateAnalysisExampleChurnvs.RetentionRateHowtoInterpretCustomerChurnRateHowtoReduceCustomerChurnB2Bvs.B2CCustomerChurnAnalysisMonthlyvs.AnnualChurn–AverageSaaSRatesAcceptableMonthlyChurnRateof5%?CustomerLifetimeandChurnRateChurnRateCalculator–ExcelModelTemplateStep1.CustomerChurnandNewSubscriberAdditionsAssumptionsStep2.ForecastCustomerCountStep3.SaaS“Bottom-Up”RevenueBuild HowtoCalculateChurnRate(Step-by-Step) Thechurnrate,alsoknownasthe“attritionrate,”istheproportionofexistingcustomersatthebeginningofaperiodthatwaslostoveragivenperiod. Thequestionansweredis,“Ofourtotalexistingcustomersatthebeginningoftheperiod,howmanydidwelosebytheendoftheperiod?” Manymodernbusinessmodelsareorientedaroundrecurringrevenueandsubscription-basedpricingmodels. Inparticular,thesoftware-as-a-service(SaaS)model–inwhichcompaniesprovidecloud-basedservicesonasubscriptionbasis–isanintegralpartofpracticallyallindustries,eitherdirectlyorindirectly. ThedistinctionfromthetraditionalbusinessmodelisthatintheSaaSmodel,aserviceisprovidedoveraprolongedperiod,andcustomersmakepaymentsperiodically,suchasamonthlysubscription. Calculatingthecustomerchurnisafour-stepprocess: Step1→SelectTimeMetric–e.g.Monthly,Weekly,Quarterly,Annual Step2→CounttheNumberofCustomersatBeginningofPeriod(BOP) Step3→TallyNumberofChurnedCustomersthatLeftatEndofPeriod(EOP) Step4→DivideChurnedCustomersbyNumberofCustomersatBeginningofPeriod(BOP) ChurnRateFormula Thecustomerchurnrateformuladividesthenumberoflostcustomersbythetotalnumberofcustomersatthebeginningoftheperiod. ChurnRate=ChurnedSubscribers÷ TotalSubscribersatBeginningofPeriod Where: ChurnedSubscribers=BeginningSubscribers–EndingSubscribers Inordertocalculatethemetriccorrectly,itisimperativetochoosetheperiod(e.g.quarterly,annual)andensureconsistencyinallsubsequentcalculations,aswellasexplicitlystatetheperiodchosen. CustomerChurnRateAnalysisExample Forexample,let’sassumethataSaaScompanyhad200customersatthebeginningoflastyear,andeightcustomersdecidednottorenewtheircontractsattheendoftheyear. Thecustomerchurnfortheyearis4.0%,whichwecalculatedbydividingthechurnedcustomersbythebeginningcustomercount. CustomerChurn=8÷200=.04,or4% Churnvs.RetentionRate Customerchurnisdefinedasusersthatsignuporsubscribeandthenlateroncancel,whereascustomerretentionisthepercentageofcustomersthatremaincustomers. Sincechurnandretentionareinverselyrelated,subtractingtheretentionratefromoneequalsthechurnrate. ChurnRate=1–RetentionRate Forexample,ifacompany’sretentionrateis60%,thenitschurnis40%. Churn=1–60%=40% HowtoInterpretCustomerChurnRate Arecurringrevenuestreamcanseemappealingtomany–hence,thereisawidespreadshifttowardrecurringrevenueasopposedtoone-timesales. Thedrawbacktorecurringrevenueistherecurringresponsibilitiesintermsofproductqualityandpost-salecustomerrelationshipmanagement. Ifcustomersareleftunsatisfied,asourceofincomeiscutoff.Cancellationscanalsonowbedoneoverthephoneorbyemail,makingiteasierthaneverforunsatisfiedcustomerstodiscontinue. Therefore,thelong-termviabilityofSaaScompaniesdependsnotonlyontheircapabilitiesinacquiringnewcustomersbutalsoonretainingthem,whichcoincideswithlowchurnrates. EventhoughSaaScompanies–particularlyintheearlierstagesoftheirlifecycle–oftenprioritizesalesandusergrowthinlieuofprofitability,theymustnotneglecttheirexistingacquiredcustomerbase. Inthelongrun,customerretentiondeterminesacompany’ssuccess(orfailure),asacquiringcountlesscustomersispointlessifmostendupabandoningtheproduct/servicesoonafter. Foracompanywithahighchurnratetocontinueoperating,itmustcontinuallyoffsetthoselostcustomersbyacquiringnewcustomers,whichisnotasustainablebusinessmodel. Cancellationscanbecategorizedaseither1)voluntaryor2)involuntary. Voluntary:Thecustomeractivelyterminatesthesubscriptionordeniesrenewal. Involuntary:Thecauseofacustomercancellationwasacreditcarddecline(e.g.expiration,insufficientfunds),networkfailure,orinternalmistake. CustomerChurnvs.Maturity Churnhasaclearcorrelationwiththelifecycleofthecompany,i.e.thenumberofyearsithasbeenoperating. Typically,thehighestchurnratesareobservedintheearliestphaseofacompany’slifecycle. Ascompaniesmature,thechurnrateusuallynormalizesbecauseatthisstage,thecompanyistypicallyrunwithgreaterefficiencyandhasabetterunderstandingofitstargetmarketandcustomers. However,itisimportanttobeawareofthesurvivorshipbiasthatmaybepresentinthisobservation. HowtoReduceCustomerChurn Churnisanunavoidablepartofthenormalcourseofbusiness,buttherearefrequentmistakesthatcausecustomerstoleavetheircurrentprovider. MarketCompetition:Acustomerisatriskofswitchingifacompetitorinthemarketoffersamoreattractiveproduct/service(orthesamevaluepropositionatalowerprice). ProductQuality:Forrecurringpurchases,acertainlevelofqualityisexpectedbythecustomersthat,ifnotmet,leadstomorecancellations,especiallyiftherearehigherqualityofferingsoutthere. SubstituteOffering:Analternativeofferingcouldstealawaycustomersifitissufficienttomeetcustomerneedsanddemands,evenwithfewercapabilities,asthosecustomersmaywanttoavoidpayingapremiumforunneededfeatures. LackofInnovation:Often,companiescanbecomecomplacentafterachievingacertainlevelofsuccess,makingthempronetodisruption,i.e.newstart-upscansometimesoffermoretechnicalfeatureswithmoremodernmarketing. Mispricing:Settingpricingappropriatelytobalancemaximizingrevenueandcastingabroadnettoobtaincustomersiscrucialforcustomerretention,i.e.pricingpowervs.affordability. After-SaleService:Ensuringexistingcustomersaresatisfiedisjustasimportant–ifnotmoreimportant–thantheinitialonboardingofthecustomer,soroutinecheck-insandrequestsforfeedbackshouldbemade(e.g.measuringthenetpromoterscore) Therecurringthemetoreducechurnratesisthenecessityforadaptabilitywithregardtoproductcapabilities,innovation,pricing,andunderstandingoftheircustomer’sneeds. Othermethodstoreducechurnincludethefollowing: Upselling/Cross-Selling:Loyaltycanbebuiltbysellingmoreproductstothecustomer,inwhichtheeventualswitchingcostscoulddisincentivizeacustomerfromleaving–plus,synergisticproductscanalsobebeneficial. LoyaltyRewards:Acompanythatrewardslong-termcustomerscanestablishstrongerbrandloyalty(andpotentiallyevenaself-fulfillingprophecyinwhichcustomersstickwiththecompanybecausetheyweretreatedwell). Long-TermPricing:Insteadofmonthlysubscriptions,securingalong-termcommitmentbyofferinganannualdiscountcouldincreaseretention. Engagement+Implementation:Companiesoftensendautomatedsurveyrequests,butthemosteffectivewaytoshowthatcustomers’opinionsarevaluedistoimplementtangiblechanges. B2Bvs.B2CCustomerChurnAnalysis B2BcompaniestendtoexperiencelowerchurnratesrelativetoB2Ccompanies. NicheTargetMarket:B2Bcompaniesoftentargetaspecificmarketniche,sogiventhelimitednumberofpotentialcustomers,theseprovidershavecloserrelationshipswiththeircustomers–whereasmaintainingcloserelationswithallcustomersistypicallyunfeasibleontheB2Cside. HigherAOV:Theaverageordervalue(AOV)issubstantiallyhigherforB2Bcompanies(i.e.morecashtospend,highertechnicalrequirements),thusfewercustomersareneededtoreachthesameamountofrevenue,makingeachrelationshipcarrymoreweight. CustomizedTechnicalOfferings:B2Bproductsattempttomeetveryspecificcustomerneedsandfixcomplexneedsinanefforttobecomeintegratedintothecustomer’soperation.Thesespecializedofferingsareoftencustomizedevenmorepost-sale,makingcustomersevenlesslikelytochurn. Multi-YearContracts:MostB2Bsalesarestructuredasmulti-yearcontractsinsteadofmonthlyasiscommoninB2C,i.e.B2Bcustomersusuallyhavemoreofacontractualobligationtoremainacustomer. Monthlyvs.AnnualChurn–AverageSaaSRates AccordingtosomegeneralguidelinesfromTomTunguzofRedpoint,theaveragechurnratesintheSaaSindustryareasfollows: TheInnovator’sDilemmaforSaaSStartups(Source:TomTunguz) LowChurn(%) Thereisonenuance,however,toourearlierstatementabouthowalowchurnisapositivesignforearly-stagecompanies. Earlyadoptersoftencomprisealargeproportionofastart-up’stotalcustomerbase–andthosecustomersaretheleastlikelytochurn–asmostaremoresopassionateaboutlearningaboutandtestingthelatest,mostinnovativetechnologies.Ineffect,thechurnratecanbeskewedbythoseearlyadoptersthatresemble“producttesters”morethanrealcustomers. AcceptableMonthlyChurnRateof5%? The“acceptable”churnrateissometimescitedas5%,whichhasbeendemonstratedbymanystartups. However,a5%churncouldleadtoafalsesenseofsecurity,especiallyconsideringmoststartupsstillfail. Foranillustrativeexampleofhowunsustainablea5%churnis,let’srunthroughahypotheticalexampleofacompanywith100usersinJanuaryandamonthlychurnof5%. BytheendofDecember,thedifferentialbetweenthebeginningandendingusercountisalossof41usersatanimpliedannualchurnof43.1%. Companieswith5%monthlychurnratescanendupsuccessful,buttheyaretheexceptionandnottherule. CustomerLifetimeandChurnRate Thechurnrateisaninputusedtoestimatethecustomerlifetime–theapproximatetimetheaveragecustomerwillcontinuedoingbusinesswithacompany. CustomerLifetime=1÷ChurnRate Forexample,ifacompany’smonthlychurnrateis2.0%,thentheimpliedlifetimeis50months. CustomerLifetime=1÷2.0%=50Months ChurnRateCalculator–ExcelModelTemplate We’llnowmovetoamodelingexercise,whichyoucanaccessbyfillingouttheformbelow. Submit Emailprovided YourDownloadisReady Submitting... Step1.CustomerChurnandNewSubscriberAdditionsAssumptions Supposewearebuildingafour-yearrevenueforecastforaSaaScompanythatsellsasubscription-basedproductthatcustomerspayforannually. Attheendofthelatestfiscalyear,thecompanyhad250,000subscribers,sothatsubscribercountwillbethebeginningbalanceinYear1. BeginningSubscribers(Year1)=250,000 Inordertoprojectthenumberofcustomers,we’llassumethatthenumberofnewsubscriberadditionswillbe14%ofthebeginningsubscribercount. Ontheotherhand,theassumptionfortheestimatedchurnratewillbe6%ofthebeginningcount. NewSubscriberAdditions(%ofBeginning)=14% ChurnRate(%ofBeginning)=6% Step2.ForecastCustomerCount Usingthoseassumptions,wecanprojectthenumberofcustomersforeachperiodbymultiplyingtheannualnewcustomeracquisitionratebythebeginningcustomercount. NewSubscribers=%Additions×BeginningSubscribers Next,thesameprocessisdonewiththechurnratebutwithanegativesignplacedinfrontsinceitrepresentsareductionincustomers. ChurnedSubscribers=%Churn×BeginningSubscribers FromYear1totheendofYear4,theendingcustomercountincreasesfrom270,000to340,000subscribers. Step3.SaaS“Bottom-Up”RevenueBuild We’llusetheestimatedcustomercountstoprojecttheSaaScompany’srevenueinthenextpart. Theaveragerevenueperuser(ARPU)isassumedtobe$16.00persubscriber. AverageRevenuePerUser(ARPU)=$16.00 Moreover,we’llaveragethebeginningandendingsubscribercountstocalculatethenumberofaveragesubscribersforeachyear. Theaveragesubscribercountisusedherebecausesubscriberschurnthroughouttheyear–butifweusedtheendingamountsinstead,thentheimplicitassumptionisthatallcancellationsoccurattheendoftheyear. AverageSubscribers=(BeginningSubscribers+EndingSubscribers)÷2 Theprojectedrevenueutilizesastandard“Price×Volume”formula,inwhichthepricemetricistheARPU,andthequantitymetricistheaveragesubscribers. Revenue=AverageSubscribers×ARPU Onceperformedfortheentireforecastperiod,wearriveatthefollowingrevenuefiguresforeachyear. Year1=$4.2million Year2=$4.5million Year3=$4.9million Year4=$5.2million Step-by-StepOnlineCourse EverythingYouNeedToMasterFinancialModeling EnrollinThePremiumPackage:LearnFinancialStatementModeling,DCF,M&A,LBOandComps.Thesametrainingprogramusedattopinvestmentbanks. EnrollToday Sharethis Twitter Facebook Google+ LinkedIn MostPopular 100+ExcelFinancialModelingShortcutsYouNeedtoKnow TheUltimateGuidetoFinancialModelingBestPracticesandConventions WhatisInvestmentBanking? 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