Understanding and Tackling Revenue Churn in SaaS Companies

As a technology founder, knowing your key performance indicators (KPIs) inside out and interpreting the story they tell is crucial in managing your business effectively. Revenue churn is one of these essential KPIs that founders of Software as a Service (SaaS) businesses must master.

What is Revenue Churn?

Revenue churn, also known as MRR (Monthly Recurring Revenue) Churn, is a metric that allows founders to track and manage the decline in recurring revenue due to customer cancellations or downgrades. You can express this metric as either a dollar amount (e.g., $30k MRR churn) or as a percentage (e.g., 3% MRR Churn Rate).

The purpose of MRR Churn is to measure how much your recurring revenue has contracted month-to-month. It should be compared against other important metrics, such as Total MRR, in order to give you a complete picture of your monthly recurring revenue.

MRR Churn Rate

Your MRR Churn can either be calculated as a gross or net rate. Which one you want to use will depend on what exactly you’re measuring. Here’s how the two compare:

Gross MRR Churn Rate

Gross MRR Churn measures the total MRR lost to an organization. In other words, in contrast to the Net MRR Churn rate, it does not account for additional recurring revenue gained due to expansions or upgrades from existing customers.

When should you use Gross MRR Churn? When you want to see just how good or bad a product is performing. Because you cannot hide a poor performance behind other numbers (like a positive expansion rate), it is arguably a more accurate depiction of user satisfaction.

Net MRR Churn Rate

Net MRR Churn measures the total MRR lost to an organization after accounting for any additional recurring revenue earned from existing customers. This is referred to as “relative loss,” since this metric is calculated in relation to Expansion MRR.

When should you use Net MRR Churn? When you are focused on measuring the overall health of the business. Because it offsets the Gross MRR Rate with the Expansion MRR Rate, Net MRR Churn effectively measures the sustainability of your business.

Does your growth make up for your losses? Can you continue to expand with your current Net MRR Churn Rate? If it is less than zero (that is, negative), then it means that your revenue from upsells and expansion from existing customers grows at a faster rate than what you lose from churn and downgrade - that's an ideal scenario many hyper growth scale-ups aim for.

How to Calculate Revenue Churn Rate?

Let’s look at the formulas for calculating MRR Churn and MRR Churn Rate, then explore some examples to learn how they work.

Revenue Churn / MRR Churn Calculation

To calculate MRR Churn, you’ll just add up the MRR you lost from cancellations with the MRR you lost from downgrades. This formula looks like:

MRR Cancellations + MRR Downgrades = MRR Churn

So, for example, let’s say you lost $500 in recurring revenue from customer cancellations, along with another $200 in recurring revenue from customer downgrades. That means your MRR Churn will be $700:

$500 (MRR Cancellations) + $200 (MRR Downgrades) = $700 (MRR Churn)

MRR Churn Rate Calculation

MRR Churn Rate takes MRR Churn within a given period and compares it against the Total MRR at the start of that period. In other words, it measures the rate at which you are churning recurring revenue rather than just the amount of recurring revenue you are churning. This is why it is expressed as a percentage instead of a number.

There are two ways to calculate your MRR Churn Rate depending on your needs. You can either find the Gross MRR Churn Rate or the Net MRR Churn Rate. They each require slightly different formulas.

Gross MRR Churn Rate

Gross MRR Churn Rate is a simpler method that’s useful for when you just want to know how much churn is eating into your Total MRR. It involves dividing your MRR Churn by the Total MRR (as measured at the start of the month), then multiplying the result by 100 to get a percentage:

(MRR Churn ÷ Total MRR) x 100 = Gross MRR Churn Rate

For example, if your MRR Churn for the month of March was $100, while your Total MRR as of March 1st was $1,000, then your Gross MRR Churn Rate will be 10%. Here is this example written out:

($100 ÷ $1,000) x 100 = 10% Gross MRR Churn Rate

Net MRR Churn Rate

In contrast to Gross MRR Churn Rate, Net MRR Churn Rate is a slightly more complex method that can help you forecast future revenue performance. Rather than just measuring MRR Churn against Total MRR, it also factors in recurring revenue earned from existing customers (Expansion MRR):

[(Churn MRR – Expansion MRR) ÷ Total MRR] x 100 = Net MRR Churn Rate

Let’s use the numbers from our previous example ($100 in Churn MRR and $1,000 in Total MRR) but add $50 in Expansion MRR. This would give us a Net MRR Churn Rate of 5%. Here’s this example written out:

[($100 - $50) ÷ $1,000] x 100 = 5% Net MRR Churn Rate

But what happens when the Expansion MRR is larger than the Churn MRR? For example, let’s increase the Expansion MRR from $50 to $200. This gives us the following:

[($100 - $200) ÷ $1,000] x 100 = -10% Net MRR Churn Rate

You get a negative Net MRR Churn Rate. While the lowest Gross MRR Churn Rate you can give is 0, you can go into the negatives when it comes to Net MRR Churn Rate. In fact, for any SaaS company, this is the goal since it means that, despite any churn, overall expansions and recurring revenue means your company is actually adding on revenue each month.

Why It Is Important to Understand MRR Churn

Gaining a good understanding of your MRR Churn is about more than just getting ahead of a potential problem. Knowing where and why your customers are churning is essential to improving your product, marketing strategy, and financial projections. Let’s break that apart:

• Product: Measuring and tracking your MRR Churn is an excellent way of identifying which parts of your product are causing churn. Especially when a feature is updated or introduced, your product team should look closely to see if MRR Churn changes as a result.

• Marketing: Your marketing team also has a lot to learn from keeping a close eye on MRR Churn. By watching which channels customers who are more likely to churn come from, they can tweak their strategy and invest more in channels that produce better results.

• Finance: Having a nuanced understanding of your Net MRR Churn Rate will help you build better projections for your company. Even if you’re gaining new customers, you’ll be able to identify whether your churn rate will eat into your revenue over the long-term, giving you time to make necessary adjustments.

Tracking MRR Churn alongside Customer Churn will help you look beyond the number of cancellations and instead take into account the value of cancellations, allowing you to identify possible deficiencies.

For example, let’s say you have two pricing tiers: $10 and $100.

In one month, you lose ten customers. In the next month, you lose only five.

If you just looked at the number of cancellations - your Customer/Logo Churn Rate - you’d think the first month was much worse.

But since you’re tracking MRR Churn, you know that you lost $100 in that first month ($10 x 10 customers) and $500 in that second month ($100 x 5 customers).

As you can see here, tracking your MRR churn allows you to take into account the differences in value from your customers.

So What Is a Good MRR Churn Rate?

Generally speaking, your goal should be to add MRR (whether from new customers or expansions) at a rate equal or greater to your churn rate. For example, if your churn rate is 5%, then your New MRR and Expansion MRR should add up to 5% or more. This would create consistent growth.

But this isn’t very realistic over the long-term. No company can reasonably expect to survive very long with a high churn rate. If you’re churning 8% of your customers per month, then you’d have to replace two-thirds of them each year – not something you’d be able to do unless you have an extremely viral product. Instead, you should aim for a churn rate that is good for your business while still being realistic.

What does this look like? Lenny Rachitsky, a leading writer on product and business growth, took a survey and came up with these numbers:

As you can see, the numbers change depending on business type. Consumer organizations can generally expect a higher churn rate than B2B enterprise companies. In large part, this has to do with price. The higher the cost of the product, the lower you’ll want your churn to be. A company that sells $5 per month subscriptions, for example, can likely afford to lose more customers than another selling subscriptions that cost $5,000 per month.

Of course, just remember that even these numbers should be thought of as variable. A lot will depend on factors such as your stage of growth and your specific vertical.

For instance, it’s normal and expected for early stage startups to experience high churn rates as they refine their value proposition and try to to reach product/market-fit. Because of this, you should always look at your MRR Churn alongside other metrics, such as Customer Acquisition Cost (CAC), Lifetime Value (LTV), Annual Revenue Per User (APRU).

By doing this, you’ll be able to form a more complete picture of your business so that you can develop an effective growth strategy, one that eventually gets your MRR Churn Rate into the negative.

Strategies to Reduce Revenue Churn

Here are some key strategies to help reduce revenue churn:

1. Improve Customer Onboarding: An effective onboarding process ensures that customers understand how to use the product, which increases the value they perceive, consequently reducing the churn rate.

2. Consistent and Proactive Customer Support: Offer timely assistance and proactively reach out to customers to resolve any issues they may be facing. This will make them feel valued and lead to higher customer loyalty.

3. Monitor Customer Success Metrics: Keep an eye on metrics like the number of active users, product adoption, lifetime value, and feature usage to identify trends or issues that may lead to churn. Address these issues promptly to improve customer satisfaction.

4. Offer Flexible Pricing Plans: Revisit your pricing strategy to ensure it appeals to your target audience. Offering flexible plans with features that match your customers' unique requirements can lead to increased stickiness.

5. Ask for Feedback: Regularly asking for feedback helps you identify areas for improvement and build a stronger relationship with your customers.

In conclusion, understanding revenue churn and taking proactive steps to minimize it will contribute positively to the long-term growth and sustainability of a SaaS business. Monitoring churn rates and implementing strategies focused on product value, pricing, and customer satisfaction will lead to stronger customer relationships and a healthier bottom line.