How to Calculate Churn Rate: A Comprehensive Guide
Calculating churn rate can be intimidating.
But it’s something no SaaS or subscription business can escape. You have to know how many customers leave at some point — so you can determine why there is a problem and if the effort to fix it is worth the effort.
(Un)fortunately, there are several ways to calculate churn, which have led to a lot of complexities. But at the same time, it’s necessary and important to understand the different ways to calculate churn rate — as long as they help you improve retention and revenue.
Moreover, each calculation method has its own usefulness. For example, you can calculate the churn you experience on:
- a specific cohort (a group of users)
- based on revenue or customer numbers
- a monthly basis
- quarterly/yearly basis
- a seasonal basis
Each method has its churn rate formula, so let’s take them one-by-one:
3 churn rate formulas to calculate how users leave
At its core, calculating churn is controlled by the following formula:
In essence, you divide the number of churned customers in a period (month, quarter or year) by your total number of existing customers in that period.
Now let’s explore the different methods for calculating churn:
1. The cohort analysis method
First, ‘cohort’ simply connotes ‘group.’ So when you identify churned customers by a common group they belong to, you’re basing your churn estimation on cohorts (groups) of users.
For example, you can get cohorts (groups) of lost customers who signed up in the same months. That’d look something like this:
Customers who signed up in May and left before September.
Users who signed up in April but left in nine months (see the gif below).
Source The lifespan of groups of users based on their signup months
You get the idea. Monitoring groups like this helps you understand activities you should be pouring more or less of your marketing/advertising investment into. The result?, You get to cut churn and improve profit. Reducing churn by 5% can increase profits by up to 125%!.
Compute churn rate (through the aforementioned formula above) for every month and you’ll get the churn rate for each cohort; more on this in #2 below.
2. The monthly % churn method
This one is clearly the simplest of all churn calculation methods:
And while it might look too simplistic to be effective, this is the churn calculation type that anyone in your organization can compute; they simply divide the number of churned customers in a month by the number of customers you had at the beginning of the month.
The result they get reveals churn rate.
But you might be surprised at how many complex monthly churn rate calculations are flaunted online today. Some of them are indeed necessarily complex, but many others? Not so much.
The chief argument complex calculation users purport is that fluctuations occur in your number of existing and lost customers during the month and your formula needs to account for those numbers. They’re right, but a much simpler way is to use the cohort method to derive monthly churn.
Compute your churn rates month-after-month, back-to-back, and you’ll discover you’re already accounting for all new, existing and churned customers in your computation.
For example, say your existing customers in May are 10,000 but by month’s end, you’ve lost 500 of them. Also, during the month, you added 1000 customers out of which you also lost 50.
How to solve this complexity:
By now, your churn situation is not so simple anymore. So at this point, it’s clear you can’t just use the simple churn calculation method to get accurate results; here’s how your churn calculation for the month of May would look:
You kick off the following month with the number of customers you ended with last month, minus the ones you lost (i.e. 10k customers from May – the 500 you lost + the new ones you added in the month).
And since you’re growing, let’s say during the month of June, you acquired another 700 subscribers but lost 60 of them. Again your churn and existing customer numbers have changed, so you can’t just apply the aforementioned monthly calculation method.
So a better monthly churn calculation formula is:
This way, your calculation encompasses all existing, churned, new and newly churned customers throughout each month.
So let’s continue with our example, assuming:
- we bring in existing customers (minus churned in May) at the end of May,
- lost 500 of them at the end of June,
- added 700 customers in June,
- and lost 60 of them.
Here’s the math:
In general, here’s the monthly churn calculation for both months:
This way, you realize that every lost, new or existing customer that wasn’t accounted for in a certain month computed into the next and was duly accounted for.
3. Quarterly churn
As a product marketer or customer success manager, monthly churn rates can be all you need to keep going about your day-to-day. But CEOs, CMOs, investors, board members and those higher up the chain need more solid and broader reports to make their decisions.
That’s where quarterly churn reports come in.
It’s simple. After computing the monthly churn rate as in #2 above, simply add up the churn rates for every three months.
This formula works for that:
X is the computed churn rate for each month (using the calculation method in #2 above)
N is 3, representing the no. of months in a quarter
A slightly more complex formula (which most businesses don’t need) is to compute the numbers of existing, churned, new, and churned new customers in all the three months in a quarter and divide the result by the ARR at the start of each month.
Comprende? Here’s how it looks in a formula:
Quarterly churn = CCn / EC
CCn is the number of churned customers at the end of every month in the quarter
EC is the number of existing customers at the start of each month
On the other hand, a wrong way to measure quarterly churn is calculating churn in the quarter’s first month and multiplying that by three.
It would have been an accurate calculation method if there was no growth in the quarter, or if all numbers of existing customers, churned users, new users and lost new customers were constant from month to month.
But that never happens. All the numbers change too frequently.
4. Annual churn
Like quarterly churn, execs and board members use annual churn to set forecasts and make company-wide decisions.
Once you’ve understood how to calculate monthly and quarterly churn rates, computing annual churn is the easiest thing to do.
But you must use the monthly churn calculation method in #2 above — since it accounts for all customers (existing, lost, and new) every month.
So here’s the formula to calculate annual churn:
Q1 + Q2 + Q3 + Q4 = Annual churn rate.
Where: Q represents the churn rate of every quarter.
M1 + M2 + M3 + M4 …… + M12 = Monthly churn rate.
Where: M represents the churn rate of every month.
And this is clearly different from just multiplying one rate by 3 or 12 to arrive at your churn rate; that’s not helpful as it would ignore all the growth/fluctuations you experience throughout the months in a year.
Calculating churn based on revenue?If your SaaS business has more than one price or contract size, an enterprise churned customer may not represent the same value as a small business churned customer. SaaS businesses that have tiered pricing need to take the loss of revenue per customer into account. To do this you will need to replace the above formulas with revenue units (i.e. dollars or euros). Churn can then be expressed as lost revenue offset by growth of new customers in terms of new revenue. And contract terms also influence churn. A contract that renews on a yearly bases churns much less than a contract that renews on a monthly basis. Understanding this can validate up to a 30% discount for contracts that renew just once a year!
What’s the best way to calculate churn?In general, it’s best you keep it super simple. And that’s why this guide centres on simple but accurate calculation methods. Stick to a calculation method that’s easy for anyone and everyone in your organization to compute; such that if your CEO, for example, isn’t great at numbers, she could still ascertain your churn rate without anyone’s help. And you’ll know your calculation method isn’t too complex when stakeholders who need to compute it themselves don’t complain that it’s too complex.
What is a good churn rate?You don’t want churn to occur at all, but we know that’s not going to happen. But then, you want it to be as low as it can be. So what’s it going to be? 5%? 7%? 10%? A good churn rate is somewhere <12.30%, but a nice sweet spot is anything around 5%. Whatever it is for business, it shouldn’t exceed the “healthy threshold” — the threshold that allows you to make enough profit to pay all salaries/other company expenses and live the life you desire.
Save yourself the stressLet us handle your churn (and other SaaS metric) analyses. Your business is different from every other business, regardless of how similar a lot of them look. We’ll help you accurately compute your churn and retention metrics — so you can focus on other important aspects of your business. Here are three key ways we help you:
- Measuring what matters
- focus your resources on what matters most in cutting churn
- track your work and focus results towards achieving your goals
- enable large groups to work together in alignment
- go the extra mile (if need be) to achieve goals you probably thought were impossible
- Speed & agility
- Simplicity & accuracy