What’s an Acceptable Churn Rate for SaaS Companies?

How good are you at keeping your current customers? You need to know the answer. The success of your SaaS business depends on it.

According to a study by Bain & Company and Harvard Business School, a 5% increase in retention rates leads to a 25% to 95% increase in profits.

A small bump up in retention rates provides a meaningful spike to your bottom line. You should do everything you can to maximize retention rates.

However, like death and taxes, losing customers is a part of life. There’s always going to be some churn. But what’s an acceptable SaaS churn rate?

Keep reading to find the answer and learn more about churn calculation.

Churn Calculation

Let’s start by defining churn rate. It’s the percentage of customers that cancel during a given period.

You can calculate churn rates using different time periods, such as monthly and annual churn rates. Pay special attention to this when you’re comparing your churn rate to a benchmark rate. The length of the time period should be the same for the two rates.

If they’re not the same, you’ll draw the wrong conclusions from your analysis. For instance, a 5% monthly churn rate is much worse than a 5% annual churn rate.

Let’s say you start with 1,000 customers. Let’s also assume you don’t add any new customers during the year.

A 5% annual churn rate results in 950 customers at the end of the year. A 5% monthly churn rate results in 540 customers at the end of the year.

With a 5% monthly churn rate, you’re losing 50 customers in the first month. Then, you’re losing 5% of your customers every month after that.

There are a couple more things to think about for the churn rate calculation:

You can calculate churn rate based on revenue (dollars) or the number of accounts. If you use a dollar basis, you can calculate it on a gross or net basis. The net calculation takes into account downgrades and upgrades during the period for the customers that stayed with the company.

If many customers upgraded their accounts during the period, the net churn rate could be much lower than the gross churn rate. In this case, the increase in revenue from upgrades offsets some (or all) of the lost revenue from cancellations.

Acceptable Churn Rate

Now that we’ve gone through the churn rate calculation, the next question is, “What should my churn rate be?”

Let’s look at the results from a Pacific Crest survey of over 300 SaaS companies:

• The average annual gross dollar churn rate is 6%.
• The average annual unit churn rate is 8%.

The unit churn rate (based on the number of accounts) is higher than the dollar churn rate because smaller customers churn more often.

Answering the “what’s an acceptable churn rate” question isn’t as simple as looking at the average churn rates. There are many factors that affect the churn rate.

Let’s dig into a few of these factors: distribution method, contract size, contract length, and customer size. Here are some additional findings from the Pacific Crest SaaS survey:

• Distribution method: the annual churn rate for online sales is more than twice the churn rate for field sales and inside sales.
• Length of contract: month to month contracts have a much higher churn rate than contracts that are annual or longer.
• Contract size: smaller contracts have a higher churn rate than larger contracts.

The size of customers also impacts churn rates. Tomasz Tunguz, a venture capitalist at Redpoint Ventures, estimates the annual account churn rates based on customer size:

• SMB (Small and Medium Business): 31-58%
• Mid-Market: 11-22%
• Enterprise: 6-10%

Small customers churn much more often than larger customers. This happens for various reasons. It’s more costly to change SaaS providers for large clients.

Also, large companies are less price sensitive. If you raise prices or a competitor lowers prices, large companies are less likely to switch. Other explanations for the differences are that small companies are more likely to go out of business or change their business structure.

Dig Deeper to Understand Your Churn Rate

Even if your churn rates are better than the rates of your competitors, you should dig in to understand why customers leave. Any improvement in your churn rates shows up in your profits.

Ask yourself, “What are the major causes of churn for my company?” Some of the causes will be out of your control. However, you’ll find that there are some things you can do to improve customer retention.

Don’t stop digging into your numbers yet. Take a look at the trends in churn rates and customer acquisition rates.

Let’s say your churn rates are below the benchmark rates. That’s not necessarily a cause for concern.

If your churn rates are steadily improving, your current strategies are working. Keep moving in that direction.

When looking at the change in churn rates over time, think about how much your business has changed over that time. It may not be reasonable to draw quick conclusions from the raw trends.

Maybe your customers have changed dramatically. Or your contracts are much longer than they used to be.

While it’s important to understand the trends in churn rates, don’t forget to look at customer acquisition rates. If more customers are leaving each month than the number of new customers that are coming in, your business is in trouble.

You can’t look at churn rate in a vacuum. Look at the change in churn rates over time. Compare your churn rate to your customer acquisition rate.

Figure out what’s behind the numbers. This will give you a more holistic view of the health of your business.

Add Value to Your Customers

New customers are expensive. According to Invesp, the cost of attracting a new customer is 5 times as much as the cost of keeping a current customer.

You’ll get more bang for your buck by focusing on keeping your current customers. Make your current customers happy by adding massive value to them. Become an essential part of their lives instead of a commodity.

Keep a close eye on your churn rate to see how well you’re doing at adding value to your customers. Start off by making sure your churn calculation is right.

Measure yourself against the competition. Measure against your past results. Measure against your customer acquisition rates.

Check out our plans if you’re ready to build reports and see your key metrics visually.