According to Walker, 2020 is the year where businesses need to shift their mindsets from "customer-focused" to "customer-committed." For years, aggressive customer acquisition strategies have dominated the marketing space. But as cost containment becomes a priority for businesses looking to thrive in the modern digitally-transformed marketplace, keeping existing customers happy and loyal is now a primary concern.
Did you know that 80% of your future profits will come from 20% of your existing customers? Loyal customers are the bread and butter of a successful ROI. Why spend all of your time and energy creating costly customer acquisition-focused marketing campaigns if you aren't going to spend time keeping them around?
But creating customer retention strategies requires a deep understanding of your retention issues. Where is the revenue leakage happening? How fast is it happening? Why are loyal clients turning away? If you want to know the answer, put on your swimsuit.
We're about to go diving for metrics.
Why you need to understand your customer retention metrics
While a piñata game is best played with a blindfold, business isn't. Creating effective marketing campaigns, R&D strategies, and sales processes require a clear and consistent understanding of your customers. That's what metrics give you. In particular, your customer retention metrics are a critical component of long-term business planning.
Customer acquisition is a fantastic way to grow your business in the short-term, fast. But, while adding customers to the ship is great for ticket sales, it's not going to prevent the boat from tipping over in the long-term. Customer retention is what makes your business stable and financially successful over time. In fact, a mere 5% increase in customer retention can boost your bottom line by 25 to 95%.
How is customer retention measured?
Your customer retention rate (i.e., the percentage of customers who continue to use and resubscribe to your service over time) is your golden ticket to profits. Again, a great customer acquisition rate with a bad customer retention rate is akin to throwing water into a leaky bucket.
There are a few ways to measure retention. The most straightforward way is to simply divide the number of active users by the total number of users at the beginning of a time period.
The number of active users = the number of customers at the end of the time period - the number of new customers gained throughout the time period. In other words, acquisitions that fall inside of the time period where you measure retention don't count toward retention. After all, they weren't retained. They just started.
6 Customer retention metrics to pay attention to
When monitoring customer retention, there are six particular metrics we like to track. I’ll go through the ins and outs of MRR churn, user churn, customer retention rate, customer lifetime value (LTV), customer acquisition cost (CAC), and LTV: CAC ratio.
1. MRR churn
For subscription-based businesses like SaaS companies, understanding how many subscriptions you lose each payment period is crucial. MRR churn is the measure of how much MRR was lost during a period due to cancellations and delinquencies. Since MRR churn is the measure of your overall erosion of recurring revenue, it's a primary SaaS benchmark for product development.
The importance of MRR churn
For SaaS service companies, MRR is what puts food on the table. It's probably either your primary or only source of customer revenue. MRR churn directly threatens your MRR. It's the number of users who call it quits or fail to charge at the start of a new time period. Since keeping existing customers is cheaper than acquiring new ones, having a low MRR churn is a vital component of long-term, sustainable growth. Understanding your MRR churn can also help you build intelligent product strategies and create consistent budgets. The more accurately you understand your MRR churn, the more acutely you can target goals, build business intelligence, and create monthly budget goals.
For SaaS companies, scoring negative net MRR churn is HUGE. It means that you're outpacing your churn and generating revenue. Without it, you're relying on investing injections and rapid acquisitions—both of which are short-term solutions.
How to calculate MRR churn
The equation: MRR churn = ΣMRR Cancellations + ΣMRR Delinquent
The explanation: MRR churn is the summation of all of your cancellations and delinquent accounts. So, if you had $5,000 in cancellations and $500 in delinquent accounts during June, your MRR churn for that month is $5,500.
Turning it into a percentage: To figure out your percentage of MRR churn, you take your MRR churn for a month and divide it by the overall MRR for the previous month. So, if your MRR at the end of May was $55,000 and your MRR churn for June was $5,500, you would divide $5,500 by $55,000. That gives you 0.1 (or 10%).
How to reduce MRR churn
There are three buckets of opportunity for MRR churn reduction—decreasing delinquent accounts, decrease cancellations, and increasing stickiness.
1. Decreasing delinquent accounts: You only recover 30% of customers who have a failed payment. A card dunning solution allows you to automatically increase your recovery rate by implementing intelligent payment processing methodologies that reattempt card charges and alert customers to failed payments.
2. Decrease cancellations: Customers cancel for a reason. Your job is to figure out why. Customer exit surveys can help (if you can get customers to fill them out,) but chances are, they cancelled for one of these reasons.
- A bad customer service interaction: Did you know that as many as 85% of customers churn due to poor service? PwC found that 32% of consumers jump ship after one poor experience. Customer service is huge!
- The price was too high: Finding the right price isn't always easy. You have to dig deep and do significant market research to make sure that you're not pricing too high or too low. As we always say, pricing is the exchange rate on the value you provide. If your pricing doesn’t align with your product value, then you’re missing out on revenue.
- They ran to your competitor or scaled out of your service: This is a job for R&D. Why did they scale out? Do you not offer them enough features? Do your competitors offer something you don't?
3. Increasing your stickiness: Your app's "stickiness" is a measure of your retention and customer engagement. Have Quality Assurance dig deep and figure out where users are getting hung up. If you can boost engagement, you can boost retention.
2. User churn
While MRR churn is focused on your overall monthly recurring revenue, user churn is simply focused on the number of users. These numbers will align tightly if you only have a single price point. But if you offer multiple subscription tiers (as most SaaS companies do), this number will be a little different than your MRR churn. User churn is how many overall users left your company during a period of time.
The importance of user churn
User churn is the baseline metric for company health. It can tell you how well priced each service tier is, and it can give you an insight into how many people are choosing to leave your company. User churn is glued to growth. The higher your user churn is, the slower you grow.
This can be tricky. If you have aggressive acquisition strategies, you may think growth is exploding. But if your churn is high, you're getting a false sense of hope. That growth is reliant on your expensive acquisition campaigns. Once you hit the peak of your customer base, customer acquisition will start to wind down and grow more slowly. If you have high user churn when this happens, your massive growth spike can suddenly turn the other direction.
How to calculate user churn
The equation: Number of churned customers/Total number of customers (for whatever time period)
The explanation: This one is simple. It's how many customers you lose divided by your entire customer base. Again, when you calculate this, use the total number from the previous time period. Otherwise, you may have acquisitions sneak into the equation, which can give you an inaccurate reading and put a mist over how high your actual churn is.
This is just one way of measuring churn. Steve Noble, a Spotify engineer, wrote an entire post on four variations of churn rate. You can read more about that here.
How to reduce user churn
Again, customers always cancel for a reason. Luckily, there are a few smart strategies that will help you immediately reduce churn.
- Implement an annual plan: Churn rate immediately drops if they pay annually.
- Catch delinquent churn early: At Profitwell, we've found that 20 - 40% of SaaS companies' user churn is due to delinquent accounts. Catching delinquent churn early and often (combined with card dunning) can shave off a significant portion of your User Churn.
- Build a churn reduction process: Here's a great churn reduction strategy you can use to start tackling user churn.
3. Customer retention rate
Another crucial retention metric is Customer Retention Rate (i.e., the number of customers that continue to use your service after a certain time period.) Customer Retention Rate is the reverse of your churn rate. It's the number of customers you keep.
The importance of customer retention rate
Your customer retention rate is a measure of how effective your retention strategy is. Keeping customers happy, engaged, and adequately priced will keep your retention rate sky high. Low retention rate is a serious issue that can quickly lead to rapid revenue erosion—especially if you bill annually. Since the vast majority of your customer loss happens at new billing cycles, customer retention rate can change fast. That's why it's important to combine it with other retention metrics.
How to calculate customer retention rate
The equation: Number of customers who continue their subscriptions/Total number of customers at the start of a period (multiply this by 100 to get a percentage)
The explanation: Your customer retention rate is simply a measure of how many customers continue to be customers after each billing cycle.
How to improve customer retention rate
The #1 way to boost your customer retention rate is to align and incentivize your team to focus on keeping customers happy and engaged. That means focusing on the right customer retention metrics. For example, sales is often incentivized to score conversions as their primary metric. At the same time, marketing is typically focused on MQLs. If you don't glue retention-focused metrics to the scoreboard, you're not going to score any touchdowns. This also includes making sure that your product team is consistently improving your service.
4. Customer lifetime value (LTV)
Ever wanted to know just how much your customers are really worth? That's their lifetime value (LTV). This is a measure of how much a customer will spend over the course of his entire tenure with a business.
The importance of lifetime value
Let's start with this. Your LTV needs to be higher than your customer acquisition cost (CAC). If it costs more to get customers than they're worth, you're in a tricky spot. Ideally, LTV should be higher than CAC and worth enough to offset your R&D costs. The great thing about LTV is that you can increase it. And, the higher it gets, the more growth you're going to achieve, and the more you can spend on acquisition. Since acquisition and LTV are married at the hip, marketing teams need to utilize LTV to build out their bids and campaign costs.
Typically, we use the rule of three. In other words, LTV should outpace CAC by three. For every $1 you spend on acquisition, you're getting $3 in value. That gives you wiggle room for R&D, new launches, etc.
How to calculate lifetime value
The equation: Average revenue per user (ARPU)/MRR churn (or customer churn)
The explanation: Lifetime value is the measure of how much your customers generate in revenue minus their overall revenue churn. This calculation is probably one of the simpler LTV calculations, but it rings true for most SaaS companies.
How to extend lifetime value
There are TONS of ways to boost LTV. But let's look at three big ones:
- Upsells and cross-sells
- New products
- Scalable pricing
1. Upsells and cross-sells: Creating upsells and cross-sells that satisfy your user base and generate revenue is a no-brainer for LTV. It pads your pockets and provides value to customers. Here's a great thing. You're 60-70% likely to sell to an existing customer (that number drops to 20% for new customers). Cross-sells and upsells let you tap into your already existing customers, boost their value, and grab some additional revenue streams while you're at it. That's a win-win!
2. New products:This one is easy. Create synergistic products that add to the value of your existing products. These should ideally integrate and drop right into your core product's workflow. The benefit of this one is that these can explode into massive successes. The bad news is that they're harder to sell out of the gate.
3. Scalable pricing: Your price is all about your value metrics. You need to know which pricing tiers you should create with what features based on existing metrics. (We have an entire post on this.)
5. Customer acquisition cost (CAC)
Remember how we said that LTV needs to be tightly aligned to CAC? Well, here it is. Customer acquisition cost is how much you're paying to get new customers. Now, we know what you're thinking. "Isn't that the opposite of churn?" Yes! It is! That's the point. To understand the damage of your churn, you have to understand the cost of your acquisitions. Let's imagine a perfect world where your buyer's persona doesn't have a roof (spoiler alert: it does). In this world, doesn't it make sense just to ignore churn and get more customers?
Well. Try calculating your CAC. You'll figure out quickly why churn matters.
The importance of customer acquisition cost
This is how much you're paying for new faces. And that's huge! If this cost is higher than your LTV, you're in major trouble. We're not talking, put it on a goal list. We're talking, stop everything and fix it today kind of trouble.
How to calculate customer acquisition cost
The equation: Total cost of sales + Marketing/number of customers acquired
The explanation: This one involves a ton of other variables. Basically, you want to take every cost bucket in marketing and sales (e.g., salary, bonuses, benefits, tools, campaigns, bids, etc., etc.), dump them into an ocean, and measure that ocean. Then, figure out how many fish you net, measure them, and divide. How much did it cost you to scoop up each customer?
Warning: This metric can get scary.
How to improve customer acquisition cost
Here are a few surefire ways to get your CAC down and your customers up.
- Optimize your funnel: Try applying the Balfour Method of growth process to your funnel.
- Optimize your pricing: Again, pricing is everything. We have a ton on this topic. Basically, you want to use value based pricing. Trust us. It's easier said than done.
- Maximize sales and marketing: You want to stay lean and agile, reduce waste, bid effectively, and (of course) A/B test everything until your eyes bleed.
- Be quick: Engaging customers faster means less spend on each one.
6. LTV/CAC ratio
This is the golden stitch. This is the A in the alphabet soup of metrics. Your LTV/CAC ratio is the single best metric to measure your overall growth potential. If this ratio is high, you're winning. If it's not, it's time to make a change.
The importance of higher LTV than CAC
Let's keep this simple. Having a high LTV/CAC ratio is essentially a measure of your success. You want to have a ratio of over one. That means you're earning money by securing customers.
How to calculate LTV/CAC ratio
The equation: LTV/CAC
The explanation: This one is easy. Take that LTV and divide it by your CAC, and pray that the number is over one. We always recommend that this number is above three.
How to improve your LTV/CAC ratio
Not to sound like a broken record, but you HAVE to optimize your pricing. It's basically your ticket to metric dominance.
ProfitWell Metrics Makes it Easy
That sounds like a ton of metrics, right? What if we told you that's only the beginning? There are hundreds. Wait! Thousands of metrics that you need to measure consistently to help you grow smart, fast, and quick in today's data-driven ecosystem. It sounds like a headache, doesn't it? It doesn't have to be! ProfitWell is the Tylenol for those metric migraines. With ProfitWell, you get all of your subscription reporting metrics in one big, beautiful window of truth. What's not to love?
Don't run away from customer churn; embrace it! Understanding your churn will help you grow like wildfire. To learn more about churn, pricing, and other SaaS metric issues, join the other 50,000 SaaS companies getting our insights, weekly. Welcome to SaaS done smarter.