The Young Startup’s Guide To Understanding Churn

Ben Lee

Ben Lee

CEO and Co-founder of Neon Roots

Ben Lee is the co-founder and CEO of Neon Roots, a digital development agency with a mission to destroy the development model and rebuild it from the ground up. After a brief correspondence with Fidel Castro at age nine, Ben decided to start doing things his own way, going from busboy to club manager at a world-class nightclub before he turned 18. Since then, Ben has founded or taken a leading role in 5 businesses in everything from software development to food and entertainment.

As a new startup, there are few things more exciting than acquiring new customers. It’s the validation of your dream: these are people that believe in your company, that see your vision, and that like your product enough to pay for it. But as exciting as customer acquisition is, it’s not the end of the story. In the SaaS and mobile app development worlds, customers will inevitably cancel or stop using the product. This is called churn, and it’s one of the most dangerous threats – or most powerful assets – that young startups face.

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Customer Churn

Churn is a complicated concept, and it’s often misunderstood by new founders. This misunderstanding can be fatal, but we’ll explore that in a minute. First, let’s take a look at the most basic and easily understandable form of churn: customer churn. Put simply, customer churn is the number of current customers you lose every month. We can find it with this formula:

Customer Churn = # of churned customers / # of total continuing customers

We know what you’re thinking:

“But wait, what about the number of customers we’re adding each month? If we’re losing 100 customers a month but adding 1000, that’s not a problem, right?”

In our opinion, it’s better to use the number of continuing customers you have and leave off newly acquired customers. Yes, those new customers make your numbers look better, but if you’re simply trying to understand your business, it’s better to take your medicine and measure churn as a function of current customers.

Calculating it this way tells you something critical: it tells you how many of your customers have used your product and are unsatisfied with it. In the long run, this is a hugely important thing to understand about your business. Adding 1000 customers a month doesn’t matter if 90% of them will drop within the next 6 months – you’re still dead in the water. Measuring churn as a function of current customers tells you that ahead of time.

Calculating customer churn like this can also give you two more crucial insights: average customer lifetime and customer lifetime value(CLV). To find the average customer lifetime, all we have to do is divide the churn rate by 1. This gives you the number of months your average customer will stay with your business or mobile app.

To find customer lifetime value, multiply the average customer lifetime figure by the average revenue a customer generates in one month. Both of these metrics are critical to understanding the health of your business.

Revenue Churn

While it’s easy to understand, customer churn isn’t always an accurate view of your business – particularly if you’re using a tiered pricing model

For a more accurate understanding of how churn affects the growth or decay of your business, we turn to another metric: revenue churn.

Revenue churn shows you the amount of money you lose each month as a result of churn. We can calculate it like this:

Revenue Churn = Churned Monthly Recurring Revenue / Total Monthly Recurring Revenue

*Once again, and for the same reasons, we’ve chosen to leave out new revenue. This is a harsher metric, but it’s a more telling one.

Revenue churn illuminates a key principle that regular customer churn calculations can hide: not all of your customers have the same value to you.

As a mobile app-based company making money off of advertisements, if most of the customers churning are your power users – the ones accounting for the majority of your revenue because they generate the most impressions – that is a huge problem.

It doesn’t matter if you have a 0% churn rate amongst the customers who rarely use the app. If your highest-revenue customers are churning, you can die even though you have a 1% overall customer churn rate.

In the same vein, a SaaS company that’s churning 50% of its premium customers is bound for failure. The free user churn rate doesn’t matter: churn really only affects your business by how it affects your revenue.

Net Churn

Now let’s take a look at another form of churn, and one that can – if things are going well – tell a very promising story about your business.

Net churn doesn’t just take into account your churned customers or churned revenue, but also includes the customers who scale up their relationship with you. For mobile app-based companies, this could be customers who move from free to premium or customers who increase their usage and generate more impressions. For SaaS-based companies, this is customers who move from a lower pricing tier to a higher one.

We can calculate net churn using this formula:

Net Churn = (Churned Monthly Recurring Revenue – Increase of Monthly Recurring Revenue from Upselling) / Total Monthly Recurring Revenue

But wait – this number could be negative, couldn’t it? If your increased MRR from upselling outweighs your churned MRR, what do you have?

This is called negative churn, and it’s a very good thing. Negative churn means that your customers are actually more valuable than you think they are – customers don’t just generate revenue when you bring them on, but they actually increase in monthly value over time. As Tom Tunguz demonstrates in this graph, negative churn can generate upwards of 70% more revenue over the course of a year as compared to positive churn.

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But negative churn isn’t just important to revenue. Negative churn is doubly important because it demonstrates the holy grail which we stress so often during Rootstrap sessions: the end-all-be-all of success, whether you’re a hot dog stand or a mobile app development company like us, is generating real value for your customers. If enough customers are upselling to create negative churn, you can be pretty sure that you’re generating real value for them – and that’s a very, very good thing.

Dealing with Churn

So now that we understand churn, what do we do about it? As a young startup, particularly one operating in the mobile app space, this can be a difficult question to answer. The number of factors that might cause customers to leave can seem infinite – but there are practical things you can do to fight churn.

Focus on Firsts

For any business – and for mobile app-based businesses especially – the first few experiences your customer has with your app, product, or company may be the most important part of your entire business. As a young startup or someone launching a new mobile app, customer firsts are critical.

Do everything in your power to make sure that the first few encounters a potential customer has with your brand are overwhelmingly positive. This will create a positive relationship from the start and set your company up for success in the long run.

Let Customer Feedback Be Your Compass

Perhaps the most straightforward way of understanding why customers churn is also the one that young startup owners forget the most often: just ask them!

In a way, your churned customers are your most valuable resource. These are the customers that used your product and decided they didn’t like it, so invariably, they know why they didn’t like it. If you can find that out from them, you can fix the problem and lower your churn rate.

The obvious step is to put a feedback form on your account deletion or subscription cancellation page, but realistically, this probably isn’t enough. We’re not sure we’ve seen a business do this yet, but you might even consider offering an incentive for their feedback.

What would happen if you offered $5 to every customer that left in exchange for feedback on what they didn’t like? For the price of a cup of coffee, you’d be getting invaluable information on how to improve your product and lower your churn rate. Obviously this is only sustainable if you can afford it, but for a young startup, those numbers may just add up.

Sell Your Vision

As a young startup with a newly-released v1.0 of a mobile app, chances are things aren’t running perfectly yet. There are still probably bugs in the product, kinks in customer service, and an overall roughness to your business operation.

But for very early stage startups, this doesn’t have to be a problem because you’re not just selling the product as it stands – you’re selling a story. You’re selling the promise of the value you plan to create. Things may be rough around the edges now, but down the line, you have an incredible product you’re working to develop.

You should communicate this vision – the end-goal of your product or app – constantly to your customers. Do all you can to smooth out the kinks as they are, but also keep in mind the power of what you’re planning to accomplish and keep that image fresh in the minds of your customers. This will help you create loyal customers early on and build the basis for a robust customer base as you grow.

Our thanks to Rawpixel &  flickr.com/photos/clemkey for the photos