Understanding the Real Impact of Churn on Your Business

In the previous blog, we looked at what customer success is and why it’s important to your business. If you’ve decided that a customer success management program is right for your business, there are some things you need to establish before you go any further.

Firstly, there needs to be organizational focus. It’s not good enough if this is just something you react to when it happens, or something you make a token effort to talk about once a month when you look at your reporting. Customer success needs to be ingrained in your organization, which means it is something someone in your company needs to live and breathe. If you don’t have this, you will not be able to implement effective and lasting change.

So make sure you decide who is going to be the primary focus for CSM before you move forward.

Secondly, you need to know—and be able to measure—who’s leaving your business and what the real effect is on your ability to grow your company. One of the key components of customer success—particularly in the SaaS space—is a company’s ability to retain its customers. The rate at which a business is losing its customers or subscribers within a specific time period is called churn.

Defining churn

We define churn specifically as the reduction in customer spend on a monthly basis. This covers everything from customers downgrading the amount of services they buy from us due to their own contraction, to those that walk out the door to the competition.

Naturally, to get a clear picture of your churn, some form of customer segmentation is essential. For most businesses, new customers will have a higher churn rate than mature customers, so failing to separate your customer base even at this elementary level could give you a biased picture. For a useful churn rate, you may want to only report on those customers that have been with you for at least 90 days—you may even want to go as far as separating churn rates for other areas, such as particular demographics. These are issues that will be specific to your business, and we’ll look at segmentation in greater depth in a future blog.

However, for now, we want to look at how this top-level churn rate can give you real and dynamic insight into the growth (or contraction) of your business. In order to grow, your acquisition rate must exceed its churn rate. Monitoring this constantly will enable you to set targets, accurately measure performance, and react if you have any sudden changes.

Introducing the Quick Ratio

There are a number of different ways to measure the real impact of churn—too many to mention here—all of which have their own pros and cons. The most important thing is to pick one and run with it. In our case, we chose the Quick Ratio.

A company’s Quick Ratio is its growth divided by its churn. We’ve already explained how we measure our churn above. Growth is essentially the opposite; in other words, the monthly value of any new accounts added, plus the value of any existing accounts that add services to their contract.

 

Figure 1.

If we look at the example in Figure 1, we can see how this works in practice. Company A has $225,000 of recurring revenues. In a given month, they lose two customers worth $45,000 and 10 customers reduce billings by a total value of $20,000. This is offset by the acquisition of a new customer worth $15,000 per month and two existing customers increasing their monthly commitments by a combined total of $21,000 per month. Company A’s new monthly billings is now $196,000 ($225,000 – ($65,000 – $36,000)).

If we look at this in terms of the Quick Ratio of growth/churn (65,000/36,000), we get a figure of 0.55. If, as a managed service provider, you maintain a Quick Ratio of 0.55 every month, then over time, your business is going to contract. If you have a Quick Ratio of one, your business will stay the same size, and if you have a Quick Ratio of two, your business will be growing at a healthy rate.

Clear picture of the health of your business

One of the key benefits of the Quick Ratio is it gives you a nice clear picture of the health and quality of your business—capturing the positive impact of sales offset against the negative impact of churn. Importantly, it does this without having to go too deeply into revenue numbers, billings data, etc.—things you might not want to share with the rest of the company. 

Quick Ratio is something you can communicate with the rest of the organization to show what you are doing and at the same time set easy-to-follow goals around. For example, if you want to double your business in the next year, you can target a Quick Ratio of 2.5 every month to accomplish that and then easily be able to measure that on a month-by-month basis.

In reality, we also look at many other metrics —including local retention on a month-by-month basis, raw revenue percentage churn per month, billings versus revenue, retention by segment, etc.—but the Quick Ratio gives us a simple performance snapshot that is easy for the whole company to understand.

Kevin Kirkpatrick is senior director, customer success, SolarWinds MSP.