Tuesday, November 10, 2009

Measuring churn for recurring revenue businesses

For any recurring revenue company, churn is almost always one of the key metrics the company (and their board) tracks. Why work hard to get new customers if you can’t keep the ones you’ve got? Moreover, low churn means you have a stronger recurring revenue base and therefore more money to spend acquiring new customers. Thus, having low churn creates a virtuous cycle for the company in more ways than one.

While churn may seem like a straight forward concept, I’ve found that recurring revenue companies often only measure monthly or annual churn in terms of customer count. While this is certainly an important measure, I’m not a fan of measuring churn just on a customer basis for the simple reason that not all customers are created equal. To take an extreme example, imagine an early stage company doing $200k in Monthly Recurring Revenue (MRR) with 200 customers ($1k MRR ASP). If the company had one flagship customer that was actually generating $5k in MRR and that customer churned, that does a lot more damage to the company than the .5% monthly customer churn would indicate.

Analyzing churn on a MRR basis lets you see other gradients as well. Notably, the recurring revenue base you have from one customer might grow or shrink over time, even if the customer never churns. If on average you lose more MRR on a monthly basis due to your existing customers downgrading their contract than you gain from your existing customer base upgrading their contract, your business would be bleeding recurring revenue and your customer churn number would be silent on the subject. It's difficult to fix what you don't track.

Measuring MRR churn can have some surprising insights too. What we’ve found is that while companies might target 10% customer number churn, those companies might have negative churn from a MRR basis. This means that on average, the company is adding MRR from their existing customer base above and beyond what they lose from customers churning or downgrading. For those companies, it’s worthwhile to try to look at which customers are churning early in their contracts and which customers are expanding their recurring revenue base; you may notice some patterns. For example, there might be some marketing activities that are picking up more of the former which you can eschew in favor of those that attract more of the latter.

You can read more about recurring revenue metrics on Bessemer's website at www.bvp.com/SaaS.

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