Understand revenue retention and churn - the magic of SaaS
This is the sixth post in our series on key subscription business metrics that every SaaS founder needs to know and understand.
Last week we discussed Logo Retention this week we are going to discuss Revenue Retention.
In these uncertain times, it is essential to double down on your efforts to minimize both revenue and logo churn.
Churn
Turning from Account Churn (or Logo Retention) your other measure of product/market fit is your monthly Gross MRR Churn rate. This is the total revenue that has been lost in a given month. This rate includes cancellations along with downgrades from existing customers. This should be examined relative to your Net MRR Churn Rate which examines the losses when subtracting your expansion MRR Rate.
Understanding your MRR Churn rates can help you assess the impact of losing customers on your business. It also helps you assess if your business can manage these losses, especially when you examine the Net New MRR brought in by new accounts from that lost from existing accounts. As you build a track record of performance data you can begin to build out fairly accurate forecasts of future revenue performance.
Understanding your MRR Churn rates can help you assess
the impact of losing customers on your business.
You should consider MRR Churn as your canary in the coal mine. By tracking churn from the beginning you can understand if you are delivering the product your customers want, with the onboarding experience they need. The lower your churn, the better your SaaS company is doing and the more likely it is that you have achieved the nirvana of product/market fit. Churn below 2% is a great indicator of a healthy business. If you are experiencing churn rates higher than 2% you may have an underlying customer experience issue.
Net Monthly Recurring Revenue Churn Rate
When you calculate month-to-month revenue that is lost due to a downgrade or cancellation, and factor in any upgrades you have calculated your Net Revenue Retention Rate.
Net Revenue Retention looks at the net impact of revenue inflows and outflows. Ideally, you have a net negative churn rate of 5% or greater. Monthly Dollar Churn looks at outflows due to a complete loss of revenue without looking at Expansion and Upgrade Revenue.
Generally, MRR Churn is bad. Your focus after winning a customer should be to drive your monthly dollar churn as low as humanly possible. If you have a high churn rate, your M/M and Y/Y growth rates won’t matter to investors. Focus on winning new customers and retaining them over the long term and keep your churn as close to zero as possible.
Calculating Revenue Churn
So what are the possible purchase options that are possible for a customer:
- Status Quo, do nothing (MRR)
- Make a first time purchase (Net New MRR)
- Increase the monthly purchase amount - upgrade or expand (MRR Upsell)
- Reduce the monthly purchase amount - downgrade (MRR Downgrade)
- Cancel purchasing all together - lost customer (MRR Cancellation)
Let’s review the chart used earlier on Tracking Your MRR:
You should be able to see how these five options work together during an analysis of monthly, quarterly or annual MRR revenue levels. It’s important to remember that you are performing this analysis over time - month over month, quarter over quarter or year over year. In the example highlighted above, we are performing a month over month analysis.
This is an early analysis of SaaSly’s revenue during its second year of operation. In January of that year, SaaSly entered the month with a $49 per month Entry plan and the $499 per month Pro plan. They had 100 customers on the Pro Plan and 1,000 customers on the Entry plan.
During the month they added $25,000 in Net New MRR made up of twenty new Pro plan customers ($9,980 MRR) and three hundred and six Entry plan customers ($15,020 MRR). They had forty-five customers upgrade from Entry to Pro for Upgrade MRR of $20,000. They had twelve customers downgrade from Pro to Entry for a net decrease of $5,000 in Downgrade MRR. Five of their Pro customers went out of business at a cost of $2,500 and a mix of ten Entry and Pro customers also cancelled for other reasons at a further cost of $2,500. So they added three hundred and twenty-six new logos, lost fifteen for a net gain of three hundred and eleven logos, but what was the net impact on revenue?
Revenue Churn Example
Beginning MRR $100,000
New Customers (326) $ 25,000
Upgrade MRR (45) $ 20,000
Downgrade MRR (12) ($ 5,000)
Cancellations (15) ($ 5,000)
Ending MRR $135,000
Now let’s examine the percentage change of each element:
New MRR $ 25,000/$100,000 = +25%
Upgrade MRR $ 20,000/$100,000 = +20%
Downgrade MRR ($ 5,000)/$100,000 = -5%
Cancellations ($ 5,000)/$100,000 = -5%
Net Change % +25% +20% -%5 -5% = +35%
Net Change $ +25,000+20,000-5,000-5,000 = 35,000/100,00 - +35%
Investors look at these metrics to assess whether your business has achieved product/market fit and whether you have positive traction and momentum providing an indicator of future performance.
Once again, Smithers manages all of these calculations for you using inputs from your payment and accounting software.
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