How do you calculate customer churn, and what are the differences between customer churn and revenue churn?
Depending on who you ask, this can be a difficult question to answer. In fact, if you google it, you can find some very complicated answers, like this one. The point of this blog article isn’t to restate what they did, but instead show you that calculating churn can be simple and doesn’t require a master’s degree in mathematics from M.I.T.
Let’s start by discussing the two different methods of calculating churn: customer churn and revenue churn.
To determine the percentage of customers that have churned, take all the customers you lose during a time frame, such as a month, and divide it by the total number of customers you had at the beginning of the month. Do not include any new sales from that month.
For example, if Company ADG had 500 customers at the beginning of the month and only 450 customers at the end of the month, its customer churn rate would be:
Customer Churn Rate = (Customers beginning of month – Customers end of month) / Customers beginning of month
(500-450)/500 = 50/500 = 10%
If your organization prefers, you can use that same method on a different time frame such as quarterly or annually.
To determine the percentage of revenue that has churned, take all your monthly recurring revenue (MRR) at the beginning of the month and divide it by the monthly recurring revenue you lost that month minus any upgrades or additional revenue from existing customers. Just like for customer churn, new sales in the month don’t count toward revenue churn as you are looking for how much total revenue you lost. New revenue from existing customers is revenue you have gained.
For example, if Company ADG had $500,000 MRR at the beginning of the month, $450,000 MRR at the end of the month, and $65,000 MRR in upgrades that month from existing customers, its revenue churn rate would be:
Revenue Churn Rate = [(MRR beginning of month – MRR end of month) – MRR in upgrades during month] / MRR beginning of month
(($500,000 – $450,000) – $65,000)/$500,000 =
($50,000 – $65,000)/$500,000 =
(-$15,000)/$500,000 = -3%
Note the negative revenue churn rate means you actually gained revenue that month!
As before you can choose a different time frame, such as quarterly or annual. Just remember that if you do, you’ll need to look at quarterly or annual recurring revenue, not monthly. Also, as the example pointed out, a major benefit to calculating revenue churn is that it’s possible to include upgrade revenue.
Now that you understand the basics of calculating customer churn and revenue churn, let’s dig a little deeper.
Customer Churn ≠ Revenue Churn
The first thing to point out is that customer churn and revenue churn are not always the same.
Company ADG has 2 product lines:
Basic: 5,000 customers that pay $500/month per customer = $2,500,000 MRR
Premium: 1,000 customers that pay $1,250/month per customer = $1,250,000 MRR
This gives ADG a total of 6,000 customers and $3,750,000 MRR.
Let’s say that in one month, 180 basic customers and 20 premium customers churn.
(180 + 20)/6,000 = 200/6,000 = 3.33%
((180 * $500) + (20 * $1250))/$3,750,000 =
($90,000 + $25,000)/$3,750,000 = $115,000/$3,750,000 = 3.07%
Note that, while similar, customer and revenue churn rate are not identical because the basic and premium packages are not worth the same revenue. This discrepancy will only grow as you gain more product lines or the price difference between product lines grows. Therefore it is very important to clearly communicate which method you use and be consistent in your regular reporting.
It’s also important to note that you may need to use both calculations as you manage your business. Revenue churn is a great way to report on performance and understand the financial health of your customer base. Customer churn is important for staffing reasons as an employee can only manage so many accounts at one time.
We’ve mentioned in this post that you can calculate churn over a monthly, quarterly, or annual time frame. While this is true, there is an important caveat to consider.
In the monthly calculation, there is an underlying assumption that no customer can churn in the first month. This is based on the assumption that your customers pay for the month up front. So when you take a snapshot at the beginning of the month and then divide that by the total number of churned customers, you don’t have to worry about any new sales churning in that time period.
Now, if in the same model we calculated churn over a quarter, we could run into a problem. There will be some new sales from the first month in the quarter that could churn in the second or third month of the quarter. If those churns are accidentally included in the calculation, then we’ll overstate churn.
For example, Company ADG wants to calculate quarterly churn.
ADG has 1,000 customers at the beginning of the month and 50 churn during the month, leaving 950 customers at the end (refer to this as Cohort A). There are 100 new sales during the month (refer to this as Cohort B).
Of the 950 customers in Cohort A, another 50 churn, leaving 900. Of the 100 in Cohort B, 5 churn, leaving 95. There are another 100 new sales this month (call this Cohort C).
Of the 900 customers still in Cohort A, another 50 churn, leaving 850. Of the 95 customers in Cohort B, 5 more churn, leaving 90. Of the 100 customers in Cohort C, 5 churn, leaving 95.
The summary is:
Cohort A – begins Month 1 with 1,000 customers; ends Month 3 with 850
Cohort B – Begins Month 2 with 100 customers; ends Month 3 with 90 customers
Cohort C – Begins Month 3 with 100 customers; ends Month 3 with 95 customers
If we look over the quarter, our initial cohort of 1,000 customers only has 850 customers remaining, giving a customer churn rate of 150/1000 = 15%.
During that same time frame, there were 300 new sales, of which 15 churn. If you included those 15 churns in your calculation, you’d have 165/1000 = 16.5%.
To get around this problem, you have 3 solutions. The first is you can use some very complex math that is available via the link in the first paragraph of this post. The second solution is much simpler, and that is to make sure to exclude all new sales from churn calculations! If you do that, you get the churn rate of Cohort A, which was our install base at the beginning of the quarter. This method gives you the true churn rate, without replacement, of your customer base over a quarter.
The one issue with the second solution is that you may want to include the churn rate of Cohorts B and C. If that is the case then you can use the third solution — a weighted average.
Cohort A – 1,000 customers; churn rate of 15%
Cohort B – 100 customers; churn rate of 10%
Cohort C – 100 customers; churn rate or 5%
[(1000 x .15) + (100 x .1) + (100 x .05)] / (1000+100+100)=
[150 + 10 + 5]/1200 = 165/1200 = 13.75%
As you can see, it’s still relatively simple to include new sales and their churns during the quarter too! Just make sure you explain this to your operations team, or whoever does reporting for you, so they know exactly what you want and how to report it!