Last week I wrote about customer churn and why it sucks. Today I’ll offer my perspective on the slightly more complex and more interesting topic of revenue churn. Unlike customer churn, revenue churn isn’t binary. Customers are either retained or not, but revenue churn assesses the degree to which they are retained — as judged by how much they spend period over period.
One of the reasons revenue churn is so much more interesting from a business perspective is that it can cut both ways. If a customer retained from a prior period spends less in the current period, that’s revenue churn. But, if they spend more in the current period than in the previous one, that’s negative revenue churn. The goal is to have the negative churn outpace the churn so that overall, you book negative revenue churn. This is easier said than done because customers who fully churn, plunk a big fat bagel in your retained-revenue column. Typically, it can take a lot of upgrades to exceed a full cancellation.
Monthly Recurring Revenue (MRR)
It’s important to note that the revenue we’re focused on is recurring — more specifically, monthly recurring revenue (MRR). It’s also important to understand that churn is based on the retained revenue in the current period less the revenue in the prior period — from the same set of customers. Meaning, you don’t count newly added customers’ revenue in the current period.
Initial or new contract MRR is set by pricing and packaging. Initial contract value includes a version/tier and/or scale of your SaaS that becomes that customer’s base MRR. Smart SaaS packaging and pricing is designed from the outset to encourage midterm expansion from the base MRR. If pricing and packaging are fixed; sold in at the top of the scale; or if customer adoption is low; expansion revenue will be harder to come by and overall churn will be that much more likely.
What is “Acceptable” Revenue Churn
I’m often asked what “acceptable” revenue churn is. That’s a tough one to answer, but the obvious answer is zero. Fantasies aside, I like to look at revenue churn on an annualized basis as a percentage. I want revenue churn to be negative, not zero or higher. If you are in positive churn territory, what’s acceptable depends on your market, price point and much more.
Think of it this way, there’s a massive, business-changing 20% swing between 90% revenue retention (revenue churn) and 110% revenue retention (negative revenue churn). If you’re posting a modest 15% new business revenue growth rate, 90% revenue retention can lower that to a paltry 5%, where 110% revenue retention can catapult that to 25%. The valuation difference between 5% or 25% top-line growth is significant.
By the way, aside from MRR, there are other ways to expand customer revenue. They’re not as “valuable” (or sexy) as expansion MRR, but to a business looking for fuel for growth — cash is king and it doesn’t have to come from MRR. Services attached can be a designed upsell to increase period-over-period customer revenue. Of course, there are caveats like the ongoing cost of sales and higher cost of delivery, but as a component of revenue growth, and potentially as an aid to retention and MRR growth, services may be key.
Land and Expand
But back to the tastiest stuff. Land and expand is the intentional and predictable strategy and design of bringing in new customers and subsequently growing their MRR. Without expansion revenue, revenue churn is a virtual certainty — and simply a question of degree. Companies throw around radically divergent “churn” numbers. That’s why it’s such a methodical part of diligence and such a contentious number for many SaaS companies. So, whatever your number is, make sure it’s consistent and defensible.
Revenue churn is a huge indicator of growth potential. That’s because, even when companies have significant customer churn, they can overcome it with expansion revenue. (This assumes that they are netting more total customers month over month. If not, they have bigger troubles.) Ideally, the expansion axis aligns with customer usage (another carefully examined diligence topic/health indicator). What you want is for successful customers to naturally scale in both usage and MRR. When you have that, combined with success in new customer acquisition, you have a growth machine that will be hard to slow down. It’s a recipe for success.