I write and talk a lot about capital efficiency. Some may consider that a bootstrap bias, but it’s really not. A SaaS company’s capital must be used wisely to maximize growth — regardless of its source or quantity. If the revenue churn rate is too close to the capital burn rate, you’ve got a problem to solve. How capital is used has everything to do with how steep growth can be. Too much capital used to replace churned revenue is a recipe for a treadmill that makes it harder and harder to post strong growth numbers.
Churn Rate Treadmill
Revenue churn is the opposite of growth. It’s money lost period-over-period from customers that were previously acquired using precious growth capital (CAC). Every month that monthly recurring revenue (MRR) continues or expands improves capital efficiency. Every churned or downgraded customer reduces capital efficiency. The objective is to amortize CAC over as long a lifetime (LTV) as possible. The higher the ratio is between CAC and LTV, the more capital efficient, sustainable and steep the growth curve can be.
When churn rate can be held in check, proportionally more capital is being used to produce new revenue rather than replacement revenue. More is used to cover new ground rather than running in place.
Exceptional Churn Rate Sideroad
This is where I relate a personal anecdote that contradicts everything I just wrote. Many years ago, I had a product with a horrifically high customer churn rate. We’re talking astronomical and unsustainable by any industry yardstick. The truth is, back then I was so ignorant of managing churn that I didn’t even track it. Years later, when we reported churn in arrears, was the first time I saw the reality of those years and how we grew right through them.
Despite what should have been crippling customer churn, we grew at a steep rate from bootstrapped coffers. How? Expansion revenue from the customers that didn’t churn. Our customer churn problem was that we were selling to too many of the wrong customers. But the right ones were ecstatic. And they expanded their usage of the platform, and our revenue, far more rapidly than the revenue lost from customer churn.
Entry-level customers came and went at our base MRR, but customers who stayed expanded their MRR 2-10x or more (plus services attached). This is, of course, a cautionary tale, as the only way to recreate that success in the face of failure is to have an equally strong land-and-expand strategy baked into your offering. But the reason for relating it is that every SaaS and situation is unique, and rarely are solutions black and white.
Institutional Implications of Churn Rate
Back to the more common side effects of high churn rate. Institutional sources of capital really don’t like seeing their funds used to replace lost revenue. That’s considered raising execution risk which is seldom popular among banks, VCs or PEGs. And, my firsthand experience with strategics was that churn was the first question asked after top-line growth and customer acquisition momentum. Again, if growth is offset by revenue churn, the question of why will quickly rise to the top of the list.
One important thing to note here is that I’m not advocating for no churn. I’m just cautioning against having a churn rate that’s outsized against your sector’s norms. Relative performance is all that matters to most institutional players.
We write a lot about managing and mitigating customer and revenue churn, so I won’t repeat those articles here. But I will say that controlling customer churn starts with sales & marketing setting accurate expectations and focusing on the ideal customer profile (ICP). Those ideal customers should be on-boarded quickly and efficiently to ensure rapid adoption and realization of value. After that, customer development needs to have a path forward to upsell and deliver expansion revenue (like my example above). Specific tactics vary based on sector, price point, monetization strategy and so on. But, big picture, the entire organization contributes to reducing revenue churn. It has to be a consistent focus for everyone.
This article was born out of some recent client meetings where they really hadn’t considered the hole they were digging with churn. They had focused, as so many SaaS leaders do, on customer acquisition and much less so on retention. They’d built a relatively efficient sales & marketing machine that was being sacked on the top line by premature customer losses. A huge proportion of their growth capital was being used to maintain rather than increase scale. The trickle-down effects of revenue churn impact the P&L, the balance sheet, and morale. I hope any question you might have about making churn a top priority has been put to rest. If you have a churn problem, you have a burn problem, and that will make it very hard to grow.