Negative churn is a bird in the hand that is worth less than two in the bush. It has emerged as a preferred and even promoted SaaS metric over the past couple of years. Yet by offsetting two (or even three) numbers against each other it obscures rather than illuminates business performance. Why would a goal that offsets two conflicting numbers be the right metric for your SaaS business?
To be clear, negative churn arises from two things 1. On the plus side, the increase in revenue from existing customers. 2. On the other side the loss of revenue from customers who stop using your SaaS (or churn for short). Thus “Negative churn” is the result of a sum, not a number or phenomenon in its own right.
Setting this as a goal or celebrating it as an achievement creates an inherent conflict. Let’s start by examining the two faces of strife in turn.
Customer or revenue churn?
The trigger for writing this blog was a post by one of my favourite SaaS companies, ChartMogul. How do I calculate LTV when I have negative churn? digs into the exact problems that this “accomplishment” generates. And the first issue centres around that single word churn.
Churn arises when a customer stops paying for your SaaS. At this point you are already losing two things: a customer and a monthly or annual revenue receipt. For an SMB SaaS these two numbers may give a similar message. The flat pricing structure and similar base limit dependence on key customers. But if you are winning larger customers? Then the monetary value of the revenue lost may not be an accurate reflection of the number that churn.
Lincoln Murphy has explained this challenge well in SaaS churn: Measure customer or revenue retention. Lincoln believes the focus should be on the dollar value of retention. And he makes a strong case for the importance of this measure to SMB SaaS.
I think there is value in tracking both types of churn depending on your SaaS business model. For now, think about the messages that these two measures of churn could be sending:
Make no mistake, churn is an important metric for any SaaS business. David Skok outlines the importance of churn in this classic article. And he continues by describing the growth that results from so called negative churn. But all he is saying is that increasing revenue from existing accounts is a powerful growth lever.
Growing revenue from existing customers
Both upsell and account expansion are ugly and jargonistic English so let me drop them now. We are talking about selling more to your existing customers. Either by increasing the number of users a customer pays for. Or by raising the value of the services your SaaS provides to those users. Often the revenue added will be a bit of both.
Measuring this type of revenue communicates an entirely different type of message:
Growing revenue from your existing customer is a powerful growth mechanism. Tom Tunguz argues in favour of negative churn on this basis. But recognises at the end of this intelligent article that this does not give the whole picture
Two whites offset to make a black hole
The heart of the problem with negative churn is the combination of these two factors. Offsetting one against the other loses the messages that each is trying to send. Without offering any new value in return.
Sure, if churn turns negative it proves that your growth from existing customer is more than you lose from customers who cancel. So what? At the same time you could be missing:
Contrast this with LTV which also combines two measures. Revenue per customer and customer lifetime. Here both point in the same direction. And are supported by a common goal of better customer satisfaction and loyalty.
Sound maths doesn't mean a good answer
Maybe part of the reason this metric has been promoted is that both elements affect LTV. David Skok has demonstrated in LTV - DCF provides the answer how the sums can account for both factors in your LTV calculation. He has even thrown a discount factor.
There is nothing wrong with David’s maths. But LTV is a summary measure. Once you have it, you break it down if you want to find the areas to make improvements. And in that breakdown the factors in negative churn apply in different places.
The value part of LTV is based on average revenue per user user/ account (ARPA/ARPU). If you grow the revenue earned from accounts over time, this value will increase. A good thing and well worth managing. Revenue growth from existing customers is an important part of this mix.
Lifetime is the inverse of churn (1/ Churn %). If churn is a genuine negative this is mathematically impossible. So even in the Skok formula you need to use the customer churn rate. In other words lifetime needs to be as accurate a reflection as possible of how long a customer stays with your SaaS. Building longer term relationships with customers is also a great thing to manage. And that is where the other half of negative churn comes into play.
Focus on building a great business
Negative churn is not an accomplishment. It is not a real metric at all. It reminds me of Boris Johnson’s policy on cake. 100% pro having it and 100% pro eating it. Great fun but not that useful in the real world.
Tangling two things together means you could be missing what really matters. You risk looking in the wrong direction or misallocating your resources. Your business becomes more fragile. Because you narrow and obscure the voice of your customers.
Forget artificial metrics. Focus on growing revenue from your loyal customers. And on extending loyalty by helping customers get the benefits of your SaaS. Listen to separate, clear metrics and learn from everything you hear. Use this to give your teams the right objectives. And put resources where they will add the greatest value.
Kenny Fraser is the Director of Sunstone Communication and a personal investor in startups.