I refer to churn as the ugly part of SaaS.
It goes without saying that if you’re a subscription company, you should be paying attention to your churn rate.
Most people think of churn rate as a metric that tells you how quickly you’re losing your customers.
But it’s much, much more than that.
Because just as the beauty of recurring revenue can compound the stacking of dollar bills. The reverse holds true when you let your churn rate compound for months or years.
You try to fix the leaky bucket of canceling customers by spending more money on finding new customers.
It’s a vicious cycle.
To really understand the compounding effects of churn, let’s introduce you to the Rule of 78.
What is the Rule of 78?
The Rule of 78 comes from the financial industry. It’s commonly used when calculating interest for lenders. Essentially, seeing how the interest compounds over time.
If we take the same principle of this formula and use it for subscription companies, you can see how significant an impact a lost subscriber will have on your business.
While you might think that losing one customer isn’t really a big deal, you’re not just losing out on that one month the customer leaves.
You’re missing out on what would be the lifetime value of that customer.
Let’s look at an example.
When a customer leaves, you not only lose that month’s revenue, you lose all future billing opportunities you would have had with them.
The important phrase here is billing opportunities.
Losing one $49 customer per month who would have normally stayed for 12 months doesn’t lead to just $588 less cash (12 x $49) …it leads to $3,822 less cash for that “1 less customer” of ongoing churn. Ouch.
This is because every customer you lose has a compounding effect on your cash flow – and on your total bottom line.
To put it differently
The Rule of 78 provides a quick way to measure the effect of churn and retention, based on a 12-month customer lifespan – simply multiply your monthly losses or savings by 78.
The math behind this, for a 12-month subscription, is:
- 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10 + 11 + 12 = 78
But this only measures the 12-month impact – the exponential power of churn and retention can reach much, much farther for customers who would’ve stayed longer. When that amount is compounded, your loss could be substantial.
And that’s only one customer per month. While everyone wishes that they’d have only one cancellation per year, it’s not happening. Imagine just how big of a loss this will be when you start multiplying it out.
How many subscribers are you losing per month currently?
After doing the math you’ll probably find that it’s too many, but what can you actually do about it?
What exactly does Rule of 78 mean for my company?
While seeing exactly how much you’re losing to churn can be a little nauseating, you can use the Rule of 78 to your advantage as well.
After you use it to calculate your losses, you can then use it to calculate what you stand to gain if your churn were to improve.
A company that has a monthly churn of $300 MRR each month would stand to gain significant cash flow back.
Using the Rule of 78, we can see that our startup would reclaim $23,400 in annual cash flow for this action.
$300 Monthly Recurring Revenue x 78 = $23,400
That’s a lot of money that any startup could desperately use, and many new SaaS companies are simply leaving it on the table because they don’t understand it’s there.
By utilizing the Rule of 78, you can explore ways to take advantage of this new cash flow pool.
Using this formula, you may also be able to identify patterns that could be seriously harming your business before they get out of hand.
Projecting future revenues can allow you to correct course or figure out areas where something’s missing.
Wrapping Up. Churn can’t be ignored.
Churn is more than just a percentage rate.
Churn is more than just losing a customer for the month.
Churn can’t be solved by just bringing in new customers to replace the old ones that left.
Now that you understand how quickly churn can compound, what are you investing in to fix it?