Don't Underestimate the Compounding Nature of Churn- It's Bigger Than You Think
Teams often focus on a few key metrics: MRR, LTV, ARPU, etc.
We rarely see blog posts about cash flow, so it's no surprise that compounding effects of customer churn (and conversely, retention) are so often underestimated by a HUGE margin.
For example, let's look at Sarah—a $20/mo customer.
When you lose Sarah in June, it’s obvious she won’t be paying you in July.
You see MRR drop by $20, and Revenue Churn increases by $20. But, that’s usually the end of the analysis.
What's missing is an understanding of how much longer Sarah could have been retained, the value of her future payments, and the compounding revenue impact this has.
Let’s assume Sarah stuck around 12 more months (that may sound like a lot, but bear with me…I’ll get to that later). This means in the coming year, she would have issued a total of $240 in payments.
Lost MRR * # of Months Retained = Lost Cash Flow
Ok, that seems pretty obvious.
But here’s where it gets crazy….What if you lose a $20/mo customer like Sarah, each month, for a year. And each would have otherwise stuck around 12 months, had they not churned.
- Month 1—Sarah churns, for a loss of $20 MRR and $20 Cash.
- Month 2—Dave churns, for a loss of $20 MRR and $40 Cash (since Sarah's payment is gone too).
- Month 3—Nikki churns, for a loss of $20 MRR and $60 Cash (Sarah and Dave are gone and you see where this goes).
Let that sink in a bit...Losing one $20 customer per month leads to $1,560 less cash after a year.
This is the Rule of 78 in action.
The formula looks like this:
In subscription-based billing, if you plug up a recurring loss, you can multiply that loss by 78. That’s the amount of cash you'll have a year from now.
And here's a more realistic example:
Startup X is churning $2,000 MRR each month. What happens when they reduce churn by a mere $250 per month?
After 12 months, Startup X has $19,500 additional cash in the bank. The simple math: $250 * 78 = $19,500.
I hear you wondering, "what if we only retain customers for 6 months instead of 12??" The results are still pretty astounding!
This is the compounding nature of churn.
Or if you’re an optimist, the compounding nature of retention. And it’s so much bigger than we been giving it credit for.
Reasons for Cancellation:
Ok, you may be wondering, "How can I retain customers who were set to cancel, and then retain them for 6+ months after?"
The answer lies in passive churn.
Odds are, 20-40% of your churn is caused by failed payment issues. Of those customers, you’re likely retaining 20-50% of them (if B2C) and 60-90% of them (if B2B).
These are customers who didn’t explicitly cancel, and if given the proper chance to remain customers, will stay for the long haul.
So with half of churn being caused by payment issues, and compounding gains available to those who optimize failed payment handling, what's holding us back from addressing this problem?
We underestimate the compounding nature of churn.
Sadly, when we talk to most customers, they're thinking about improving retention in simplistic terms. They hope to reduce churn by, say, $250 MRR/mo and are only expecting to have $3k more MRR 12 months later. In reality, they’ll have nearly $20k more in the bank as well.
Pause. Let’s let this simmer a bit more.
$20k more in the bank as well. Twenty thousand dollars more than they assumed.
As we scale, the compounding compounds further (😱), and the math becomes even more important.
It's easy to become so focused on MRR that we overlook Cash Flow, but it's a dangerous oversight.
Internalize the math, optimize retention as early as possible, and reap the compounding benefits enabling us to build a more efficient subscription machine.