What Is Churn Rate?

By Markets Fool.com

Many businesses rely on recurring revenue from subscribers in order to stay healthy and keep growing. However, if you're in a subscription-based business, it's not good enough just to woo new subscribers to start using your service. You also have to make sure that you treat your existing customer base well, so that they will keep subscribing year after year and produce the predictable flows of revenue that successful businesses enjoy. One way to measure customer satisfaction is through the churn rate, which focuses on how many existing customers decide not to renew subscriptions and instead leave the service.

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How to calculate churn rate

In simplest terms, the churn rate is the percentage rate of subscription-based customers who choose to stop using the service in a given period of time. For instance, if a company has 1 million subscribers and 10,000 of them decide to stop subscribing, then the churn rate for that period is 10,000 divided by 1 million, or 1%.

Depending on the business, you can measure churn rates in a couple of different ways. The example above uses customer-based churn figures that are based on actual subscriber counts. That metric works well if you're in a business in which all customers pay roughly the same amount for their subscription costs. However, revenue-based churn measures the dollar value of lost subscription revenue due to nonrenewal and compares it to the overall revenue that the subscription-based service brings in. The advantage of using revenue-based churn is that it puts more weight on high-value customers who leave than on low-value customers.

For instance, using the example above, say that the company's 1 million subscribers bring in a total of $10 million. If the 10,000 customers who leave have more expensive subscriptions that represent $1 million of that total, then the resulting 10% revenue churn rate paints a more accurate picture about the high impact of the loss of those customers on the overall business than the 1% customer-based churn rate.

Churn and challenges to growth

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At the same time that businesses are trying to retain their existing customers, they're also bringing on new ones. In order to grow, a company must have a growth rate in terms of new customers that exceeds the churn rate of existing customers who leave.

That makes it critical for subscription-based businesses to balance new-subscriber growth and existing-customer retention. Given the costs involved in obtaining new business, it often makes sense to sacrifice some level of new-subscriber gains in order to reduce churn.

Churn rates are simple to calculate, but they contain critical information for investors evaluating a subscription-based business. The lower the churn rate, the more successful a company is at keeping its customers hooked on its products and services.

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