Churn Rate: What Every Startup Should Know

The goal for every startup should be to acquire a large enough and reliable client or customer base in order to gain revenues and make sustainable profits in the long run. A startup can effectively get new clients through marketing campaigns designed to increase the appeal and the perceptions of the value of their product or service. However like any other business, startups could lose some of their customers for several reasons.

Customer churn rate is essentially the rate at which customers end their business relationship with a company. Business to business (b2b) startups need not have as high a concern for customer churn as business to consumer (b2c) startups. This is because most b2b startups will typically have a small number of high-value businesses as clients and these are afforded personalized attention and are generally easier to keep track of. On the other hand, b2c startups typically aim to gain as many end-user consumers as possible in the shortest time they can. In the process, some of their existing clients may stop purchasing the good or services on offer and it is impractical to afford each individual consumer personalized attention to understand why they would have ended that business relationship. Different business models experience different kinds of customer churn. It is essential every startup to know how to calculate churn, understand what factors influence the longevity of individuals as customers of a business, and how to predict and prevent customer churn.

Calculating Customer Churn for Different Business Models

Startups usually fall into two main categories. They either manufacture and/or distribute products or they provide services. Some startups may have a combination of both. Depending on the business model, customer churn could be calculated either using number of customers the business lost, the nominal value of recurring revenue lost, or the percentage value of the recurring revenue lost.

For example, a business which has 100,000 customers at the beginning of a period, be it a month, quarter or fiscal year, losing 2,500 existing customers by the end of the year results in customer churn of 2.5%. This method is particularly useful for businesses which have a paid subscription service. A startup which delivers lunch to offices on business days, entertainment, internet or cellphone packages, magazines or online publishing, and accounting services are all examples of businesses where a customer base typically pays a similar subscription for the services provided. In such a case, number of customers is a very strong predictor of revenue and earnings so calculating churn in terms of number of customers lost makes sense.

A more complicated model would be a business with two tiers of customers. Take Spotify, for example. One could pay the subscription fees and remove adverts on the music streaming app, or one could listen for free while being exposed to advertisement. For such a business, it would not make sense to calculate churn in terms of end-users who stop utilizing Spotify as their streaming app. Advertisers also bring in significant revenue for the company. Perhaps Spotify could calculate churn in terms of paid subscribers lost per period but that model would not be efficient for the advertiser side of the model. Instead, churn should be calculated in terms of recurring revenue lost.

Recurring revenue may be calculated as monthly recurring revenue (MRR) or annual recurring revenue (ARR). A local bank may enter into an advertising contract which allows them to run different campaigns on Spotify over a two year period, with renewals available 3 months prior to expiration of the service agreement. That would count as recurring revenue, as would monthly subscriptions paid by users who are expected to continue using the Spotify streaming service indefinitely. If an artist is going on tour in Georgia, for example, and decides to run ads promoting that tour on Spotify for a month, that would not be considered recurring revenue. Churn for Spotify can then be calculated in terms of the nominal or relative value of revenue lost. This would apply to many service provider startups as well as product manufactures whose clients are retailers.

To further clarify why this is significantly different from merely measuring number of customers, think of a startup which delivers lunch packages to 10 companies in a central business district. Two of their biggest clients, OmniCorp and Goliath National Bank, contribute nearly 50% of their revenue. However, the tech startup next door, the Bluth Company, decides that KFC is a better option than the home-cooked meals offered by the delivery business. Calculating churn in terms of number of customers would result in a churn of 10% even though only 3% of their revenue was lost due to the change made by the Bluths. When dealing with hundreds or thousands of customers whose contributions to the business vary significantly, churn in terms of revenue reflects a clearer picture than customer numbers. Regardless, customer numbers are still useful in certain contexts.

Drivers of Customers Churn

Regardless of how brilliant a business is, customers will churn. It is what they do. Some factors are beyond a business’ influence. If a customer no longer requires the products or services offered by a business, there is not much that can be done to influence that decision. Sticking with the food delivery startup example, if an individual who was a regular customer of the business relocates or their company gets a cafeteria which provides free food for their employees, they will not continue being a customer of the business. Factors such as these cannot be mitigated. On the other hand, if a customer defects and utilizes a competitor as in the case of the tech startup next door, there are several reasons this may be happening.

Better Competing Products or Services – If another business is supplying objectively better offerings, the onus is on your startup to do better
Inadequate Customer Service and Support – When clients are constantly frustrated by a service provided and communication between the end-user and the business is poor, customers will seek other alternatives, even if the substitute is objectively poor. Lunch from KFC which consistently arrives at 1230pm is better than gourmet lunch which sometimes arrives 10 minutes before the end of lunch hour. Additionally, when customer queries are not solved within a reasonable period, expect customers to be actively seeking alternatives.
Unsuccessful On-boarding – This mainly applies to service which offer various features. When customers find it difficult to use a service the first time and fail to achieve full potential, they are likely to abandon the service.
Significant Changes and Lack of Innovation – When customers love a certain product or service, ill-advised changes could result in them churning. Changing a recipe, for example, or disabling a beloved feature, or eliminating a complimentary service (such as free delivery with certain purchases) could result in customer churn. Additionally, if your business is failing to innovate and unable to keep customers engage, their attention may turn elsewhere.

Predicting and Preventing Customer Churn

Not all customer churn is avoidable but that which is preventable should be. Customers cost money to acquire. Customer acquisition costs (CAC) are marketing costs mainly in the form of advertising, promotions and discounts. This value is taken in context together with the concept of customer lifetime value (CLTV). CLTV measures the value of the profits an average customer brings into a business. High customer churn means your business spends more on CAC in order to maintain the same size of customer base, and that CLTV for an average customer is lower due to the relatively short life spans of the relationship between the business and the customer. This reduces the profitability for any business. Having a loyal customer base should be the primary aim for a business. There are several indicators which predict customer churn. These include frequently high levels of customer complaints, backlogs in queries to be solved and negative feedback on ratings and/or social media. In order to prevent churn, a business should employ retention strategies. These include:

Customer reward schemes and incentive programs – sometimes products and services don’t need to be objectively the best. If customers feel valued and appreciated, even through superficial means like special discounts and rewards, they are less likely to churn.
Innovation and continuous improvement to products and services – sometimes reward schemes and incentive programs do not need to be objectively the best. If the quality of your products and services are peerless, even on a superficial level like aesthetics rather than functionality, customers are less likely to churn.
Efficient customer support and timely responses to queries – Nothing is more frustrating to customers than a company which is slow to respond to what can seem to be the simplest of problems with an easy solution.
Markets and trends analysis – sometimes external factors unrelated to an organisation’s core business could influence the perception of a brand in consumers’ minds. Appearing responsive to trending issues – such as the crisis in the Amazon rain forest could endear customers to your brand and earn their loyalty.