The Hidden Math of Churn: Why You Can't Scale Past $1M
If I have learned a single thing working with subscription companies, it’s this.
Your churn rate is worse than you think. And it hurts you more than you think.
Your churn rate is kind of like you bank account balance.
It's stressful to look at so you don't check it often. Also, the number that you tell everyone is from a good month.
Your churn rate also dictates the “ceiling” of your subscriber base, which impacts profitability, which directly impacts the value of your company.
Almost no one understand the full impact of your churn rate and I’ll explain why.
What Impacts Churn
If you’ve worked in a subscription company for any period of time, you know churn is important.
Your churn rate driven by (roughly in order of impact):
- How long will users have the problem you solve? Is this a thing that consumers will do for a long time? Or is it a temporary habit?
- How strong is your product market fit? The thing people come to you for, how good are you meeting that need?
- How well do you activate users onto your product? what % of the users that you attract actually feel value from your product to come back a few times? How many abandon immediately?
- How good are you at payment processing? Do you actually collect all the money?
- How good are you at winning people back once they leave or think about leaving? Or after they do leave?
Most founders know their churn rate, but few understand how it caps their company's growth potential and massively impact profitability.
As mentioned before. there are multiple ways of tackling churn. One of my favorite tools to do so right now is Churnkey, which has great out of the box tools to implement the best practices listed in previous posts.
Let's start with what most people know about churn.
The Basic Way of Looking at Churn
One of the most helpful equations in a subscription business is this:
Average Months of Retention = 1 / Average Monthly Churn Rate
So if you churn 20% of your users each month, you are keeping your users around for 5 months.
Let's look at this for a range of churn rates.
This makes intuitive sense. The lower the churn rate, the longer you keep people around.
Obviously 20 months of retention is better than 4 months of retention, but it still kind of abstract.
The LTV Connection
Thanks to math, you can approximate your LTV in the same way by swapping your monthly price into the numerator.
So it looks like:
LTV = Monthly Price / Average Monthly Churn Rate
If your product is $9.99 USD per month and you run the same math, you see this.
Now this gets a bit more real. LTV jumps ups significantly the more you reduce churn.
The difference between 30% churn and 20% churn isn't 10%. Its 50% which translates directly to LTV.
Every time you churn churn by in half, your business doubles. Doing that isn’t easy, but the math is clear.
Additionally a higher LTV give you more cash to acquire users.
This can open up new acquisition channels and allow you to increase the number of new users each month.
Again, not rocket science, this is still pretty basic.
Advanced View #1: Tracking Annualized Churn
This was shocking to me the first time I saw it.
What’s easy to forget, is the monthly churn rates compound. Every month, you lose another percentage of the same cohort.
Unless your churn rate is under 20%, you will lose 100% of your users within 12 months.
Numbers over 90% highlighted in red for dramatic effect.
Yeah, that sucks.
Needless to say, its really hard to grow a user base when you lose 100% of the users your acquire within 12 months.
This brings us to our next point.
Advanced View #2: Growth Ceilings
(big credit to Bryan Starck, who’s great linkedin post was the first time I saw this clearly articulated)
Obviously the churn rate dictates the number of users you keep, it also governs the total number of users you can get to overall.
If you divide the number of users that you acquire each month by your churn rate, you get your growth ceiling. So:
Maximum Subscribers = Monthly New Users / Average Monthly Churn Rate
If you look at this for a range of churn rates, it hammers the point home.
Math being math, the company with a 5% churn rate is 400% larger than the company with 20% churn.
A more subtle, but powerful point is how this impacts your valuation as a company.
The 5% churn rate company is still growing at month 24 while the 20% churn rate company’s growth has stared to stall around month 11.
Your growth stalling sucks for a few reasons, but the main one is this that it impacts your valuation.
You can’t get the high growth multiples on your company valuation from VCs or acquirers if you can’t break the growth ceiling.
The 5% churn rate comapny has much, much longer to figure this out.
Advanced View #3: The Impact on Profit
Back when I started in the VC backed startup world, profit wasn’t really a thing we talked about.
We raised money and used it on free lunches, an awesome office and buying custom slippers for everyone.
Good times.
Sadly, those times have changed.
Now you need to make money.
What hammers home the value of this is when you start to look at your profit per user and how this impacts overall profit.
Lets assume for the same business, your product sells for $9.99 USD per month and you have an acquisition cost per user of $30.
So your churn rate is now the difference between losing money, surviving on ramen and being rich.
So What Do You Do With This Information?
Obviously the whole point here is to improve your churn rates. But more specifically:
- Calculate your growth ceiling right now (You can do that here). Take your average monthly new users and divide by your churn rate. That's your future unless something changes.
- Focus on churn before growth. Cutting your churn in half doubles your ceiling AND doubles your LTV. That's can be easier than doubling your acquisition.
- Set realistic growth targets. If you want to hit 10,000 users and have 10% monthly churn, you need to acquire 1,000 new users every month just to maintain that level.
The good news? Understanding these limits early lets you fix them before they become emergency problems.
Additionally, I have a few posts from the archive that talks about tactics you can use to lower churn:
- Deep Dive on Cancellation Flow Best Practices - Tactics that I have seen work across companies to drop churn within your cancelation flow
- The Basics of Fighting Churn - Where to start and what are the types of anti churn programs that work?
- Payment Processing 101 - How does payment processing work and what can you do to lower your payment failures?
Good luck out there.
Dan
Note: This post is also sponsored by Churnkey. They are exactly the type of tool I look to install quickly when I am working with a client to make an impact quickly in these areas while we work on larger projects.
If you don't have automations set up, I think they are a great way of doing this. You can either click this link or I can intro you to the team.
Sponsored by Churnkey: Churnkey helps subscription companies like Jasper, Veed.io, and Copy.ai, to drastically reduce voluntary and involuntary churn. On average, Churnkey saves companies 20%-40% of subscription revenue that would otherwise be lost to churn.
