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Churn and contraction are more than just metrics; they are critical indicators of a business's health and trajectory toward growth or decline. A high churn rate can flag customer dissatisfaction with a service or product (or both). At the same time, contraction reflects a decrease in customer spending or partial misalignment on the use case that the product or service was designed to fulfill on the value proposition. Both metrics profoundly affect a company's financial performance and strategic planning around resources, investment, and planned exit for the startups.
Calculating churn and contraction is essential for any business looking to understand and improve customer retention and revenue stability. It's a strong indicator in your startup that what you're building around your value proposition and solution resonates with your audience, and customers find it indispensable.
Churn rate, often expressed as a percentage, is the rate at which customers stop doing business with a SaaS company over a specific period. It is calculated by dividing the number of given customers lost during the period by the total number of customers at the start of the period.
Churn Rate Calculation Example:
If a SaaS company starts a quarter with 1,000 customers and loses 50 of them by the end of the quarter, the churn rate for that quarter is:
Churn Rate = (Number of Customers Lost/Total Customers at Start of Period)×100=(50x1000)×100=5%
Revenue Contraction Calculation Example:
Contraction in a SaaS business is measured by the reduction in recurring revenue from existing customers. Unlike churn, where customers stop entirely using the service, contraction involves continuing their subscriptions at a lower value.
Imagine a SaaS company that tracks monthly recurring revenue (MRR). At the start of the month, its MRR from existing customers is $100,000. Due to downgrades and reduced subscriptions, the MRR has decreased to $90,000 by the end of the month.
Revenue Contraction = ($100,000 initial MRR - $90,000 end-of-month MRR) / $100,000 initial MRR × 100 = 10%.
This shows a 10% contraction in revenue from existing customers, which can be just as critical as losing customers outright.
Now, these metrics are the output measurements that are hard to predict if you don't have a whole infrastructure setup around handling your customer's expectations from the acquisition phase, the metric won't improve, so to make it better, you must look under the hood with the excellent understanding why certain events leading to churn and most importantly whether these trends are reversible.
The consequences of neglecting these signals are creating significant issues across the board. In other words, you must always invest time to understand your customers. Analytics is the way, but you must look at the non-qualitative to get validation from your customers or external body that will verify whether what you are reading makes sense. More on that later in the conclusion section. Before focusing on the solutions, let's identify the typical and atypical reasons driving the churn rate up.
Plenty of reasons can be identified to drive the churn rate up. Rarely one, often several, and not all are known to your or maturing startup organization.
Poor Product-Market Fit: If the product doesn't meet the needs or expectations of the target market, customers are likely to churn. Full stop. If your product didn't get solid traction with the acquisition and your churn rate needs to improve over time, there is something that should tell you that your primary concern and investment should be in the product. The use case(s) must improve to fit the buyer's/decision-makers expectations. It must address the problem that often happens to offer misaligned features, lack of essential functionalities, or the product being too complex or simple for the intended audience. Depending on the buying persona, your UI/ UX might be another factor that users don't trust the software you're selling (rarely, but it happens in specific categories).
Customer satisfaction issues: Poor product or service quality, inadequate customer support, and unmet customer expectations are leading causes of churn. A negative customer experience can prompt customers to look elsewhere. These are often a continuation of the wrong or misleading product development process that needs to be more comprehensive with the support and customer success objectives and resource allocation. Companies forget they are selling a SaaS box that includes these services; therefore, they should be complementary.
Pricing Issues: High prices or perceived lack of value for money can lead to customer churn. Similarly, customers may downgrade services if they feel they're not getting sufficient value. Pricing must follow the value of the offering. Suppose your competitors are catching up with you with the features, and you try to increase your price for the same functionality. In that case, you must run your price sensitivity analysis before making that decision. Many don't; therefore, even a small price change might impact the short- or mid-term churn rate. The same applies to the new feature release and whether to charge extra or offer that as an add-on.
Competition: Losing customers to competitors is a common challenge. Customers might churn if they find a competitor offering better features, pricing, or customer service. That's usually a business intelligence error that companies don't sufficiently invest in understanding the buyer persona, the company's intent, and how adopting critical features works on the customer side. Most importantly, organizations forget about reflection under one framework that triggers preventive actions. You will lose to your competitors as your product can only cover some use cases. That's the beauty of the market.
Market Changes: Shifts in market trends or customer preferences can result in churn. Organizations that fail to adapt to the changes risk losing relevance with their customer base. That's a strategic failure for the company and its boards and investors. I think the function of the management is to find answers for the market shits as they are vital to any startup growth trajectory. However, often, we need to remember that the buck continues with the C-level or product manager but should be constantly monitored by their boards and investors. Ultimately, they are working on their upside with each of these ventures, so putting this on others doesn't make sense. Let me clarify. This is not to say that every board member or investor should run their Excel or analysis (although it's highly advised to refresh them often) but to ask the right questions about the market conditions, competitive landscape, or other emerging trends. Ultimately, you can change the course if someone tells you about the iceberg ahead.
Internal Operational Issues: Inefficiencies in sales, marketing, or customer service processes can contribute to churn. Poor internal operations can lead to a lack of coordinated effort in addressing customer needs and expectations. This topic is very close to me. Insufficient internal communication, resource alignment, or ability to react fast make these issues more acute, impacting your capacity to respond to a likely churning account. Yes, it starts with good analytics and proper business intelligence but must be converted into meaningful actions. Yes, this can't be just a lower price but something that convinces customers that you genuinely care about them and what value your product delivers. If one team can identify the problem but others drop the ball on reacting, that account is gone, and it will take time before they consider returning.
Let's run this through the hypothetical but actual use case to illustrate how this would work for your company. Imagine a SaaS company specializing in SalesTech solutions experiencing a higher-than-industry-average churn rate. The company offers a comprehensive set of tools for account intent auto-dialer, including analytics, email sequencing, social media management, and customer relationship management.
The company noticed a 40% annual churn rate, which was alarmingly high compared to the industry average of 15%. It was particularly concerning as the company relied heavily on its subscription model for steady revenue.
The company implemented a robust customer success program, improving the onboarding experience and ensuring regular check-ins with clients. This program aimed to help customers realize the product's value more quickly and promptly resolve usage issues.
At the core of the CSM program, the team conducted a detailed segmentation analysis to identify high-risk customer groups with specific attributes. This analysis revealed that small businesses were churning at a higher rate, possibly due to the complexity of the tool and a perceived mismatch in features offered versus their needs. The customers had smaller budgets to receive the expected ROI that required additional investment that the small entities couldn't afford. So, customers in the grace period started to understand that they bought something without fully comprehending the offering and required total investment before they saw the result.
Based on these insights, the company developed tailored engagement strategies for these high-risk segments. They offered specialized training webinars for small businesses, simplified their user interface for this segment, and provided more responsive customer support. Their analytics started to drive their selective targeting among the small segment customers, the most withdrawn customers, and far from the total product adoption.
The initial results were looking promising. Within six months of implementing these strategies, the company witnessed a 15% reduction in its churn rate, bringing it down to 25%. The CSM led to a higher customer satisfaction score, particularly among new clients who rated their onboarding experience more positively. The tailored engagement for small businesses helped better align the product with their needs, resulting in increased usage and reduced churn in this segment.
Alight. This is a partially true scenario. First, turning around 15% of your churn to renew accounts is very doubtful; even the best would have a problem doing that over 6 months (please ping me if you disagree). The second problem is that 25% churn is still a bad result for any SaaS company, which means that CSM programs can go that much. More often than not, you need a substantial change on the product side to improve from here, which usually takes work to turn around over a short period. You must re-allocate your resources to a product before scaling your sales, marketing, or CSM. Companies wrongly try to expand their GTM functions without ensuring their product resonates with customers in a way that doesn't require extra hiring in the CSM or support functions, which over time become an expensive party. Your operational ability to conduct that change over the short period will depend on how much analytics you put in place, how well you understand your customers, and how well your operational/ revops team is conducting and guiding the GTM teams toward the highest returns. They must devise a new approach to financials, FCST, and expense line shifts and re-assess their risks in these areas. Building a contingency plan like this requires separate planning, connecting, and altering your previous assumptions.
Conclusion
In summary, churn and contraction are not just metrics but vital signposts that guide businesses in navigating the complex terrain of market dynamics and customer preferences. They are derived from the logo retention, GRR, and NDR/ NRR metrics. All of them, as ratios calculated of the volumes, contract value, ARR, or ACV, must work in concert. These metrics require a clear definition so everyone in the organization can understand how they can participate in their improvements. The second conclusion is that your churn rate reflects the product fit and your value proposition more than your CSM practice. Yes, there is a weight on that part, but CSMs can only compensate for the product misfit if your customers buy predominantly a platform or solution that includes CSM service on top, not vice versa.
Effectively managing churn and contraction metrics, you should focus on the following areas:
Prioritizing product-market fit to reduce churn due to misaligned features or complexities is essential. Consistently refine your product based on customer feedback and market trends to ensure it aligns with your target audience's needs and expectations. Invest in your product, and don't fall in love with this founder's perception that your company will be like a scaling machine because you hire more reps. It won't, and very likely, you understand that after spending $100M on something that will never come because of something more fundamental. Scale slowly based on your product fit promise.
Enhancing customer support and success is the key to addressing customer dissatisfaction and improving the overall experience. This learning organization must be based on a robust data-driven process that focuses on customer perception of the solution and problem you're trying to solve. Invest in customer success programs that offer regular check-ins, tailored training, and responsive support, particularly for high-risk segments like small businesses.
Optimize pricing strategy to prevent churn due to a perceived lack of value or pricing issues.
Conduct price sensitivity analysis and adjust pricing models to reflect the value offered. Consider options like bundled services or loyalty programs to enhance perceived value, and only do that in isolation by looking at your competitors. Ultimately, your pricing will be compared with your competitors' pricing, along with other factors.
Conduct competitor and market analysis. It's vital for staying competitive and preventing customer loss to rivals. Regularly assess competitor offerings and market shifts. Utilize business intelligence tools to understand buyer personas, adapting your product and marketing strategies to stay connected. Invest in product marketing that can work with your sales teams on the right messaging, POV, and value proposition. The story that your reps will tell matters.
Improve internal operations and analytics to ensure a coordinated approach in addressing customer needs and predicting churn trends. Tracking reasons at the granular level is one, but confirming the plan is set and delivering commitments requires much time and ownership. Estimating the impact and providing the data that helps to draw the lines for all these actions is something that your operations must assist with. Foster internal solid communication and align resources across teams. Your operations team must act as a grand station for all these efforts, prioritizing these projects based on the highest ROI for the company and helping reduce the churn rate. To do that, you must constantly invest in your analytical abilities to track customer engagement, product adoption, and churn indicators and use these insights to inform operational and strategic decisions.
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