In a board meeting yesterday, we had a brief discussion around “negative churn”. Negative churn is a catchy phrase and apparently a hot-topic in some SaaS circles. I like some of the concepts and disciplines that an understanding of negative churn implies, but I also think it is an unnecessary concept that actually makes it more difficult to understand the inner workings of an MRR based SaaS business. Some background…
What is Negative Churn?
Negative Churn is an increase in revenue which occurs when the change in revenue within an installed base of customers is net positive from one period to the next. Negative Churn implies that the revenue gained from existing customers who purchase more over time exceeds revenue lost from existing customers who purchase less over time, including customers lost outright.
The term “negative churn” is an attempt to understand net organic revenue growth within an installed base of customers in the context of churn. Understanding the change in revenue within an installed base of customers is really important. But seeking to understand organic installed base growth in the context of churn begs a question: What if the revenue gained from existing customers who purchase more over time is less than revenue lost from existing customers who purchase less over time. Such a scenario would indicate that Negative Churn is NEGATIVE! Can Negative Churn be negative? Should we call this scenario Negative, Negative Churn? Of course not.
Conflating Churn and Revenue Lift
The fact that Negative Churn is a double negative is the first reason to not like it. Further, Churn is always and unambiguously revenue reducing. Therefore, Churn is always negative. Churn is never, ever positive.
Churn should be analyzed independently from the revenue lift from upsell (or extension) that has the potential to drive organic revenue growth in an installed base of customers. Conflating the two is dangerous. To some degree, the concept of Negative Churn is a response to companies having difficulty calculating a churn rate. Calculating churn is never as easy as it seems it should be. There are two types of churn that are critical to measure and analyze, each separately.
Customer Loss Churn
Customer loss churn is the easiest type of churn to understand and measure. Customer loss churn occurs when a customer is no longer a customer and all of the revenue (MRR and otherwise) that the company earned from that customer is no longer.
Customer loss churn can be measured in terms of either customer count or revenue; the revenue version used above. Unless your customers are homogeneous in terms of their monthly revenue, the revenue-based version of Customer Loss Churn is a far better indicator of the impact of churn on your business.
Revenue Churn occurs when the revenue you receive from a customer falls in total dollar amount. Several factors drive Revenue Churn. Common examples including a customer using less of your service (fewer seats, lower utilization, etc.), and a customer renegotiating the rate at which they buy from you downward. The customer is still a customer, but you’ve incurred a revenue reduction. I recommend that for each period over which you are measuring churn that you capture all of the Revenue Churn from customers whose revenue declined during a period and state it as a % of the MRR at the end of the prior period.
Once you have each of Customer Loss Churn and Revenue Churn nailed, you can add them together and derive Total Churn.
Installed Base Growth/Decline
So now that we’ve got churn nailed, lets turn attention to the organic growth/decline conundrum that the concept of Negative Churn was designed to address. One of the great facets of SaaS businesses is that they have the potential to capture more share of wallet from their customers over time. In my experience greater share of wallet comes from three primary sources:
- Higher Utilization: Many SaaS models have a utility based component to their pricing model. Utilization can be based on an unlimited number of factors including, but not limited to the number of transactions processed, cpu/storage utilization, etc. Higher utilization means more revenue.
- More Seats: Most SaaS models have a seat-based component to their pricing. The more seats (users), the higher the cost to the customer.
- Cross-Sell: SaaS companies should strive to capture greater share of wallet by selling other services that are adjacent to the core service offering, thereby capturing additional revenue per customer by providing a broader array of services those customers demand.
Whatever the source, it is important to measure and maximize revenue increases that are attributable to these sources. One can capture these revenue increases in a factor I refer to as Revenue Lift.
Revenue Lift is the opposite of Revenue Churn. Just like Churn can never be a positive, Revenue Lift can never be a negative number, because the numerator includes only those customers whose revenue increased during a particular period and is therefore a positive number.
Organic Growth/Decline in the Installed Base
Now we can answer the question that Negative Churn is trying to address: What is the organic growth/decline in revenue from our installed base of customers? Given that we’ve done the work to parse apart Customer Loss Churn, Revenue Churn and Revenue Lift, the remaining work is a snap.
Stated as a percentage:
If the Organic Growth/Decline calculations results in a positive number, congratulations, the revenue from your installed and continuing base of customers is increasing; you have organic growth in your installed base. Lets also hope that your new logo bookings more than offset your Customer Loss Churn. If the Organic Growth/Decline calculations results in a negative number, you have Organic Decline in your installed base. In order to fill the hole, you need to book an even greater amount of MRR from new logos to offset your Customer Loss Churn and Organic Decline in revenue from your installed base
Note that I prefer to exclude Customer Loss Churn from the Organic Growth/Decline calculation because I prefer to evaluate the revenue trend for customers who have made the choice to continue to be customers in isolation from Customer Loss Churn. I’m not suggesting ignoring Customer Loss Churn; quite the contrary; by isolating it, you have to focus on it. In fact, you need your bookings from new logos to fill the hold from Customer Loss Churn and then some, if your business is going to grow.
Organic Growth/Decline vs Negative Churn
For me, Negative Churn tries to accomplish too much with one statistic. And because the results of the Negative Churn calculations can actually be a negative number (i.e. Negative, Negative Churn), I strongly prefer the Organic Growth/Decline calculations above to the Negative Churn construct. I don’t argue with the intent behind the concept of Negative Churn; the intent is good. I just believe that looking at Organic Growth/Decline in revenue from an installed user base and each of its component parts can yield far greater insight and understanding.
I should add that the statistics presented here aren’t comprehensive for understanding Organic Growth/Decline. It is important to understand the distribution of where both Revenue Churn and Revenue Lift are coming from. If Revenue Churn is highly concentrated among a small set of customers, it is important to understand but perhaps not a crisis. On the flip-side if Revenue Lift is concentrated among a small number of customers it might not be repeatable, so you should stop the high-fives immediately. You should always take a look at the distribution and dispersion of Churn and Revenue Lift across your customer base as well as the root causes behind the results.
Other Negative Churn Resources
Much has been written about negative churn. From what I can gather, Dave Skok of Matrix Partners first coined the term in a 2012 post about Why churn is SO critical to success in SaaS. Tomasz Tunguz of Redpoint wrote a piece focused on Negative Churn as did Lincoln Murphy of Sixteen Ventures. There is a lot of good stuff in these posts and others that I’ve read. They key take-away is that if you can drive net positive organic growth in your installed and continuing base of customers, you win, particularly if you continue to acquire new customers at a rate that exceeds your Customer Loss Churn.