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The churn rate, a dangerous and underestimated lever

Churn is like gravity, it inevitably pulls revenues down!

Hybrid by nature - it depends as much on internal factors within the company (control of the customer relationship) as external ones (competitive pressure, changing needs) - the churn rate is a tricky concept, and is often relegated as a secondary priority behind the acquisition of new customers, upselling or cross-selling.

And yet it is a very powerful lever for improving performance with a significant influence on revenues, business risk, profitability, and valuation.

Understanding the impact of churn

Churn can be measured in terms of volume: number of customers (total churn) or in terms of value: turnover per customer (relative churn). The value measurement being more accurate (it accounts for the variations in consumption per customer), it is the one that we will tackle in this article.

1. Revenues

One of the advantages of a churn rate under control, is its impact on long-term revenues and their growth rate.

To illustrate this point, let’s consider two companies generating a turnover from new clients of € 300 000 per year, perfectly identical in every respect, except that one (A) has a churn rate of 5% while the other (B) has a churn rate of 30%. After 5 years, company (A) will generate revenues 1.8 times higher and a marginal growth rate 2.8 times faster (Figure 1).

In other words, but very adapted to SaaS offerings, churn can be measured at a "net negative" rate. The objective is to quantify, for each customer, the amount of additional revenue (upselling or cross-selling) in relation to the lost revenue. As an example, if for a given customer, the additional revenue is 9% and the lost revenue is 6%, then the net negative churn rate will be -3%.

2. Business risk

A second benefit of a controlled churn rate is less obvious: stabilizing the generation of revenues over time.

Let's take our example of a company with a turnover of €300 000 from new customers. If it maintains its churn rate at 10% over the period, in year N+5 the share of revenue generated by the renewal of existing customers will be 79% (Figure 2).

The greater the relative weight of existing customers, the more accurate the growth forecasts and the more likely the revenue will be.

3. Profitability

The impact of the churn rate on profitability is multiplied by the fact that renewing an existing customer costs 5 to 25 times less than acquiring a new one.

In the example of our two companies, if we assume that the renewal of existing customers is 15 times less expensive than the acquisition of new customers, then the one with the churn rate of 5% (A) will generate in N+5 an EBITDA 2.2 times higher (Figure 3).

A deterioration in churn always has a long-term impact on profitability due to the reduction in the average customer lifetime value without reducing the acquisition costs.

VCs are increasingly attentive to the relationship between churn and profitability, and it is not uncommon for them to require, for a defined period, the continuation of positive profitability without the addition of new customers.

4. Enterprise value

All the previous effects have a decisive impact on the valuation of a company.

Figure 4 shows the different valuation levels on a continuum of churn rates. The hypothetical example is that of a company with a turnover of €300 000 at the beginning of the financial year, valued over a period of 5 years, and with as only variable parameter the churn rate.

Over an interval of 2% to 30%, a 2-point fluctuation in the churn rate results in an average change of €200 000 to €250 000 in the value of the company.

(1-The valuation is calculated here using the Discounted Free Cash-Flow method)

How to correct, or better, prevent churn?

The churn rate is as preventable as it is correctable and, when we carry out sales performance consulting engagements, we always rely on these two levers.

Here are 14 of the variety of measures we use:

Preventive actions – Protect against a deterioration of the churn rate:

  1. Target your prospects to avoid signing poorly chosen clients

  2. Carefully onboard your clients so that they understand and use ALL the value you will bring to them

  3. Mitigate client expectations by agreeing on target KPIs at the beginning of the project

  4. Develop offers that open upselling or cross-selling opportunities

  5. Structure an optimal set of offers to prevent unwanted cannibalization effects

  6. Proactively manage renewals to avoid using one-off discounts that have very negative consequences in the medium term (cash flow slippage)

  7. Structure the sales force compensation with a churn rate target that can be adjusted according to priorities

  8. ...

Corrective actions – Reduce the churn rate of existing customers:

  1. Set up competent, accessible, and responsive customer support

  2. Analyze churn rates by profile (segment, company size, seasonality, intensity of use, competition, payments history, etc...)

  3. Adapt your offering to integrate the most important features requested by your clients

  4. Carry out lost clients’ post-mortem analysis to understand their reasons for not renewing

  5. Never consider a termination to be final. For example: customers may not know that a desired feature exists or is coming soon

  6. Allow customers to easily access offering information and training modules (webinars, blog, white papers...)

  7. Structure a pricing strategy that is flexible enough to accommodate the most problematic churn cases (unit prices, volume discounts, feature pricing, etc.)

  8. ...

The slow rise in churn rates that we have observed recently is probably set to continue, fueled by competitive pressure, large-scale imponderables (Covid, war, inflation, etc.) and technological innovations. This hypothesis, if it’s proven true, militates for a strong reaction of the sales managers.

If you are interested in delving deeper into this topic and learning more about our experiences, please do not hesitate to contact us.

Alexandre Giry-Deloison, founder and CEO of GROW



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