Churn, and Other Horsemen of the Apocalypse

“I’ve got a problem,” says App Developer. “My software sells well enough, but income is hard to predict. I’m thinking about switching to a subscription model.”

“Now you’ve got four problems,” I reply.

Managed properly, subscriptions can smooth a business’ income and improve its predictability. But it’s a delicate balancing act. Every subscription business, whether cutting-edge SaaS or humdrum periodical, must confront the four horsemen of the subscription apocalypse: churn, average revenue per user (ARPU), cost of customer acquisition (COCA), and cost of goods sold (COGS). These metrics demand a watchful eye; any change can send a carefully calibrated business spiraling into oblivion.

The web is chockablock with great writing about the Zen of subscription metrics. But churn deserves special mention. Of the horsemen, it looms largest in early stage startups. At a high level, churn is best seen as a proxy for customer (un)happiness. When a startup is still discovering its product/market fit, happiness can change on a dime. Any slight uptick in churn can overwhelm a businesses’ positive metrics, quickly quashing growth.

It’s worth teasing apart happiness. In markets where non-consumption is not (or not much of) a competitor, churn and happiness go hand-in-hand. When a customer leaves AT&T, they’re almost certainly heading to Verizon, Sprint, or T-Mobile… and they’re almost certainly unhappy. On the other hand, when non-consumption is a viable alternative, customers may leave because they just don’t need a service right now. Even in their absence, these customers might be perfectly happy.

The flip side to churn is customer lifetime value (CLV). When average revenue per user is fixed, lifetime value is strictly determined by churn. As churn decreases, customers become more valuable on average. When this happens, businesses become free to spend more on customer acquisition, pursuing leads and strategies that would not previously have been profitable1. Even when average revenue grows, it tends to grow slowly; churn remains the dominant factor in nearly any CLV computation.

Because churn is such a critical metric, larger companies manage it with in-house customer success teams. What is a penniless young startup to do? Why, build a customer success “team,” of course — even if it’s just one employee. For a tiny startup, churn management is bound to be time-consuming and non-scalable. Just remember that this cost is balanced against the high-magnitude, high-probability outcome of churn-dominated doom. The good news is that, for early stage startups, it’s easy to understand churn: simply ask your customers why they left2. The feedback you receive will guide you.

As successful subscription businesses grow, churn tends to converge to a predictable rate. Established SaaS startups might see 3% churn on average. Even in this “steady” state, churn is a relentless enemy, forcing businesses to continually find new customers to replace those they will inevitably lose. Tomasz Tunguz has written an excellent piece on the churn mitigation strategies used by maturing subscription businesses.

[1] I’m speaking as someone who has bootstrapped his subscription business to profitability. The trend today in SaaS is to find a pot of gold and use it to grow unprofitably until it’s time to “flip the switch.” I understand this game abstractly, but I have no taste for it. Perhaps this is why I’m not a particularly good entrepreneur!

[2] Cloak presents departing customers with a super-simple (and completely optional) exit survey. Customers — happy or otherwise — seem to like the opportunity to speak their mind. Beyond this, I’ve learned that sending personal emails to departing customers is a wonderful way to learn more and to let them know that we care.