Churn. 5 letters for such a scary word. Churn is the bogeyman of B2B SaaS founders (“be good, or Churn will eat away your company and you’ll die!”), they have nightmares about it. If you mention a Churn higher than 5% MoM to an investor they’ll either laugh at you or run in their offices, lock the door and then slip a note from under the door saying “do NOT talk to me!”.
Just look at this slide below; it’s from a Social+Capital’s presentation (awesome presentation at the even awesom-er SaasTr Conference a few weeks ago BTW, you should read the whole thing here if you didn’t already); it’s referring to a Gross Monthly Churn higher than 3% and a Net Monthly Churn higher than -wait for it- 0%:
Another very recent example is from Christopher Janz, Managing Partner at PointNineCapital, the European thought-leader when it comes to B2B SaaS companies.
Uhmmm, still not satisfied; if you ask me. Empirical evidence suggest otherwise. What about another B2B SaaS guru, Tom Tunguz of RedPoint?
In practice, churn rates vary by customer segment. Startups serving SMBs tend to operate with higher monthly churn, somewhere between 2.5% and 5%+, because SMBs go out of business with greater frequency and tend to be acquired and managed through less retentive channels, e.g. self-service. In the mid-market, which I’d define by average customer revenue of between $10k and $250k loosely speaking, the churn rates I’ve seen are between 1% and 2% per month. Enterprise companies, those with customers paying more than $250k per year are typically closer to 1%.
You get the point. And yet I’ve been talking with several SMEs/SMBs companies in the last couple years, and hearing about a 30-days churn below 5% is more rare than going to your local Starbucks and finding out that your barista is Kim Kardashian. Maybe that’s why the average SaaS investor is still way more focused on companies serving the enterprise instead of the Mid Market or the SMBs?
Maybe. And, as a following question: are all these companies f*cked? Possibly. Or maybe not. That’s when I went back to the graph Christoph Janz was mentioning in his tweet (below, for your ease of consultation) and found out a few interesting things that make that graph a too simplistic representation of reality:
- capping the new MRR at $10k/month means that the company’s *actively* avoiding to scale the go-to-market strategy, not only unsustainable on the long run by itself (regardless of having 10% or 5% or 1% Churn) but also a bit unrealistic. If we accept that assumption, we’re essentially saying that the company is growing at +10% Month-over-Month at $100k MRR and +3% Month-over-Month at $330k MRR, which is a +42% Year-Over-Year at $4M ARR. Would be interesting to see how many investors get excited about it.
- on the other side the graph compares a given absolute amount of new revenue with a relative percentage amount of churn, without factoring in -I guess for simplification purposes- that different cohorts behave in a different way. I know, it’s getting a bit complicated at this point, but bear with me. Cohorts are essentially groups of users, created based on the month of signup. You’ll have cohort by ‘Month’ (January) and by ‘Age’ (6 months old). ChartMogul recently released a nice CheatSheet on this.
In SMB SaaS, churn rates tend to be much higher, results from GrooveHQ’s SaaS small business survey showed an average churn rate of 3.2% monthly (annualised that is 32% annual churn 100 * (1 — (1-.032) ^ 12). It’s unclear from Groove’s blog post if they’re measuring customer churn or revenue churn but either way it’s not good. If it’s customer churn these companies will need to be adding new customers at a rate of 32% per year just to break even on the customer count they started the year with.
That’s where it struck me. 30-days churn for SMEs/SMBs is just *another* step of the funnel. Let it sink for a second. If you’re an enterprise company you front-load all the cost of qualifying the leads, and managing the length of the sales cycle, and hiring your salesforce to do that while filling up the top of the funnel with an outbound approach.
Of course, after a 3–6 months process and with a $10-250k Annual Customer Value (ACV) the churn *should* be below 3%, or something didn’t work out within your Inside Sales Team *because* you already screened your customers (I’m sure you read ‘Predictable Revenue’, right? If you didn’t, go do it right meow). But what if you’re a SMEs/SMBs company with, let’s say, $3–25k ACV?
Here’s the average situation: the company cannot afford to have an Inside Sales Team and is not too thrilled about it because even if it could afford to have it, it would be very very difficult to make it profitable and to keep it motivated. So the company doesn’t have a Sales Team altogether, just a Customer Success Team in place. At the same time it acquires new users not through an outbound approach but via inbound marketing and some paid advertising. People find about it and sign-up. Lots of them. It’s very likely a self-service tool and has a conversion funnel in place. Of course the first 1–3 months churn is going to be high: the company is practically not screening customers (if not with forms), it’s letting customers screen themselves through the first months of usage.
Question: could a company like this survive? Even more, could a company like this thrive to the point to be venture-backable and maybe become a billion dollar company, with -say- 15% Churn in the first month and 35% in the first quarter? I know: just the thought of it will have sent chills down the spine of more than some people right now, but let’s see if math back it up.
Let’s be extreme: what about a company starting from $0 ARR and adding $1.5k in new MRR the first month which, after that, grows the new MRR of 15% MoM but loses 15% Revenue Churn the first month, 15% Revenue Churn the second month, 10% Revenue Churn the third month, and an amount decreasing of 1% afterwards up to 3% Revenue Churn per month? Like this:
Pretty shitty company, right? Wrong. Because by using the product’s funnel and the first months of churn as a “low cost” screening of their customers, what ends up happening is that -yes- around 1 of 3 dollars will churn in the first quarter, and 1 out of 6 of the remaining dollars will churn in the second quarter… but the dollars that stick around really *do* stick around.
So the company ends up losing only 11% of the ones remaining over the following 6 months, which is surprisingly comparable with the Annual Churn mentioned by Tom Tunguz. Wow, right? And if this pattern keeps repeating itself cohort after cohort after cohort, it’s actually sustainable *and* scalable. For your geeky pleasure, complete data is here, this is the result over 36 months:
No flatline, but a nice up-and-to-the-right HockeyStick curve instead. Now, to be clear, the example above is theoretic and pretty extreme; but if math backs it up with such high percentages, it works even better if you’re losing only 1 dollar out of 4 in the entire first quarter, only 1 out of 10 in the entire second one and only 1 out of 20 in the entire third one (which of course is better for your Customer Acquisition Cost)… even if you grow ‘just’ 10% Month-over-Month in new revenue. Some may ask: is using the product’s funnel to screen customers such a good idea? Fair point, the answer depends on what’s cheaper/faster for you in the specific stage your company is in. But consider this: when it comes to SMEs/SMBs, a certain amount of churn is unavoidable.
A certain amount of companies will go out of business, a certain amount of credit cards will be rejected, a certain amount will reactivate shortly after. Also consider that lower barrier to entry for customers usually also means lower lock-in compared to the enterprise world. Finally, a couple general recommendations.
For founders: before running to your investors with this post, make sure that the dollars you’re retaining after 90-days do stick around *and* be sure to build some scalability in your go-to-market strategy (which usually means also a good NPS). For investors: when it comes to SMEs/SMBs products, do look at the behavior of dollars beyond the first 30-90 days… you could be surprised.