How to Calculate Customer Churn and Revenue Churn

How do you calculate customer churn, and what is the differences between customer churn and revenue churn?

Depending on who you ask, this can be a difficult question to answer.  In fact, if you google it, you can find some very complicated answers, like this one.  The point of this blog article isn’t to try and restate what they did, but instead show you how calculating churn can be simple and doesn’t require a masters in mathematics from M.I.T.

Lets start by discussing the two different methods of calculating churn.  They are:

Customer Churn

Take all the customers you loose during a time frame, such as a month, and divide it by the total number of customers you had at the beginning of the month.  You do not include any new sales from that month.

EXAMPLE
Company ADG had 500 customers at the beginning of the month and only 450 customers at the end of the month.  Their customer churn rate would be:
(500-450)/500 = 50/500 = 10%

If your organization prefers, you can use that same method on a different time frame such as quarterly or annually.

Revenue Churn

Take all your monthly reoccurring revenue (MRR) at the beginning of the month and divide it by the monthly reoccurring revenue you lost that month minus any upgrades or additional revenue from existing customer (just like customer churn, new sales in the month don’t count).  The reason you subtract additional revenue is because you want to know how much total revenue you lost and new revenue from existing customers is actually revenue you gained.

EXAMPLE
Company ADG had $500,000 MRR at the beginning of the month and only $450,000 MRR at the end.  They also had $65,000 MRR in upgrades that month from existing customers.  Their revenue churn rate would be:
(($500,000 – $450,000) – $65,000)/$500,000 = ($50,000 – $65,000)/$500,000 = (-$15,000)/$500,000 = -3% Note the negative revenue churn rate means you actually gained revenue that month!

As before you can choose a different time frame, such as quarterly or annual.  Just remember that if you do, you’ll need to look at quarterly or annual reoccurring revenue, not monthly.  Also, as the example pointed out, a major benefit to calculating revenue churn is that it’s possible to include upgrade revenue.

Now that you understand the basics of calculating customer churn and revenue churn, let’s dig a little deeper.  The first thing to point out is that customer churn and revenue churn are not always the same.

EXAMPLE Company ADG has 2 product lines: Basic: 5000 customers, $500/month per customer = $2,500,000 MRR Premium: 1000 customers, $1250/month per customer = $1,250,000 MRR This gives them a total of 6,000 customers and $3,750,000 MRR In a month, 180 Basic customers and 20 premium customers churn. Customer Churn (180 + 20)/6,000 = 200/6,000 = 3.33% Revenue Churn ((180 * $500) + (20 * $1250))/$3,750,000 = ($90,000 + $25,000)/$3,750,000 = $115,000/$3,750,000 = 3.07%

The problem will only get worse if you have more product lines or the price difference between product lines is greater.  Therefore it is very important to be consistent and clearly communicate which method you use.

It’s also important to note that you may need to use both calculations as you manage your business.  Revenue churn is a great way to report on performance as well as understand the financial health of your customer base.  Customer churn is important for staffing reasons as an employee can only manage so many accounts at one time.

The next major point to discuss is how in the examples above we mention that you can calculate churn over a monthly, quarterly, or annual time frame.  While this is true, there is an important caveat to consider.

In the monthly calculation, there is an underlying assumption that no customer can churn in the first month.  The reason is that you pay for the month upfront.  So when you take a snapshot at the beginning of the month and then divide that by the total number of churned customers, you don’t have to worry about any new sales churning in that time period.

Now, if in the same model we calculated churn over a quarter, we could run into a problem.  The reason is that there will be some new sales from the first month in the quarter that could churn in the second or third month of the quarter.  If those churns are accidentally included in the calculation, then we’ll overstate churn.

EXAMPLE Company ADG wants to calculate quarterly churn.  Month 1:  1000 customers at the beginning of the month and 50 churn, leaving 950 customers at the end (refer to this as Cohort A); 100 new sales (refer to this as Cohort B). Month 2: Of the 950 customers in Cohort A, another 50 churn, leaving 900; of the 100 in Cohort B, 5 churn, leaving 95; another 100 new sales this month (call this Cohort C) Month 3: Of the 900 customers still in Cohort A, another 50 churn, leaving 850; of the 95 customers in Cohort B, 5 more churn, leaving 90; of the 100 customers in Cohort C, 5 churn, leaving 95. The summary is: Cohort A – begins Month 1 with 1000 customers; ends Month 3 with 150 Cohort B – Begins Month 2 with 100 customers; ends Month 3 with 90 customers Cohort C – Begins Month 3 with 100 customers; ends Month 3 with 95 customers If we look over the quarter, our initial cohort of 1000 customers only has 850 customers remaining, giving a customer churn rate of 150/1000 = 15% During that same time frame, there were 300 new sales, of which 15 churn.  If you included those 15 churns in your calculation, you’d have 165/1000 = 16.5%

To get around this problem, you have 3 solutions.  The first is you can use some very complex math that is available via the link in the first paragraph above.  The second solution is much simpler, and that is to make sure to exclude all churns from new sales!  If you do that, you get the churn rate of Cohort A, which was our install base at the beginning of the quarter.  This method gives you the true churn rate, without replacement, of your customer base over a quarter.

The one issue with the second solution to this problem is that some of you may want to include the churn rate of Cohorts B and C.  If that is the case then you’ll want to use the weighted average.

EXAMPLE Cohort A – 1000 customers; churn rate of 15% Cohort B – 100 customers; churn rate of 10% Cohort C – 100 customers; churn rate or 5% [(1000 * .15) + (100 * .1) + (100 * .05)] / (1000+100+100)=
[150 + 10 + 5]/1200 = 165/1200 = 13.75%

As you can see, it’s still relatively simple to include new sales and their churns during the quarter too!  Just make sure you explain this to your operations team, or whoever does reporting for you, so they know exactly what you want and how to report it!