Why Gross Churn/Retention is the Preferred Standard for Measuring SaaS Retention
March 24, 2016
I would estimate that we have seen churn measured at least two dozen different ways over the years, but thankfully some standards are now emerging.
The metric gaining widespread adoption, and the one we believe best at measuring retention, is what is now being referred to as “Gross Churn/Retention.” It is a measurement of annual revenue lost from a company’s installed base of customers NOT accounting for cross-sells, up-sells, price increases, or organic account growth. Gross Revenue Retention will always be less than 100%.
A simple way to calculate this starts with a list of your customers from 12 months ago and their MRR for that month. The sum of that list is the denominator. The numerator is the total MRR from that same list of customers less any that are no longer active.
This metric best isolates lost customer revenue without being obscured by a myriad of other important, but tangential factors. It allows businesses to be more accurately compared to each other, and it may also better identify business model issues that would otherwise be hard to isolate.
That said, in landing on this metric, the industry has almost forced businesses to also report “Net Churn/Retention.” Obviously, this number includes cross-sells, up-sells, organic growth within a customer account, and price increases. This is an important and broader metric which tells the story of what would happen to a SaaS business over time if it did not acquire any new customers. Growth in the installed base that completely offsets losses (a.k.a. Negative Churn) is a very powerful financial driver.
Some high-performing SaaS businesses have “Net Retention” numbers in the 150% to 300% range. It is these outliers that demonstrate the usefulness of reporting both Net and Gross Churn, as cross-selling, up-selling, or individual customer organic revenue growth completely obscures any meaningful erosion in the customer base. Two very different stories emerge between companies that both have 150% Net Retention, if one has strong Gross Retention of 95% and the other only has 60% Gross Retention. The former indicates a more financially stable and sustainable business while the latter is more dependent upon less predictable growth in the installed base and cross selling or upselling.
To be clear, increasing revenue from the installed base is a fantastic growth driver and typically very profitable. It is, however, substantially distinct from the activity of retaining customer revenue, and should be measured separately from churn, and the “Gross” metric achieves this goal.
One other area of difference in reporting churn is a monthly vs. annual number. We prefer the annual approach because it is more intuitive. It’s easy to understand the implications of 95% Gross Revenue Retention, but more obtuse when a company reports .5% monthly churn.
For some perspective, the hundreds of private SaaS companies that participated in our annual survey reported an average Gross Retention of 90%, while Net Retention averaged exactly 100%. We will dig deeper into these numbers in an upcoming research brief.
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