Jörg Ladner, 2020, info@subscription-economy.de

The goal of this article is to help you answer the following questions:

- What is the churn rate?
- Is there a “good” churn rate?
- How does the churn rate affect the number of subscribers?
- How does the churn rate affect growth forecasts?

In the subscription economy new challenges arise for the providers:

- The bindings to brand and product are less strong than in the buying economy.
- The total turnover is made up of a multitude of amounts.
- The amount of the contribution margin depends on the duration of use.
- The duration of use depends on customer satisfaction and competitive pressure.

These challenges fuel the risk of subscriber fluctuation. It is a task of controlling to evaluate the churn rate and the business consequences. After all, acquiring new subscribers is expensive and only existing subscribers are margin earners. Companies therefore try to keep the number of subscribers who cancel their subscription contract as low as possible. In this article, however, I do not want to discuss the tactics and measures to prevent subscriber churn, but rather the influence of the churn rate on the number of subscribers, sales and growth of a company in the subscription economy.

## Churn Rate: The key Performance Index For The Loss of Customers

We use the churn rate as a business key figure to document the fluctuation of subscribers. The churn rate is the percentage of a subscriber base that a company loses in a period under review. The churn rate is also used in other key performance indeces, such as Customer Life Time Value. Churn is a made-up word from the English terms “change” and “turn”. The formula for calculating the churn rate is

K_{0}: Number of subscribers at the beginning of the assessment period

Kn: Number of lost subscribers

CR: Churn Rate in %

The churn rate is specified on an either annual or monthly basis.

The churn rate is a prognostic value. Of course, existing statistical data helps to look into the future. Nevertheless, the development of subscriber fluctuation is also influenced by external factors:

- How does customer satisfaction develop?
- Is the offer still trendy?
- Does the offer at least correspond to the current standard?
- How is the social perception of the provider by subscribers?
- Are there changes in the target group?
- How is the competitive situation?

The sister of the churn rate is the retention rate. Both, churn and retention rate, are the two sides of the same coin. The retention rate is the “positive” view to the existing subscribers: “How many subscribers remained at the end of a period?” I prefer to look at the churn rate. The perception of a loss and the possible negative influence on sales, margin and growth rather encourage to think about the business significance and possibly take appropriate countermeasures.

## The Churn Average

The loss of subscribers is never positive. To evaluate our own fluctuation rate, we ask ourselves the following questions:

- How does your own churn rate compare to the competition, the industry, the region?
- What influence does the churn rate have on your own growth planning?

There are statistical evaluations of the churn rate. (see Library – Articles) They show that the churn rate is dependent on region, industry, target group and price point. In order to make comparisons with your own churn rate, you need to look for suitable sources and find the “best fit” for your own situation. The comparison with other companies is important. Necessary strategies can be derived from it:

- the churn rate is worse than the average:

how do we bring the churn rate closer to the average? - the churn rate is equal to the average:

how do we differ from the average? - the churn rate is better than the average:

how do we maintain our outstanding position?

An often quoted overview of key indeces of the subscription economy comes from the American company Zuora. Zuora’s Subscription Economy Index™ (published October 2019) describes the development of the subscription economy since 2012 in selected key figures based on hundreds of companies. Zuora’s Subscription Economy Index™ publishes information on the North America, Europe and Asia/Pacific regions as well as on Business Services, IoT, Manufacturing, Media, Publishing, SaaS and Telecommunications industries.

For Europe, Zuora’s Subscription Economy Index™ has a churn rate across all industries of

- 26,2% yearly or
- 2,5% monthly.

In comparison, the average churn rate across all regions and industries as listed in Subscription Economy Index™

- 25,5% yearly or
- 2,4% monthly.

Churns in the Zuora Subscription Economy Index™ are subscribers who have not been active for twelve months.

## The Math Behind The Churn Rate

Let us illustrate the influence of a churn rate on the subscriber base with an example: A company has 10,000 active subscribers. We want to calculate the effect of three churn rates on the subscriber base:

- 2,5% per month, the European average, and
- 1,5% and 3,5% as better and worse values

How will the number of subscribers develop within five years? The calculation is based on the formula:

n = current number of the month (1 to 60)

K_{0} = number of subscribers at the beginning of the period (=10,000)

K_{n} = number of subscribers in month n

CR = monthly churn rate %

The churn rate is an expression of “negative growth”, therefore the churn rate is a negative number in the calculation.

The diagram shows the development of the number of all subscribers in absolute figures.

x-axis: month; y-axis: number of subscribers

blue: 1,5% churn rate; orange: 2,5%; grey: 3,5%

Here is the table of values in 6-month steps:

period / churn per month | 1,5% | 2,5% | 3,5% |

6 | 9.133 | 8.591 | 8.075 |

12 | 8.341 | 7.380 | 6.521 |

18 | 7.618 | 6.340 | 5.266 |

24 | 6.958 | 5.446 | 4.253 |

30 | 6.355 | 4.679 | 3.434 |

36 | 5.804 | 4.019 | 2.773 |

42 | 5.301 | 3.453 | 2.239 |

48 | 4.841 | 2.966 | 1.808 |

54 | 4.421 | 2.548 | 1.460 |

Here are the values for subscriber loss in %:

period / churn per month | 1,5% | 2,5% | 3,5% |

6 | 8,7% | 14,0% | 19,3% |

12 | 16,6% | 26,2% | 34,8% |

18 | 23,8% | 36,6% | 47,3% |

24 | 30,4% | 45,5% | 57,5% |

30 | 36,5% | 53,2% | 65,7% |

36 | 42,0% | 59,8% | 72,3% |

42 | 47,0% | 65,5% | 77,6% |

48 | 51,6% | 70,3% | 81,9% |

54 | 55,8% | 74,5% | 85,4% |

60 | 59,6% | 78,1% | 88,2% |

The loss of subscribers is greatest in the first year. At a churn rate of 2,5%, the loss of subscribers is more than a quarter, and at a churn rate of 3,5% more than a third within twelve months. We see that small changes in the churn rate have a significant impact on the result. To illustrate this, we use the 25% line. This line shows in which month the 25% subscriber loss is expected. The chart shows the 25% line for monthly churn rates between 1,0% and 4,0%:

x-axis: churn rate; y-axis: time to reach the 25% line in months;

red line: 12 months

The diagram is based on the formula:

n = month in which the number of subscribers is K25

K_{0} = number of subscribers at the beginning of the period (=10,000)

K25 = number of subscribers minus 25% (=7500)

CR = Churn Rate %; interval from 1,0 to 4,0 in 0,1 steps

The curve drops steeply to about 2% monthly churn rate. Every small increase (=deterioration) of the churn rate leads to a higher fluctuation. Churn rates higher than 2.4% already mean a loss of 25% of subscribers within one year.

## Fluctuation And Increase In The Number of Subscribers

What influence does the fluctuation of subscribers have on the growth of companies? Let us return to our example company. Within one year, the subscriber base is to be expanded by 15%, 20% or 25%. Based on the 10.000 existing subscribers, this leads to the following planned subscriber growth in absolute figures:

growth | new nubscribers,year | new subscribers,month | subscribersafter 12 month |

15% | 1.500 | 125 | 11.500 |

20% | 2.000 | 167 | 12.000 |

25% | 2.500 | 208 | 12.500 |

Und nun beziehen wir die Churn Raten 1,5% (16,6% pro Jahr), 2,5% (26,2% pro Jahr) und 3,5% (34,8% pro Jahr) in die Wachstumsplanung mit ein:

growth rate 15% | churn 16,6%per year | churn 26,2%per year | churn 34,8%per year |

churn | 1.662 | 2.624 | 3.482 |

new subscribers (planned) | 1.500 | 1.500 | 1.500 |

total new | 3.162 | 4.124 | 4.982 |

total new % | 31,6% | 41,2% | 49,8% |

The growth rate of 15% corresponds to a nominal increase of 1.500 new subscribers at the end of the 12-month period. The churn rates counteract this growth. In order to compensate for the loss of subscribers and to achieve the growth target, 3.162, 4.124 or 4.982 new subscribers are required, depending on the churn rate. For the lowest churn rate in our example, the actual growth required is 31,6%. This is more than double the actual planning of 15%. Below are the data for the growth rates of 20% and 25%.

growth rate 20% | churn 16,6%per year | churn 26,2%per year | churn 26,2%per year |

churn | 1.662 | 2.624 | 3.482 |

new subscribers (planned) | 2.000 | 2.000 | 2.000 |

total new | 3.662 | 4.624 | 5.482 |

total new % | 36,6% | 46,2% | 54,8% |

growth rate 25% | churn 16,6%per year | churn 26,2%per year | churn 34,8%per year |

churn | 1.662 | 2.624 | 3.482 |

new subscribers (planned) | 2.500 | 2.500 | 2.500 |

total new | 4.162 | 5.124 | 5.982 |

total new % | 41,6% | 51,2% | 59,8% |

Companies whose primary growth strategy is to expand their subscriber base, especially newcomers to the subscription economy, must consider the churn rate as their most important indicator.

## Fluctuation, Active Units And Revenue

Since the churn rate is a ratio related to the number of subscribers, we have so far focused on its development under the influence of the churn rate. Loss of subscribers also means loss of sales.

How does the churn rate influence the sales development? Does 10% loss of subscribers also mean 10% less revenue? If there are some top subscribers among these 10%, the loss of sales will be more painful than if only “small” subscribers drop out.

Let’s extend our example with customer segments, a graduated price list and segment-dependent churn rates. Our actual target group are subscribers who use five units of our offer. They represent 70% of the subscribers and an annual turnover of 6.300.000, a second segment comprises 1.000 subscribers with two units each (small) and a third 2.000 subscribers with eight units each (large). The usage prices per month are 10, 15 and 20 per unit.

segment | units | price permonth and unit | number ofsubscribers | possibleannual revenue | percentage ofrevenue |

small | 2 | 20,00 | 1.000 | 480.000 | 5,5% |

target | 5 | 15,00 | 7.000 | 6.300.000 | 72,4% |

big | 8 | 10,00 | 2.000 | 1.920.000 | 22,1% |

total | 10.000 | 8.700.000 |

The annual revenue figures are given without consideration of the churn rate.

The three subscriber segments differ in the churn rate. The focus segment has the lowest churn rate of 1,5%, as all marketing and sales activities are geared towards reducing fluctuation in this segment. For the other segments the churn rates are 3,5% and 2,5%. The diagram shows the development of the number of subscribers in the individual segments and overall.

x-axis: months; y-axis: number of subscribers

small: blue; grey: medium; orange: focus; yellow: all

The number of subscribers in the focus segment is reduced to 5,839 in 12 months, with a total of 2,033 subscribers lost. The churn rate across all segments is 1,9% per month. The 25% line is reached after 15 months.

segment | small | target | big | total |

25% line by months | 8 | 19 | 11 | 15 |

The diagrams show the development of turnover and number of units per month.

x-axis: months; y-axis: revenue

small: blue; grey: medium; orange: focus; yellow: all

x-axis: months; y-axis: units

small: blue; grey: medium; orange: focus; yellow: all

The number of active units in the market decreases from 53.000 to 43.101 at the end of the twelfth month. Annual sales fall by 11% to 7.736.852 in the first twelve months.

in thebeginning | after 12months | difference | |

subscribers | 10.000 | 7.967 | 20,3% |

units | 53.000 | 43.101 | 18,7% |

revenue | 8.700.000 | 7.736.852 | 11,1% |

The loss of subscribers reduces sales and market share. The churn rate affects the number of subscribers, the number of active units and the revenue differently. Various factors determine the degree of influence:

- the degree of heterogeneity of subscribers
- the differentiation in pricing
- the focus on subscriber segments
- the churn rates
- the distribution of active units among the subscriber segments

The loss of subscribers reduces sales and market share. Companies whose growth strategy is primarily focused on revenue must monitor the effects of the churn rate, particularly on the customer life time value.

In two sentences: The churn rate indicates the loss of subscribers. It is an important indicator when planning company growth.