As discussed earlier the two most important metrics of a SaaS company are growth rate and retention rate. Wall Street understands this and considers retention as the second most important factor in valuing a SaaS company (first is growth rate). I would take it even further and argue that for SaaS startups retention should be the number one metric to track as it has the biggest impact on long-term growth.
Let’s look at two companies: Company A has a great sales team which generates $200K of new revenue per month. Company B struggles to generate attention and is able to generate only $100K of new revenue per month. However, company B has a better product which results in 99% monthly retention versus the 90% rate which company A has. Fast-forward 3 years, company A will be at a $2M run-rate while company B will be at a $3.1M run-rate (although it added half the revenue per month). Moreover, a closer look shows that company A has reached a cap on how much it can ultimately grow.
$200K new revenue per month, 90% monthly retention
$100K new revenue per month, 99% monthly retention
In real life this will be even worse: Company A will most likely start spending more on sales and marketing to artificially hold on to the growth rate, while company B will be able to sustain growth as is.
There are two kinds of revenue churn rates every startup should measure: Gross Churn and Net Churn.
Gross Churn is the percentage of your customer CMRR that has been lost over the measured time period. If you started the year with $500k of CMRR for your same 500 customers, and the 40 customers that churned represented $30k of CMRR at the start of the year, then your Gross CMRR Churn Rate is 6% annually ($30k of starting CMRR churned/$500k of starting CMRR).
Net Churn also takes into account revenue expansion from existing customers (up-sells, cross-sells, higher usage, etc.) In the previous example you started the year with $500k of CMRR from 500 customers and 40 customers churned which represented $30K of churned CMRR. Now let’s assume that the 460 customers you retained grew CMRR by $80K by end of year then your net CMRR from the existing customers is $550K ($500K base + $80K expansion – $30K churn). Therefore, your Net CMRR Churn rate is -10% annually. Or, in other words, you have a 10% net negative churn rate.
Companies that enjoy net negative churn (expansion revenue is higher than revenue loss) are extremely valuable. In theory, they can stop acquiring new customers and still keep growing. Some of the best companies we see have extremely high net negative churn of 120%+ annual. For example, if company B in the example above had 20% net negative churn then it would end year 3 with a $4.9M run-rate!
Bottom line- make churn your number one priority. Try to constantly optimize retention by doing things like improving your product, building a dedicated customer success team, generating multiple touch points with your customers and building the right organizational mindset.