Churn rate definition
/What is Churn Rate?
Churn rate is the rate at which customers leave a business. This is a critical issue, since it is more expensive to find new customers than it is to hold onto old ones. Also, the only way to increase sales is to add new customers faster than the rate at which you are losing existing ones. Consequently, companies are constantly examining how they can reduce their rate of churn.
Churn rate is one of the key operating metrics examined by prospective investors in a business. If your company is experiencing an inordinately high rate of churn, they will consider this to be an indicator of one or more underlying problems, and so will be less inclined to invest in the company. Or, they will only do so at a lower presumed valuation for the business.
The churn rate is a particular problem in industries where sellers are not perceived to have any unique advantages over each other. In this situation, customers can easily switch to a new supplier, forcing sellers to spend inordinate amounts to retain them - typically by cutting their prices. The churn rate is also a concern in industries where sales are generated from many ongoing sales to each customer (such as a grocery store), but less so in industries where there tends to be just one sale to each customer (such as a piano dealership).
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How to Calculate Churn Rate
To calculate an entity’s churn rate, divide the total number of customers lost during a measurement period by the total number of customers at the beginning of this period. For example, if ABC Electronics had 1,000 customers at the beginning of the measurement period and lost 50 of them during the period, then its churn rate would be 5%.
Example of Churn Rate
A subscription-based streaming company starts January with 1,000 subscribers to its catalog of trout fishing dramas. By the end of January, the business has lost 50 subscribers. The calculation of its churn rate is as follows:
(Churned subscribers ÷ Total subscribers at start of period) x 100 = Churn rate
(50 Lost subscribers ÷ 1,000 Total subscribers at start of period) x 100 = 5% Churn rate
The company’s churn rate for January is 5%, meaning 5% of its subscriber base left during that month.
Advantages of the Churn Rate
The churn rate provides a key insight into the quality of the goods and services being provided to customers, especially when supported by customer surveys that pinpoint exactly what has gone wrong (and right) with each customer. For example, an increasing churn rate may be a sign of a defective product, poor field service, or incorrect instruction manuals. For this reason, management should delve deep into the reasons for an excessive churn rate.
Disadvantages of the Churn Rate
The basic churn rate is simply a percentage figure, showing the proportion of the customer base that no longer does business with the seller. As such, it does not provide any information about why they are leaving. For example, a sudden spike in the churn rate might indicate that a new market entrant has launched a competing product, or perhaps that the seller’s recent price increase is perceived as being too high, or maybe that a recent product recall has soured customers on the firm’s products. Without additional research, it is impossible to discern which of these issues is causing the churn.
What is an Acceptable Churn Rate?
The ideal churn rate is zero, but even a seller providing superior goods and services at a reasonable price would have trouble attaining this figure. At a minimum, customers will be lost simply because they have stopped making purchases from any sellers.
The best way to determine whether your churn rate is acceptable is to compare it to the industry average. Better yet, compare your churn rate to the rate being experienced by best-in-class businesses (which may not be in your industry). Churn rates will vary substantially by industry.