in business models, business strategy, churn, Marketplaces, retention rate, royalty businesses, SaaS, subscription businesses

Yearn for Churn (if you’re this type of business)

As SaaS, marketplace and subscription companies blossomed in the past decade, so has a cottage industry of bloggers, thought-leaders and advisors on providing support on how to reduce churn.

The common rhetoric is that churn is bad. Indeed it is the case for the average business. But churn is a counter-intuitive metric for the best businesses. Here’s why.

Churn taken at face value is a sign that people are voting with their feet and discontinuing their relationship with your product or service. For the average business (model) this can be a disaster.

Even if you have a 95% retention rate, theoretically you’ll be out of business in ~20 years. (Likely a lot earlier as you have normal operating costs and overhead.) And I would see this 95% retention rate float around as a badge of honour!

But while that’s good signalling by the average business that’s actually counterintuitively not-so-great, the opposite is true that a higher churn (and lower retention rate) is not actually bad for the best-of-breed business. More importantly, the best business models can have churn work in their favour.

But let’s first think about what churn is.

Churn is a first-order effect of customers no longer having a relationship with you. Emphasis on first-order.

In the case of the average business, this means a direct effect on the top and bottom lines of your business.

The second-order effect(s) is that it hurts even more when it’s a subscription customer and the discounted cash flows in the future are now effectively 0 going forward. The only way to dig oneself out of this hole (again, if you have an average sub-model business) is to keep ploughing money back into your costs of customer acquisition. More dollars spent on SG&A. And on and on it goes.

But … churn in a royalty or royality-like business is a fantastic thing.

High churn can mean many things, but in the case of a subscription business that also has a royalty on the growth of the customer, churn can likely mean that you are self-selecting for the best customers.

Churn actually helps not hurts in these cases because:

  1. Those that churn, likely are not doing well themselves (though there are other reasons but if you’re a B2B business there’s a good chance of that) and;
  2. Those that do stick around and continue to be your customer has adapted well and has “survived”. Among this group, they’re likely growing with you, using more of your offerings and allowing you to take a transactional piece of their business along the way.

Think of it this way: churn (for the best businesses) can be a symptom of high-experimentation and high-throughput and what is left over from the “survival of the fittest” are the best customers. Any lost # of customers is made up for by the growth from your continuing, thriving customers.

Your customers’ battle-testing (as revealed in the data by churn metrics) means they are likely more resilient and are themselves the best-of-breed. It’s the power of the Power Law. You, in-turn, become the best business because you self-selected the best customers in their respective markets.

Next time, yearn for churn if you have one of these businesses:

After all, Buffett said it best:

“The best business is a royalty on the growth of others, requiring little capital itself.”

Warren Buffett quoted in “The Money Masters”, by John Train (1980)