Churn Rates Are Distorted (2/4)

I said in my last post that customer churn rate is not a reliable measure of churn. In this post, I'll briefly explain why… THE DENOMINATOR PROBLEM It’s logical to measure churn as a rate so that it can be used over time and as the company grows. In simple terms, customer churn rate is an equation in which lost customers (churn) is the numerator and total customers is the denominator. The problem is that this makes the metric highly sensitive to changes in sales. Here’s why... CHURN IS DELAYED The churn delay refers to the fact that some amount of time passes between when customers join and when they leave. Although this delay varies, the result is that the denominator changes in response to sales BEFORE the numerator changes in response to churn. The average churn delay for most companies is several months but it can be much longer. For example, when there is a significant increase in sales the denominator (total customers) goes up immediately. However, because churn is delayed, the numerator will mostly not be impacted by that new cohort of customers for some period.

In the meantime, the denominator has grown making the resulting rate lower. But this is a temporary illusion caused by the churn delay. Even if the absolute share of customers who churn stays the same, the calculated rate will be distorted downward temporarily to look better than it really is. This also works in the other direction. When sales go down, the denominator reflects the change immediately which distorts the rate upward to make it look worse than it really is. This is the reason so many companies appear to experience an unexpected spike in churn. THE GENERAL RULE IS: • As long as sales are increasing, the churn rate will continually be distorted downward. • When sales are decreasing, the churn rate will be distorted upward. This is why you can’t use the churn rate to manage your churn effectively. WHICH DIRECTION? It also means that your churn rate isn't comparable over time, and can’t be used to determine whether real churn is getting better or worse. And if you can't compare a company's churn rate over time, then it obviously isn't valid to compare churn rates between companies. That's why so-called churn rate "benchmarks" are bunk. Any attempt to act on these distorted metrics will be literally misguided. The common pattern is for companies to underinvest in customer success during the rapid growth phase when the churn rate appears low, and then to panic when churn appears to suddenly spike upwards due to slowing sales. Sound familiar? NEXT UP: In my next posts, I'll explain more problems with churn rates and ultimately show how you can calculate churn metrics that drive results. Churn Rates Lie (3/4)