Negative churn, the holy grail of subscription business models
When I talked about the importance of being a data geek in a previous article, I explained the conversion funnel, which is formed by a set of data that we can consider short-termed, because within a few days (or even hours) you can notice trends, take conclusions, create hypotheses and validate them, whether talking to your users or making experiments and measuring the results.
I also talked about engagement metrics, that show how your users interact with your product, and about churn, both user churn and revenue churn. These concepts will help you understand how many users are no longer users, why they gave up, and what is the impact of they leaving your product in your revenue.
Aside from these data, there are others that take more time to be established and start to show some tendency, but that should be monitored since your product's first month. These are the financial metrics, that can be categorized in global numbers (revenue, costs, user and revenue churn) and individual numbers: CAC (Customer Acquisition Cost), LT (Lifetime) e LTV (Lifetime Value).
Global numbers: revenue and costs
Revenue is the money you get when people use your product. Cost is any money that has to be spent or given up in order to get your product going. Basically, revenue will be used to pay for your costs. When you can afford to pay for your monthly costs, the surplus will be used to offset the investment of the months when the monthly revenue didn't cover the costs.
Both revenue and costs should be checked out month over month. It is important to categorize your costs, so it can help you to understand where you are spending the most and where you can save. I use to put costs under 3 categories:
- Infrastructure: it's all the necessary costs to keep the service running. In this category, I include website and app hosting costs, domain registration, tools for e-mail marketing, SEO, A/B tests, online chat system, etc. Usually, these costs are recurrent; therefore require a lot of attention every time you hire a new service like the above.
- Development: here are all the costs to develop and implement new features in your website or application, including programming, interface development, visual design, logo design etc.
- Marketing: every investment you do to attract clients, such as AdWords, Facebook ads, ads on websites, magazines, newspapers, and TV. We should also include here the costs with flyer printing and distribution, coupons, folders etc. It is important to note that in the beginning, you will very likely need to invest time and money in ways to attract clients for free. This is a long-term investment, but it will help you to save on marketing expenses in the future.
In order to have a profitable product, the monthly income should be higher than the monthly expenses. It is as simple as that. However, it is easier said than done.
Individual numbers: CAC, LT, and LTV
The revenue and the costs are global indicators of your product's health. It is important to have also individual indicators, i.e., one for each of your customers.
There are three very important indicators:
- CAC: is the Customer Acquisition Cost. It is the sum of the associated costs with finding and getting the attention of potential clients, and bringing them to your site, converting them into users of your web product and later, into a paying user. For example, imagine that you have only invested in Google AdWords and, on a given month, you have spent $1,000 and got 10 new clients in that month. Dividing $1,000 per 10, you'll have a CAC of $100. That is, your cost for getting each client is $100.
- LT: it's the Lifetime of your client, i.e., how long on average a client is your client. This number only makes sense when you have a recurrent revenue stream. Using the previous example, let's imagine that the LT of clients you have acquired is 20 months.
- LTV: it's the Lifetime Value, or the value of a client while he stays as your client. It's the revenue this client generates while still your client. Following the previous example, let's imagine this client generates monthly revenue of $8. Multiplying the LT of 20 months by the $8 per month gives us an LTV of $160.
In these definitions, it's easy to see that your product will be as profitable as higher is the LT and the LTV and that you need your LTV higher than your CAC.
In this example, we have an LTV of $160 and a CAC of $100, which shows that we have a profitable situation. It is necessary to follow up closely these numbers, month by month. If in a given month the LTV continues on $160 and the CAC goes up to more than $160, it's necessary to review the client acquisition efforts. Also, you should study ways to increase the LTV, augmenting the LT and/or augmenting the monthly value.
Revenue Churn is a measure of the lost revenue for a business model based on subscriptions, calculated in terms of client churn and the total revenue over a period.
You can calculate it as follows:
Monthly revenue churn = revenue from clients who canceled on the month / total revenue of the month.
In order for your product to grow, it is necessary to have an increase in the monthly revenue higher than your monthly revenue churn.
There is an important difference between revenue churn and client churn. Client churn will always be a positive number, but the revenue churn can end up being negative. How? The revenue growth from your existent clients must be higher than the revenue churn from clients who are canceling the service that month, without considering the revenue from new clients on that given month.
Client churn is the number of clients who are no longer users or clients. It is important to know how many are they, and the reasons why that happened because you need this data to improve your product, to reduce the churn.
See in the following picture the difference between client churn and revenue churn:
How is it possible to have negative churn?
The negative churn occurs when your existing clients use more of your software product and they have to pay for it, and revenue gain exceeds revenue lost from existing customers who purchase less over time, including clients churn. For example, when clients upgrade a service plan with more features, when they hire additional services, when they pay for additional usage, or when they buy more access accounts.
This will make your product to grow more than the number of new sales per month, because with a negative churn, even if you don't have any new sale your revenue will grow due to the revenue increase from existing clients. That's why negative churn is considered the "Holy Grail" of products that have a business model based on subscriptions.
In the next article, we'll see the best metric of all, in my opinion: the loyalty metric.
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