Churn Calculation Pitfalls

1. Don’t Include Growth

Calculating the number of churns during the period should NOT include any new subscriptions or cancellations for those new subscriptions. Here is an example:

Customers at Start 1800
Existing who leave by end of period 102
New Customers 127
New who churn 18
Total churns 120

The wrong way to calculate:

(127 - 102 - 18) / 1800 = 2.89%
The correct way to calculate:
102 / 1800 = 5.67%

Why?

Since the first calculation includes new subscribers in the formula, we’re not measuring churn anymore, we’re measuring growth. Don't include new subscribers in the formula.

2. How to Calculate Annual Churn

Many people look at their monthly churn rate and think that’s all there is to it, but one’s monthly churn rate is only part of the picture. From the above example we might say that a 5.67% isn’t too bad. And that would be true for an annual churn rate, but it’s not true for a monthly churn rate.

To calculate the annual churn rate first we need to determine the annual retention rate:

(1 - churn rate) ^ 12 = Annual retention rate
(1 - .0567) ^ 12 = 0.496361414

Once we have that we can figure out the annual churn rate:

1 - Annual retention rate = Annual churn rate
1 - 0.496361414 = 0.503638586 = 50%

So a monthly (or average monthly) churn rate of 5.67% is actually an annual churn rate of 50%. This means that every year you’d have to replace half of your customers just to stay even.

Why do we raise to the power of 12? My friend Cayce Balara of Pragmatim Consulting Services explains it with a roulette analogy:

Take roulette, rounding down the house edge is 5%. After placing 100 $1 bets, mathematically speaking on average, you'd lose $5 and have $95 left. Then if you played that $95, you'd lose $4.75 and end up with $90.25, then $4.51 leaving you with $85.74, and so on. The math is .95 *.95 * .95, etc., or (1 - .05) ^ x, where x is the number of cycles.

With 12 monthly cycles, (1 - monthly churn rate) ^ 12 tells you what percentage you are left with at the end of 12 months, so the reciprocal is your annual churn rate.

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