Doesn’t this equation seem logical?
Churn rate + Retention Rate = 100%.
After all, your customers either stay (retention) or they leave (churn). Unfortunately, the answer is NO. And that is because each term measures something different. Let me explain.
Calculating churn rate is done by getting a list of all customers on the first day of the period in question – usually one year – so make the list as of Jan.1. Make the same list at the end of the year – in this case December 31. From the year-end list remove all new customers in the year; the remaining list is either of shorter or the same length as the starting list. The number of customers no longer on the list, divided by the starting quantity, is the annual churn rate when expressed as a percentage. For example
- Starting # customers = 250
- New customers = 50
- Ending # customers = 250
- # missing from list = 50
- Churn rate 50/250 = 20%
Retention rate refers to the percent of existing customers who remain a customer after they had the choice to leave. Let me explain by examples:
Case 1 – During the year your company signed all of its customers to non-cancelable three-year contracts. These customers are locked in and will not have an opportunity to leave during the next two years. In year three they all have to make a decision whether to sign-up again for some amount of time or move on to another supplier. For those first two years, assuming there are no new customers who will be allowed to make a stay/go decision in the years in question, there was no opportunity for any of the long-term customers to leave so the retention rate is NA (not applicable).
Case 2 – Your business is such that your customers make a new purchase each time they need an item. The simplest example I can imagine is putting fuel in your car. We know that “gas is gas” and so when the time comes to fill’er-up you have 2 decisions to make: 1) whether or not to purchase the same brand of fuel as the last time and 2) whether or not to purchase from the same fuel station. In this example your decisions can mean that you repurchase the same brand of fuel as previously (brand loyalty) or not and from a different retailer (no sales location loyalty) or not. Thus, retention rate is in the eye of the marketer who is making the measurement.
Case 3 – You decide to purchase a totally new-to-you item from you local hardware store. In this case, there is no product or brand loyalty but positive retailer loyalty, with a corresponding impact on the store retention rate.
All this means is that calculating retention rate is totally dependent on what your customers are buying. And that is the easy part. The more difficult consideration is when is a customer no longer a customer? If you operate a retail store with low cost items in a busy location and where people pay cash, you might not even know the names of your customers. Maybe you know Bill who comes in once a week to purchase lottery tickets but you certainly don’t know the occasional shopper who stops in to pick up a quart of milk or a loaf of bread. If most of your customers are like that how can you ever tell if the deserted you or not? And the same goes for the occasional B2B customer. There may not be a predictable buying pattern so you have no real way to know if they will come back the next day or never. Measuring retention rates are challenging, to say the least.
Finally, we look at service contract renewal rates. Like retention rates, we must only think about choices; no choice then no impact on retention. Lets assume we focus on customers with contracts that expire within the renewal horizon of the business. As a result of your sales process there are four possible outcomes:
- They renew on time (which you may define as within 30 days of the expiration date)
- They renew very early. If you start your renewal process 90 days before the end date, the contract can easily be renewed 75 days early – that is a good thing.
- They let the contract expire, tell you the paperwork is in process, and you backdate the contract to the renewal date when the paperwork finally arrives at your salesperson’s desktop. Not a great practice but most companies do it to accommodate their customers and maintain the revenue stream.
- They never renew.
With this many possible outcomes it is advisable to track each opportunity so you can optimize your renewal sales process, predict cash flow and proactively identify probable non-renewal accounts and work with them to craft an offer that keeps them under contract and helps you plan and run your business.
So now you know why Churn rate + Retention Rate ≠ 100%.