Doesn’t this equation seem logical?
Churn rate + Retention Rate = 100%.
After all, your customers either stay (retention) or leave (churn). Unfortunately, the answer is NO. And that is because each term measures something different. Let me explain.
Calculating Churn Rate
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 a 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 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
Retention rate refers to the percentage of existing customers who remain a customer after they had the choice to leave. Let me explain by examples:
Case 1 – Your company signed all its customers to non-cancelable three-year contracts during the year. These customers are locked in and cannot leave during the next two years. In year three, they all have to decide whether to sign-up again for some time or move on to another supplier. For those first two years, assuming no new customers were allowed to make a stay/go decision in the years in question, there was no opportunity for any long-term customers to leave. Hence, 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,” so when the time comes to fill’er-up, you have two decisions: 1) whether 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 repurchasing the same brand of fuel as previously (brand loyalty) or not from a different retailer (no sales location loyalty). Thus, the retention rate is in the eye of the marketer making the measurement.
Case 3 – You purchase a new-to-you item from your 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.
This means that calculating the retention rate depends on what your customers are buying. And that is the easy part. The more difficult consideration is when a customer is no longer a customer. You might not even know your customers’ names if you operate a retail store with low-cost items in a busy location where people pay cash. 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 to pick up a quart of milk or a loaf of bread. If most of your customers are like that, how can you tell if they deserted you? And the same goes for the occasional B2B customer. There may not be a predictable buying pattern, so you have no natural way of knowing if they will return the next day or never. Measuring retention rates are challenging.
Service Contract Renewal Rate
Finally, we look at service contract renewal rates. Like retention rates, we must only think about choices; no choice then no impact on retention. Let’s 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 good.
- They let the contract expire, tell you the paperwork is in process, and backdate the contract to the renewal date when it 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 to optimize your renewal sales process, predict cash flow, proactively identify likely 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 the Churn rate + Retention Rate ≠ 100%.
Read more at 9 Reasons People Fail to Renew Service Contracts
About Middlesex Consulting
Middlesex Consulting is an experienced team of professionals with the primary goal of helping capital equipment companies create more value for their clients and stakeholders. Middlesex Consulting continues to provide superior solutions to meet the needs of its clients by focusing on our strengths in Services, Manufacturing, Customer Experience, and Engineering. If you want to learn more about how we can help your organization minimize the risk of churning your customers, please contact us or check out some of our free articles and white papers here.