Any company that wants to succeed must keep a close eye on its customer retention metrics.
There’s a simple, economic reason why customer retention is so important: Keeping your existing customers is a lot less expensive than trying to win new ones. Loyal customers also contribute to your business’ health by providing referrals, promoting your brand on social media, and giving feedback to improve your product or service. So, it’s critical for companies to keep an eye on their customer retention rate.
Considering how important it is for companies to hold on to their customers, having a high degree of visibility into customer churn is equally essential. It can be daunting (or even depressing) to think about, but churn is a powerful way for a business to understand what’s working well and what needs to improve.
While the primary metrics for understanding customer loyalty are customer retention rate and churn rate, these measurements can’t tell you everything you need to know about how and why customers return or leave. There are several other customer retention metrics you can use in conjunction with retention and churn rates to cultivate a loyal customer base.
What is customer retention rate?
Customer retention rate measures the number of customers a company retains over a given period of time. It’s expressed as a percentage of a company’s existing customers who remain loyal within that time frame. (We’ll get into the formula a little later.) For example, if your business starts the year with 10 customers and loses two of them, you have an 80-percent retention rate.
But bear in mind—there’s a little more to your customer retention rate than that. You also have to account for new customers you took on so they don’t throw off your data. After all, if you start with 10 customers, lose two, but then gain four, that doesn’t mean you have a 120-percent retention rate. In fact, if you think you can simply offset churn by acquiring new customers, you can wind up ignoring serious flaws in your business.
Monitoring retention metrics is critical for a business to understand lifetime customer value and to quantify the efficacy of its marketing strategy and customer service program.
How do you calculate customer retention rate?
To determine your retention rate, first identify the time frame you want to study. Some companies evaluate retention on an annual, quarterly, monthly, or weekly basis. Fast-moving SaaS companies—with user bases that fluctuate rapidly and dramatically—may even look at this data daily.
Next, you need to collect three simple pieces of information:
- The number of existing customers at the start of the time period (S)
- The number of total customers at the end of the time period (E)
- The number of new customers added within the time period (N)
When you have this data, you can plug it into the retention rate formula.
Customer retention rate formula
Calculate customer retention rate with this formula: [(E-N)/S] x 100 = CRR
Start with the number of customers at the end of the time period (E)
If you’re measuring retention for the calendar year, E is the number of customers you have on December 31.
Subtract the number of new customers gained within the time period (N)
Remember, you don’t want new customers throwing off your data, so subtract all customers you acquired in the past year from E.
Divide the result by the number of customers at the beginning of the time period (S)
In this case, S would be the number of customers on January 1 of the previous year.
Multiply by 100
The result is a percentage. Say a company had 100 customers at the start of the period (S), ended the period with 100 customers (E), and added 10 customers over the period (N). They would have a customer retention rate of 90 percent: [(100-10)/100] x 100 = 90 percent.
Retention rate vs. churn rate
Your customer churn rate is simply the inverse of your customer retention rate. For instance, if your retention rate is 90 percent, then your churn rate is 10 percent. The simplest way to determine your churn rate is to take the number of churned customers during a given time frame, divide it by the total number of customers at the beginning of that same time period, and then multiply the result by 100.
Customer churn rate formula: (Churned customers / Original number of customers) x 100
Again, say a company had 100 customers at the beginning of the year but lost 10 customers by the end of that same year. The business would have a churn rate of 10 percent: (10/100) x 100 = 10 percent
Identifying your number of churned customers can be more complicated than it first appears, though—the moment of churn has multiple definitions. For instance, you can consider a customer to have churned when they cancel a subscription or when the subscription ends and they don’t renew. But it can get tricky: A customer might have canceled their Disney+ subscription after finishing WandaVision but then started watching The Falcon and the Winter Soldier before their service ended and ultimately decided to renew.
Likewise, businesses have to decide which types of customers they should count as having churned. Say a company offers a free trial of its product and some customers cancel at the end of it. Should the company consider those customers churned even though they never had an impact on revenue?
Issues like these are why it helps to use multiple customer retention metrics for building a more nuanced understanding of why some customers stay and others go.
Other key customer retention metrics
It’s always a good idea to prioritize customer loyalty and aim for a high retention rate. But not all customers are equally valuable to your company, and the mere fact that a customer churned doesn’t tell you anything about why they left. To better understand why certain customers remain loyal and others don’t, you need to look at additional customer retention metrics.
Revenue churn tells you how much monthly recurring revenue (MRR) you lost over a given period of time.
Revenue churn formula: (MRR lost within the time period / MRR at the beginning of the time period) x 100
Unlike customer churn rate, revenue churn doesn’t measure the total number of customers—it measures their impact on your bottom line. This information is useful if you have a tiered pricing model, no set average order values, or many customers who downgrade rather than churn.
Using the revenue churn formula is a helpful way to put churn in context. Say you lose old customers who were paying legacy rates for your service. After tracking revenue churn, you might see that losing these customers doesn’t have a major impact on revenue and frees up resources to take on new customers who are willing to pay more.
Net Promoter Score
Net Promoter Score (NPS) is a tool for measuring customer loyalty. Companies get their NPS by sending customers a one-question survey and asking how likely they are to recommend their product to other people.
People who respond with a low score are classified as “detractors,” while those in the midrange are “passives,” and customers at the top are “promoters.” The aggregated results are converted into a company’s overall NPS score.
NPS is useful for identifying churn before it happens. Companies can see which customers are satisfied and which need extra attention.
Repeat purchase rate
Repeat purchase rate is the percentage of customers who do business with a company again after their first purchase.
Repeat customer rate formula: Number of return customers / Total number of customers
Thus far, most of the customer retention metrics we’ve covered apply specifically to SaaS companies or other businesses that operate via contracts or subscriptions. But repeat purchase rate applies more to companies without fixed contracts, such as retailers. If you’re running an ecommerce business, for example, you want to make sure customers come back to you instead of defecting to Amazon.
Some companies go a step further and calculate loyal customer rate, which measures customers who made more than two purchases. The number of transactions it takes for a customer to qualify as “loyal” is at your discretion. The loyal customer rate formula is the same as the one above; it merely isolates a smaller number of customers.
Customer lifetime value
Customer lifetime value (abbreviated as CLV or sometimes LTV) is a measure of how much profit the average customer contributes to a business over their entire lifecycle. There are several CLV formulas, ranging from simple to complex, but most of them attempt to account for the costs of acquiring and retaining customers.
One CLV formula is: (Average order value x Repeat purchase rate) - Customer acquisition cost
Another way to calculate CLV is: (Average number of transactions in a time period x Average order value x Average gross margin x Average customer lifespan) / Total number of customers
CLV is an important metric because it points to whether your company needs to invest more in marketing campaigns to acquire new customers or in a retention strategy to keep the customers you’ve got.
You can boost a low CLV by encouraging customers to make additional purchases, putting more resources into customer loyalty programs, and generally focusing on improving customer satisfaction. If your customers have a high CLV, you can likely afford to spend more on acquisition.
Most companies don’t have a single CLV for their entire customer base; instead, they use separate calculations for different customer segments.
Improving customer retention rates
The first step for any business that wants to improve customer retention, slow customer churn, and reduce customer acquisition costs? Get a handle on customer retention metrics. A company that understands the right metrics has an easier time aligning marketing and customer service with its larger retention strategy.
Make sure you build customer feedback into your retention strategy. Listening to the people who share their time and money with your business may not be as concrete to calculate as retention rate or a KPI, but their input will help you create a richer customer experience and lead to more returning customers.