How to double the revenue of your SaaS business with 1% reduction in customer churn?
“Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t pays it”
Albert Einstein
Compound interest is typically understood in the context of financial products and monetary policy of the central bank. Understanding it requires thinking in exponential (where the variable is an exponent of a constant) or power-law (where exponent is constant and the base is the variable) terms. Consequently, comprehending compound interest does not come naturally to the human mind because humans tend to think in linear terms: we tend to think that if one variable increases by a unit, another variable will increase or decrease proportionally by a fixed amount. This linear thinking is intuitive and straightforward, but it fails to capture the essence of exponential growth.
Understanding compound interest involves shifting from a linear mindset to one that appreciates exponential growth. A classic example will help illustrate the point. If you take a sheet of paper and fold it 42 times, how long will it become? What are your initial thoughts? That it will become 1 inch long? Perhaps 2 or 3 inches?
Wrong. The paper will reach the moon! If you don’t believe me, look at the math. Assume a standard piece of paper is about 0.1 millimetres thick. Each time you fold the paper, its thickness doubles. This is an exponential process described by 2n, where 𝑛 is the number of folds. So the formula for calculating thickness T of the paper is T=0.1mm*2n. Plugging 42 into the formula gives us 439,805km which indeed is the distance to the moon!
The implications of compound interest are profound, especially over long periods. Small differences in interest rates can lead to significantly different outcomes. This principle is crucial not only in finance and economics, but also in the context of customer churn. Equipped with knowledge about compound interest, we can appreciate how profitable it is to ensure that the percentage of customers leaving the company should be kept as low as possible, and that any efforts aiming at reducing churn by even less than 1% can have a MASSIVE difference on the revenue generated. This is especially true if you have a software-as-a-service (SaaS) business or any business that generates monthly recurring revenue (MRR) from customer subscriptions. Understanding compound interest allows us to appreciate how even minor reductions in customer churn rates can dramatically enhance revenue.
The Impact of Churn Reduction on Revenue Growth: 1% churn reduction can increase revenue by 110%
To illustrate, consider two SaaS companies — Company A and Company B. Both of them are exactly the same. They have a base of 10,000 customers each paying $5 per month yielding $50,000 in MRR. Their monthly customer acquisition rate is also the same sitting at 6%. While initially companies A and B churn rate was 5%, company A decided to invest into a data science churn reduction project, which resulted in a seemingly modest 1% reduction in customer attrition. Seems like 1% wasn’t worth it. However, look at the substantial difference in MRR growth between company A that invested in churn reduction (black line) and company B that hasn’t (red line):
10 years after commencing the churn reduction project, company A has accumulated $12,475,583. Company B on the other has had cumulative growth standing at $5,833,477. Hence, after 10 years, 1% reduction in churn increased overall revenue by 110%! This translates to an impressive 560% return on investment for the churn reduction project, assuming an initial investment of $1,000,000. The table below summarises the statistics:
This example underscores the exponential impact of small changes over time. Just as compound interest exponentially increases investments, reducing customer churn by even a small margin can lead to dramatic increases in revenue. Businesses that don’t want to live “hand to mouth” and care about the future, will benefit the most from investment in churn reduction project. By understanding and applying the principle of compound interest, businesses can achieve remarkable long-term success.
