As mentioned in Part 1 of the KPI series, churn is an integral metric that has a number of nuances that one must consider when evaluating a company’s performance. Two other important considerations to supplement the calculation of churn is the inclusion of the impact of upsells and downsells, as well as the delineation of type of churn between controllable (“voluntary”) vs. uncontrollable (“involuntary”). Each of these elements provide additional granularity that can be used to enhance one’s analysis of churn.
Gross vs. Net Churn: The Impact of Upsells and Downsells
Select companies have the option of presenting a gross and net number when reporting churn. With gross and net churn, companies provide stakeholders an opportunity to understand more about the unique dynamics of its business and financial profile. Additionally, the company has an opportunity to extract incremental value from an investor if the company has a tenured history of strong upselling and can thereby present a lower net churn number. On the contrary, companies may also be penalized by investors if they incur repeated downsells that would generate a higher net churn figure. Therefore, it is important to understand what upsells and downsells are to grasp how they affect a company’s financial metric positioning.
The Basics of Upselling and Downselling and How Each Fit into Net Churn
Upselling is a common term that describes a scenario in which a company drives a customer to purchase a higher priced or add-on product / service. For companies operating in a relatively saturated total addressable market with limited growth available via new logo acquisition, upselling can serve as an important growth vector. It also can serve as an offset to gross churn, giving businesses a way to recoup the value lost from some / all cancellations. On the other hand, downselling represents instances where existing customers choose to make a reduction in the price they will pay for a product / service (this could be based on a customer’s limited wherewithal to pay full price) or reduce the number of users or modules they pay for. Although these customers are not fully churning off a product / service, downselling is commonly used to assess the health of a company’s customer base, as persistent downsells can be a leading predictor of eventual churn. Let’s explore how upselling and downselling affect a company’s annual recurring revenue profile and churn presentation:
Distinguishing Between Voluntary and Involuntary Churn
Another approach to further analyze a company’s performance is categorizing churn by customers that voluntarily choose to cancel vs. others that cancel due to liquidity issues (i.e. bankruptcy) or a change of control event (i.e. customer gets acquired by another entity, which is not a customer of the company). Voluntary churn is something that is largely controllable and can be affected by a company’s business decisions, while involuntary churn is uncontrollable, as it is triggered by variables and factors outside of a company’s purview. Two example scenarios are provided below to expand upon these nuances:
Concluding Thoughts: Double-Click into Churn to Gain a Further Understanding
In today’s challenging and ever-evolving business environment, there is an endless list of potential variables that can affect a company’s churn metric. Some of these factors, such as macro industry trends described in the cases above, are out of a company’s control, but still very much contribute to increased churn and the destruction of enterprise value. Other variables, such as price increases to existing customers, are entirely driven by the company’s strategic decisions and can be adjusted accordingly and used to mitigate other factors that drive increased churn. By digging into and presenting alternative datapoints such as net churn and involuntary / voluntary churn, business owners and investors can enhance decision-making with these additional tangible heuristics.