Published on Jul 19, 2021
Churn. It’s a word that keeps many SaaS business owners up at night.
Although inevitable and unavoidable, churn is something you want to constantly monitor and keep in check. Otherwise, things can get out of control in a hurry, and before you know it you’ve got a full-blown mass exodus on your hands.
There are countless factors that impact churn rate, including SaaS product quality, features, UX, pricing, and the competitive landscape. But hands down, one of the biggest is contract length.
In this post, I’ll share with you some compelling data I’ve found that shows the correlation between contract length and churn rate. Then, I’ll offer some practical advice on how to find the sweet spot for your product’s contract length so you can retain more customers and improve their overall experience.
Let’s start from the top. What exactly is the average churn rate for today’s SaaS companies?
According to 2019 research from ProfitWell, it’s 13.2%. There’s a ton of other data out there, with some stats finding the average churn rate to be much higher and others pinpointing it as being much lower. But 13% is about the average.
Considering, however, that most experts say a “good” or “acceptable” churn rate is significantly lower than that at 7% or less, it shows that many SaaS companies could use some improvement in this area.
And a good place to start is with contract length.
One of the best studies I’ve found about how contract length impacts churn rate is this one from Finances Online.
According to their findings, longer SaaS contracts equal lower churn, while shorter SaaS contracts equal higher churn.
Those, for example, that are less than a year have an average churn rate of 16.7%.
Those that are between 1 year to 1.5 years have an average churn rate of 15%.
And those that are at 2.5 to 3 years have an average churn rate of only 8.5%.
So, a quick look at this data and it’s easy to see that extending SaaS contract length helps reduce churn. The only caveat from this study is that month-to-month contracts actually have a slightly lower churn rate of 14% than 1 to 1.5 year contracts of 15%.
But the difference is only marginal, and we can safely surmise that customers will hang around longer when they have longer contracts. After all, they can’t help but do so.
After absorbing this data, the logical conclusion would be to increase the lengths of customer contracts. But is that always the best approach?
SaaS strategist Natalie Roy makes a great point about the potential pitfalls of doing so.
“Let’s say you’ve locked a customer into a three-year contract. This is great, right? The likelihood of churn is statistically low, and you have ample time to recuperate customer acquisition costs and turn a healthy profit.
There’s a downside though. If you’re using a traditional pricing structure it means you won’t be able to increase the price of your product for three years.”
Considering that SaaS prices increase 5-7% annually, this can take a toll on your profitability in the long run.
Besides that, you may lose out to competitors. If, for example, a customer doesn’t want to be tethered to a long-term contract and instead only wants a year max, they may go elsewhere if you only have a 3 year option.
This is extremely important to keep in mind. While having a contract length of 2.5 years or longer has nearly half the churn rate of one that’s less than a year, there are some inherent drawbacks that could potentially hurt your overall revenue.
Like many areas of business (and life in general), the optimal path is often in the middle of two extremes. When it comes to determining the ideal contract length, I suggest looking for the sweet spot — one that allows you to get your churn to the absolute minimum, but without diminishing your revenue or compromising the customer experience.
But where exactly is the sweet spot?
That’ll vary from company to company, and there is no one-size-fits-all game plan. Usually finding it requires some trial and error where you experiment with different contract lengths to see what works best.
Many SaaS brands start at year simply because that’s what a lot of other brands do. If this is where you’re currently at but you’re unhappy with your churn rate, I suggest lengthening it to see if it has any noticeable impact.
Because the average churn rate for contract lengths of 1 year and 1.5 years are exactly the same at 15%, you’ll probably want to go ahead and make the shift to 2 years. If you’re happy with the results, you can just stick with that.
Otherwise, if you think you could do better, you could extend the contract length further to 2.5 years or even 3. As you gather more data, you’ll be able to figure out what’s best for your brand.
The churn rate for most SaaS companies is somewhere around 13%. 7%, however, is a more acceptable number, and the lower the better.
There are numerous factors that contribute to churn, but contract length is one of the most obvious. Research indicates that extending a SaaS contract length from less than a year to 2.5 years or more can nearly slash your churn rate in half.
Doing so, however, requires a careful, calculated approach where you test the waters rather than jumping in head first. But with the right experimentation, you can find your contract length sweet spot for minimal churn and maximum revenue.
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