Company A is worried that its customers are unsatisfied with its service. To confirm their suspicion, the company decides to calculate its churn rate. They are pleasantly surprised to find that the company had 100 active customers in January, and only two customers decided to cancel their subscription in the month of February. Company A has a churn rate of only 2%. This would be impressive if Company A’s revenue hadn’t dropped more than 20% in February. This company isn't losing revenue from cancellations but downgrades.
A common Subscription-as-a-Service (SaaS) pricing structure is the three-tier model consisting of low-end, standard, and high-end options. A downgrade is when customers choose to go from a higher-tier to a lower-tier subscription.
Even though the customer is still using the service, downgrades have the potential to decrease monthly recurring revenue substantially. So what makes a customer choose to downgrade?
The price does not reflect the service
A customer may downgrade because the high-end or standard plan doesn’t add significant value over the low-end plan. The additional features offered in the higher-level options must have a monetary value equal to or more than the additional costs incurred by the customer. Better pricing at another company can also entice customers to downgrade or cancel their subscription.
Your company can identify both of these issues through market analysis.
Market analysis can help determine:
- How your competitors are pricing their subscription options
- Who is the target market for your SaaS
- What features appeal to the target market
- What features do your competitors offer
- How your target market values certain features
Conducting market analysis doesn’t have to be daunting. Causal’s customizable templates allow you to analyze your market without complicated formulas and excel spreadsheets. You can compare your company’s metrics alongside the leaders of your industry, to ensure that your pricing, features, and functionality is competitive.
Your high-end subscription doesn’t appeal to your target market
One of the most useful aspects of market analysis is the capability to find your company’s target market. Your target market is a group of people with shared demographics who are most likely to subscribe to your service.
If your company is losing revenue from downgrades, it could be that your high-end subscription doesn’t appeal to existing customers. Any additional features offered in more expensive subscriptions should appeal to your target market. A company may choose to offer a customer choosing to downgrade an incentive to stay on their current plan. The success of these strategies lies in whether they appeal to the target market.
A company may also decide to segment their target market by asking, “ Out of the identified group of people, who is most likely to upgrade?” Marketing campaigns should appeal to this segmented target market since customers are more likely to choose, benefit, and stay with a higher-end subscription.
It’s important to note that a few downgrades aren’t necessarily an issue with the company. With the tiered pricing model, gained revenue from upgrades can counteract or exceed the revenue lost from downgrades. A great way to determine the effects of downgrades on your company are metrics like revenue churn, and downgrade MRR can offer more clarity.
Revenue churn calculates the amount of money churned from downgrades and cancelations, making it the best metric for a SaaS with a tiered pricing system.
Within revenue churn, there are two types:
- Net Revenue Churn (Insert formula Churned MRR + Downgrade MRR – Expansion MRR) / MRR at the end of last month)
- Gross Revenue Churn (Churned MRR + Downgrade MRR / MRR at the end of the previous month) x 100
The difference between gross revenue churn and net revenue churn is that net revenue churn includes upgrades in the calculations.
For example, Company A lost $400 in downgrades and $600 in cancellations in September. However, they gained $500 that month in upgrades. Company’s A’s MRR in August was $1000. Therefore their net revenue churn is: 400 + 600 - 500)/ 1000 = .5 or 50%.
Now let’s calculate gross revenue churn for Company A: 400+600/1000 = 1 or 100%.
Gross revenue churn doesn’t show the complete picture, which is why net revenue churn is better used to determine the success of a tiered pricing model.
Another great metric to use is downgrade MRR, which calculates the lost revenue due to downgrades. The formula is simple.
Insert formula(MRR before the downgrade – MRR following the downgrade)
Let’s say a company had an MRR of $10,000 in January. After downgrades, their new MRR in February is $5,000. Downgrade MRR takes the monthly revenue from month A and subtracts the monthly revenue from month B. Therefore, the downgrade MRR is $5000.
Upgrade MRR is the amount generated from upgrades in a month. For example, if ten customers move from a plan that costs $10 to a plan that costs 15$, the upgrade MRR would be $50.
A company can encourage upgrades through an efficient marketing campaign that targets the people most likely to become customers.
Causal is the perfect tool to plan a marketing campaign that will lead to upgrades and increase revenue. Causal’s customizable models allow you to create a range of forecasts, so you can decide which marketing campaign will produce the best results.
Why not eliminate tiered pricing?
This decision depends on the company, but tiered pricing can stop customers from canceling the service altogether.
They may choose to downgrade instead of cancel in situations where:
- They can no longer afford the premium option but still enjoy the product
- They don’t believe the higher-tier option is worth the amount spent
- They found a cheaper alternative to the features offered in the higher-tier option.
While downgrades may look bad on paper, they can save revenue in the long run.
Causal’s customizable templates can track revenue churn, downgrade MRR, and other essential metrics to help your company retain as much revenue as possible. Our forecasts can show the trend of growing downgrades before it happens.