This article is part of our three-part INSIDE Metrics series on measuring subscription retention.  

• Part I, below, focuses on understanding retention opportunities and trends, tracking attrition patterns and developing a methodology for tracking retention.
• Part II shows us specific ways to apply those metrics to manage your retention business more effectively. 
• Part III is our detailed retention workbook that INSIDER Members can use to track their own retention using the concepts in this series.
• Tutorial:  See our on-demand tutorial for guidance on how to use the workbook. For INSIDER Members only.

To understand your retention opportunities and trends, you need to have a simple way to track attrition patterns.  But you also need a methodology which accommodates different billing periods and the fact that some customers pay for only part of a term and then cancel.  Part I of this guide introduces two basic measurement concepts.  Then Part II shows you specific ways to apply those metrics to manage your retention business more effectively.

Basic Requirements.  You need to be able to break up your business into meaningful pieces.  “Meaningful” means groups that behave differently from one another.  In an ideal world, you’ll want your reporting system to be able to break out performance by channel, initial offer (free trial, discount, etc.) and billing term (3-month, 6-month annual, etc.)  Each of these variables separates your subscriber base into groups with different retention characteristics that have different leverage points.

You will also need to create a shared language across your organization for what you mean by “renewal rate”.  Specifically, what will be your standard timeframe for this definition?  Since almost all billing terms are 12 months or less, and fiscal years are defined as 12 months, that’s the most logical timeframe to use.  (Remember, based on the “Four Fundamentals” Insider Guide, you want your marketing, financial and operational reports to all be aligned with one another.)

You also want to measure retention on a year-by-year tenure basis, i.e. retention from one year to the next – not just cumulative retention.  This means studying how a single group of new subs is retained from month 0-12, 13-24, 25-36 and so on.  This is because subscribers who have been with you for longer have different retention and loyalty characteristics from those who are new, and changes in their behavior have different implications from those with shorter tenures.  We’ll talk more about this when we discuss interpretation in Part II.

Metric #1: Simple Retention Rate.  This metric freezes a group of subs and follows their attrition over time.  You measure how many people from that group are “still standing” — i.e. are paid members – as of the end of a certain time period, and divide them by the number of members who started.

Typically you’d look at this in terms of a one year period, but it can be used for any time period depending on your objective.  If you want to benchmark, a year is a good yardstick.  If on the other hand you want to determine where attrition is highest, week-to-week or month-to-month is better.  More in Part II.

WHEN AND WHY TO USE THIS METRIC.  The strengths of the Simple Retention Rate are in its simplicity and readily-available data.  It’s also important for budgeting and forecasting purposes because it tells you how many people are available to be renewed at the end of the year. But it doesn’t truly refect retention rate in terms of the revenue associated with those bodies.  For example, people who canceled in mid-year, or after their first quarterly billing period in the middle of a billing term – you collected some revenue from them, right? But that doesn’t get reflected in the Simple Retention Rate.

And what about comparing groups which have subscribers with multiple billing terms?  For example, what if at the end of six months, the semi-annual term has more subs standing – but the quarterly term had more people stay for the first quarter?  Your Simple Retention Rate isn’t accounting for those people and the revenue they produce.

To account for these we’ll use…

Metric #2:  Annual Equivalent Retention Rate.   The strength of this measure is that it’s the most accurate method of measuring retention because it’s more representative of an offer’s cumulative offer impact on subscriber volume and revenue.

It’s based on pooling all the months served and recalculating them in years.  Each of these years counts as a whole subscriber.  It’s a more accurate way to account for the number of subscriber months served by one offer vs. another, especially those with different billing periods.

WHEN AND WHY TO USE THIS METRIC.  Use this when you need to aggregate offers into a single number, for example comparing a 12-month/3-month offer to a 12-month/6-month/3-month billing offer.  Also when you need to explain revenue changes.  It simplifies the numbers into a single aggregated metric.  Then when you see a need to, you can drill down into the rat hole to find the driver detail.

To use an analogy, it’s sort of like counting eggs.  Suppose you have to take inventory of your egg supply.  You need to describe it in terms of the number of full egg cartons you have, but some cartons are only partially full.  So imagine that you took all of the eggs out of the cartons, put them into a giant pile, and then placed 12 eggs into each carton.  Then you count the full cartons.

As a formula, Annual Equivalent Renewal Rate is calculated as:

(Total subs served by month for all months in the period) / (the number of months in the period) / (the number of subs at the beginning of the period).

Here’s a detailed description of both metrics.  The first row of the table above shows how many subs stuck around for Month 1, then for Month 2, and so on until you have the total months served.  So for the Simple Retention Rate we discussed above, you’d simply say that you started with 100 subs in Month 1 and ended with 23 subs in month 12.  Your Simple Retention Rate would be 23%.

But you got revenue during the year from lots of people before they decided to cancel.  So to account for that, you want to translate all of those months of paid membership into “virtual subscribers”, which is another word for Annual Equivalent Subs, and then use those subs to calculate your Annual Equivalent Renewal Rate.  You’re turning your individual eggs into egg cartons.

To calculate Annual Equivalent Subs, add up all of the active subs for each month for the entire year (651 “months served” at the far right of the table) and then divide by 12.  This expresses those months of service as if they were years – think of those years as if each one was an individual subscribers.

Divide Annual Equivalent Subs by the number of subs you started with and you get Annual Equivalent Retention Rate.  In this case it’s almost twice that of the Simple Retention Rate: 54% vs. 23%.  NOW you’re measuring a retention rate that correlates to actual revenue.

Which one matters most?  Both.

Coming in Part II: We’re gonna get really geeky and look at some sample reports and how to draw insights from them.

Bill Baird, our INSIDER Guide to Inside Metrics, is a leading Internet subscription marketing advisor, specializing in insightful metrics and marketing practices to help subscription-driven online properties convert and retain more visitors and customers. His clients have included AmericanGreetings.com, Consumer Reports Online, Socrates.com, Edweek.org, Merriam-Webster.com, The Motley Fool and numerous others.  He is a contributor to numerous industry trade magazines and websites, as well as a popular speaker for a variety of web marketing trade organizations. (Read Bill’s full Bio)