Cohort churn, not aggregate churn

Aggregate churn is close to useless in diligence. It is reported almost universally, it is the figure most management teams track, and every experienced buyer rebuilds it by cohort within the first two weeks of access to the data room.

What the blend hides

A single churn percentage mixes together customers acquired at very different times, through very different motions, into very different segments. It can stay flat for years while the underlying business changes character completely.

The pattern that matters is the direction of travel between cohorts. If customers acquired two years ago retain better than those acquired last quarter, the business is buying growth from a progressively worse-fitting segment. Current growth looks healthy and is not durable. If recent cohorts retain better than older ones, the product found its market, the sales motion improved, and the growth rate understates the quality of the business.

Those two businesses can report identical aggregate churn in the same year. They are worth very different amounts.

The other cuts

Cohort by acquisition date is the first cut. Three others are worth having ready, because a buyer will ask for them.

By segment or customer size, because a business retaining enterprise accounts while losing small ones is a different proposition from the reverse, and the blended figure hides which is happening. By acquisition channel, because inbound and outbound customers frequently retain differently and the mix has usually shifted. And by product line, where a business has more than one, because a declining legacy product can mask an excellent new one or the reverse.

Why it matters beyond price

Cohort analysis is also the most useful management tool most software businesses are not using. It identifies which customers to stop selling to, which is a faster route to improved retention than any amount of customer success investment.

An owner who has been running the business on cohort data for two years arrives at a process with a better business, not merely a better-presented one.