E-commerce Profitability

E-commerce Retention Explained: Customer Churn & Why It Matters

Henrik Hoffman
January 25, 2024

The concept of churn is based on the fact that customers have not come back and bought again from the e-commerce company during a certain period that was expected.

E-commerce companies are like all companies, you have three groups of customers: new customers, returning customers and the customers who have churned. In a time when customer acquisition becomes increasingly expensive for most e-commerce companies, having control over the churn becomes more and more important. 

Understanding your customer churn is vital for any company that relies on returning customers in their business model, or just in general to hit their growth trajectory. “What’s a reasonable churn?” “How can I improve my churn?”, and “What is my churn?” are all important questions, and our article will answer them all.

Basic understanding: What is customer churn in e-commerce?

Customer churn means customers are not returning to the site to buy again within a certain time frame. Customer churn is the opposite of Customer Retention, i.e., returning customers.  

Customer Churn Rate Formula

The most common time frames to calculate churn rates are monthly, quarterly, and yearly for e-commerce sites, but you can have a Customer Churn Rate reported in any time format.

The formula is the number of churned customers during a certain period / the active customer base at the beginning of that period.

Churn from a customer perspective

But if you think of churn from a customer perspective, it could be an active choice because of, for example, unsatisfying service or products, and it can also be a natural reason that the delivery fulfills the need. It just doesn’t appear again for whatever reason. In that case, it might not have anything to do with how satisfied the customer is.

Why Customer Churn Rate Is So Important?

Over time, the only way to build a sustainable e-commerce business is to have a higher Customer Lifetime Value (LTV) than the cost of acquiring the customers (CAC). If you don’t know your churn rate, you cannot know your LTV; if you don’t know your LTV, then you don’t know what you can allow your CAC to be.. 

Benefits of tracking your customer churn

  • When you measure it - you can improve it
  • It gives you a chance to understand what drives churn in your business
  • It gives you a possibility to predict the long-term retention rate and customer lifetime value
  • It gives you an understanding of the need for Customer Acquisition

Why customer churn is especially important for ecommerce businesses

Customer Churn is more important for certain e-commerce companies, than others. And why is that? And why not all?

Customer Acquisition Costs generally rise with higher advertising prices, especially as long as you don’t have a growing loyal base of customers that will act as ambassadors for your brand.

In e-commerce, many companies rely on a significant percentage of revenue from returning customers. Still, if that loyal group of customers churns, the e-commerce company can quickly get into a stressful financial situation.

What happens if I don’t track my customer churn 

If you don’t prioritize understanding your Customer Churn Rate, it is very hard to decrease it. That might be fine for you, but what if the customer churn suddenly increase? If you haven’t been measuring it, you won’t understand when to react to an increasing churn, and when you finally understand that churn is the issue for your worsened results, it might be too late.

I follow my revenue from returning customers, is that enough?

No. It is not enough. It won’t tell you the full story. Big spenders can easily make up for an increase in churn. That could be fine; most likely, you would rather have fewer and more profitable customers than many unprofitable customers. But you don’t know the retention rate, if you don’t follow the churn. 

Suppose you only measure the revenue from returning customers. In that case, you run the risk of being misled if you have an increasing number of new customers coming in, and you might think that an increase in revenue from returning customers means better retention. Better retention equals lower customer churn, a sign of more long-term sustainable growth and less marketing money needed to acquire new customers to get the same revenue, i.e., increasing profit. 

How do you calculate customer churn, and When do you consider a customer churned?

That question will get different answers not only between companies but also sometimes between colleagues at the same company. However, to define this, the most important is to get a common understanding of what part of your customer base has churned. When that is defined, you can come up with the rules. It might be as easy as after X days of no purchase, a customer is churned, or it can be much more complicated.  

The goal is that all know whether the total customer base is growing or declining, if your most important customers are churning, or if it’s customers that aren’t part of your target customers that are churning. 

To consider a customer churned in a non-subscription-based e-commerce, you need to define how many days after purchase before a customer turns into a churned customer. 

A customer has churned IF the # of days from last purchase IS GREATER THAN the maximum # of days you expect it should take for a loyal customer to return and purchase from you again.

To decide the number of days, you can base it on common sense and reasoning based on your industry, target audience, and company.

Industry Your Audience Your Offer Definitions of Churn Explanation
Grocers Urban people Huge assortments, Fast delivery 14 days We expect our customers to shop as often as 3 days a week and if you don't use us in 2 weeks, then you are not considering us as the grocery shop.
Grocers Surburb families Huge assortments, Fast delivery 30 days We expect our customers to shop as often as 3 days a week and if you don't use us in 4 weeks, then you are not considering us as the grocery shop.
Fast fashion Young women Changing trendy assortment, fast delivery 60 days We expect our customers to shop at least 2 times per month and if you don't use us for 2 months, then you are not considering us to fulfil your ongoing need of new fashionable clothing.
Timeless classic premium clothing Older women A classical premium in many sizes 180 days We expect our customers to shop at least every season, and if you haven't used us for six months, then you are not considering us to fulfil your ongoing need for high-quality clothing.

Deep dive example into the many sides of customer churn in ecommerce

To visualize the challenges with customer churn and its implications when you get it wrong, let’s come up with an example:

  • One fashion e-commerce company might consider a loyal customer to be a customer who purchases from them every season. 
  • Let’s assume they have two seasons per year, one summer and one winter. 
  • As long as a customer returns and buys each season, he or she has not churned. 
  • To have a more practical rule for this, we decide that a customer churns if the customer doesn’t return less than 200 days after their last purchase.
  • But let’s say that the customer buys from us in March year one from the summer collection that drops in March and then comes back and buys the winter collection first during the end-of-season sale in January of the following year. Did the customer churn before buying again? According to the rule that was set up, yes!
  • We can then change the rule to 400 days instead. 
  • Then we have a customer who shopped for the end-of-season sale in January of year two, and has yet to return. In our reports, we will only see a churn's “failure” appear more than a year after the purchase. But perhaps, that customer had already “churned” mentally three months after the purchase, and the likelihood to get that person back after three months is very small. 

The above fashion company needs a deeper understanding of its customer base, churn, and the decline of the probabilities of returning over time to enable proactive retention activities. If they don’t understand fast enough, a customer is likely to churn, and they will be too late to have the chance to activate the customer. If they don’t understand other defining differences between customer churn and time from the last purchase, the actions taken to decrease churn will likely be ineffective and not as accurate as they need to be. For example, some customers might be very likely to churn just by looking at their order compared to previous customers. 

This is where prediction models like Dema’s LTV (Lifetime Value) Prediction Model come in handy since you can improve retention and decrease churn in how you market your products, and what products you sell. Also when the customer makes the order, you will understand the predicted value of that customer. Read more about Dema’s LTV Prediction here

What if a churned customer returns?

First of all, if a customer returns - that is great. Always.

Secondly, to learn how to grow your business better, we need to know if that customer churned before making that second purchase or if you had the wrong definition of churn.

Third, if a previously churned customer returns, the customer is no longer churned and is most likely a customer with a high potential of becoming a loyal customer in the future, given that he or she is treated well. 

Ways to work with Churn: RFM-Analysis

One of the easiest ways to work with churn, when configured and setup, is an RFM-analysis. It stands for Recency, Frequency, and Monetary Value. To simplify it a lot, it’s a relative model that scores your customers from, for example 1 to 5 on all those values and then groups your customers to make it much easier for you to know which customers that are about to churn now should I focus on.

A conceptual sketch of an RFM model. Each space represents a group of customers that have relative score on Recency (when they last purchased), Frequency (how many times they have purchased), and Monetary Value (how much they have purchased for).

With an RFM analysis you don’t need to come up with a certain number of days that defines a churned customer since the model does that for you. You can focus on action.

The downside of an RFM analysis is that for many, the analysis is quite complicated, and to get started, it might be a lot of data gathering and time-consuming connection of different data sources.

The upside of an RFM analysis is that when it’s set up, you “only” need to provide more data into the model to get it updated. 

The best way to work with an RFM-model is by automating it and tracking its progress over time. It could, for example be part of your CRM system, connected to your data-warehouse or in an platform like Dema.ai

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