Vonage and the Churn Ceiling

This week is all about churn.  Monday we saw how Vonage's 3.3% subscriber churn in the 1st quarter has driven their cost per net subscriber addition above $2000, meaning that Vonage will need to keep each customer it added in the 1st quarter for 6 years just to pay back the marketing costs it took to win that customer.  Ouch!

Today, we'll look at how churn actually creates a ceiling on how big a service provider's subscriber base can grow.  It turns out that the limit is really easy to calculate: 

Max subscriber base size = Monthly gross subscriber additions / Monthly churn rate

Now, I don't believe that Vonage's rate of churn in the first quarter of 2008 will persist...I think that churn will come down a little for Vonage next quarter.  Also, I don't believe that Vonage's rate of gross subscriber additions will stay at recent levels, as the company has to ramp up its marketing spending and should see a corresponding ramp in subscriber additions.  But if you assume that Vonage's 1st quarter subscriber addition and churn figures will persist, then Vonage's maximum customer base is calculated as follows:

Max subscriber base size = 95,558 gross monthly adds / 0.033 churn rate = 2,895,694

Unfortunately for Vonage, their current customer base is about 2.6M, so if the can't get their churn to come down or their monthly gross adds to come up (or both), Vonage is currently close to reaching their subscriber base ceiling. 

Of course 1Q08 was Vonage's worst quarter ever in terms of churn, so it paints an uglier picture of subscriber ceiling than will probably be the case later this year.  To see how Vonage's subscriber ceiling has changed from quarter to quarter ever since Vonage went public about two years ago, see the following table:

Vonage's Subscriber Ceiling by Quarter
	2Q06	3Q06	4Q06	1Q07	2Q07	3Q07	4Q07	1Q08
Monthly Marketing Spending	$30.1M	$30.4M	$31.9M	$30.3M	$22.6M	$20.6M	$23.6M	$22.6M
Monthly gross adds	125,668	119,716	104,031	110,831	78,947	99,993	99,537	95,558
Actual Monthly churn achieved	2.3%	2.6%	2.3%	2.4%	2.5%	3.0%	3.0%	3.3%
Possible Churn Rate Range (below)
3.5%	3,590,524	3,420,457	2,972,324	3,166,600	2,255,619	2,856,933	2,843,910	2,730,225
3.4%	3,696,127	3,521,059	3,059,745	3,259,735	2,321,961	2,940,961	2,927,554	2,810,526
3.3%	3,808,131	3,627,758	3,152,465	3,358,515	2,392,323	3,030,081	3,016,268	2,895,694
3.2%	3,927,135	3,741,125	3,250,979	3,463,469	2,467,083	3,124,771	3,110,526	2,986,184
3.1%	4,053,817	3,861,806	3,355,849	3,575,194	2,546,667	3,225,570	3,210,866	3,082,513
3.0%	4,188,944	3,990,533	3,467,711	3,694,367	2,631,556	3,333,089	3,317,895	3,185,263
2.9%	4,333,391	4,128,138	3,587,287	3,821,759	2,722,299	3,448,023	3,432,305	3,295,100
2.8%	4,488,155	4,275,571	3,715,405	3,958,250	2,819,524	3,571,167	3,554,887	3,412,782
2.7%	4,654,383	4,433,926	3,853,012	4,104,852	2,923,951	3,703,432	3,686,550	3,539,181
2.6%	4,833,397	4,604,462	4,001,205	4,262,731	3,036,410	3,845,872	3,828,340	3,675,304
2.5%	5,026,733	4,788,640	4,161,253	4,433,240	3,157,867	3,999,707	3,981,474	3,822,316
2.4%	5,236,181	4,988,167	4,334,639	4,617,958	3,289,444	4,166,361	4,147,368	3,981,579
2.3%	5,463,841	5,205,043	4,523,101	4,818,739	3,432,464	4,347,507	4,327,689	4,154,691
2.2%	5,712,197	5,441,636	4,728,697	5,037,773	3,588,485	4,545,121	4,524,402	4,343,541
2.1%	5,984,206	5,700,762	4,953,873	5,277,667	3,759,365	4,761,556	4,739,849	4,550,376
2.0%	6,283,417	5,985,800	5,201,567	5,541,550	3,947,333	4,999,633	4,976,842	4,777,895

Vonage is now faced with the difficult task of reducing their churn rate, while simultaneously increasing their rate of gross adds, while limiting marketing spending.  I do expect to see Vonage's subscriber ceiling rise in the coming quarters, but It's a tricky business, so it will be interesting to watch.

(Many thanks to the Telecosm reader who reminded me of this interesting aspect of churn)

Comments

[Parkite]

Very interesting.........I think you are seeing the impact of wireless substitution on voip (in addition to wireline) as more and more consumers and small businesses cut the cord altogether. I would expect that Vonage's customer base is highly exposed to consumers and small businesses who consider voip unnecessary given the mobility advantage of wireless. In summary, the most likely candidates to switch to voip are also the most likely candidates to take the next step and go completely wireless. Thus, a provider like Vonage has an unusually high number of progressive subscribers that will readily migrate to the best value proposition.

[matt wilson]

Ike - I have been reading your blog for sometime keep up the good work you came it at 114 for top telecom blogs.

http://www.voipnow.org/2008/05/top-100-telecom-industry-blogs.html

[Dan Caruso]

This is an interesting and useful analysis. I would add one more concept to it. What is a reasonable expectation for steady-state churn?

A 1% churn rate implies a dollar of revenue will stay on the books 5 years. Think of all the reasons a customer might churn--go out of business; move; out-grow the service; benefit from repricing; or switch to another service provider. If, on average, only one of these events every five years would seem to be a a fantastic result for most recurring revenue businesses. Yet many telecom business tout 1% or lower rates and attribute it to their great service. Eventually, it becomes clear that the churn rate is really higher--this is explained usually by citing external uncontrollable events.

What is really happening? Newer companies, so long as their service is okay, will have low churn. The maturity of their customer base is simply low. If you have been in business only three years, your average customer has been with you less than 1.5 years. Your churn better be very low!

Rapidly growing companies have a similar dynamic. When Cbeyond was in its rapid geographic expansion phase, it's average customer life was unnaturally low (relative to steady state)--churn, you'd expect, would be much lower than steady state as well.

Wait--why am I writing this as a comment on Ike's blog? I might as well do a post on bearonbusiness. I will complete this there.