Contraction refers to the reduction in Monthly Recurring Revenue (MRR) from existing customers due to downgrades or reductions in their subscription fee. Unlike Churn, Contraction focuses on revenue decreases that don't involve losing the customer entirely, like downgrades or cancellations of add-ons.
The metric helps to understand the rate at which customers downgrade their subscriptions. It's considered good if this rate is significantly lower than the rate of Expansion. This metric is useful for spotting early signs of customer dissatisfaction, identifying accounts needing attention, and noticing shifts in product-market fit.
MRR at Start of Period - MRR at End of Period from Existing Customers
Contraction is calculated by subtracting the Monthly Recurring Revenue (MRR) at the end of a period from the MRR at the start of the same period, focusing only on existing customers.
It's essential to understand the reasons that customers are downgrading by regularly collecting feedback. If customers downgrade due to cost, consider revising your pricing or creating custom plans that better fit customers' needs. If customers downgrade due to product-related reasons, consider educating customers further about your product so they can maximise value extraction and justify your pricing. Also, prioritise product roadmap based on customer feedback.
Don't confuse Contraction with Churn; they are different. Contraction signifies a decrease in revenue without customer loss. Also, a very low Contraction rate is not always healthy; it can indicate a lack of upselling which might suggest a stalling product or service.