Calculating Recurring Revenue Metrics for Subscription Based Business Models
Properly monitoring your recurring revenue sources is very important if you are running a business where revenue is primarily generated through providing subscription based services. Monthly Recurring Revenue (MRR) is the normalized monthly revenue from all of the recurring items in a subscription. This metric is the truest form of visualizing the subscription cash coming into your business from your customers.
Profitwell, a data analytics platform for SaaS companies, outlines why tracking MRR is important for your business:
1. Post product-market fit compass metric: After finding initial product-market fit through user testing and activity, MRR/ARR typically takes over as the main compass metric to track growth within a subscription based organization. This is because MRR is the purest measure of your revenue, indicating how your momentum is building or waning over time.
2. Product and Sales team: Every month your product team should be incentivized by MRR to develop features and experiences to defend MRR against MRR Churn. Most product teams also have incentives to push for net new MRR, as well. Yet, your sales and marketing teams typically will primarily be focused on net new.
3. Critical financial metric: MRR is a crucial financial metric to your financial projections and gives you the most accurate status checkup of your business. It explicitly accounts for the “recurring” components in your subscription model and for those same components on a yearly scale using Annual Recurring Revenue (ARR). Together, these metrics give your finance team a crystal ball into your future.
It is a measure of predicable and recurring revenue components of your subscription business model. In most cases it excludes one-time and variable (infrequent) revenue sources (e.g. one-time set up charges).
MRR = Subscription Rate X Customers
Hipster Vinyl Distributors Inc. charges $25/month per customer to receive a new exclusive indie record monthly. They have 135 customers in September, therefore, the MRR for September and beyond is $3,375, at least (hopefully this amount increases because they attract more customers).
MRR for multiple recurring models
MRR = Model 1(Subscription Rate x Customers) + Model 2(Subscription Rate x Customers) + …
Hipster Vinyl Distributors charges $25/month per customer (model 1) to receive a new indie record each month, and $45/month per customer (model 2) to receive two indie records per month. They have 155 model 1 and 32 model 2 customers in September.
MRR = ($25 x 155 Customers) + ($45 + 32 Customers) = $5,315
Therefore, the MRR for September is $5,315.
Churn MRR is the revenue that has been lost from customers cancelling or downgrading their plans. So let’s say on a given month you had two cancellations from the $25/month plan and three customers downgraded their plans from $45/month to $25/month. You Churn MRR would be $110. It simply means that you’ll have minus $110 on recurring revenue for next month. Note, MRR churn is different from customer churn.
Net MRR = MRR — Churn MRR
If you don’t bill on a monthly basis, you should normalize your revenue in a monthly amount in order to measure MRR. If you have a $300 annual plan, you can divide by 12 which would give you $25 MRR.
Calculating Annual Revenue Per Account (ARPA)
Average Revenue per Account (sometimes known as Average Revenue per User or per Unit), is a measure of the revenue generated per account, typically per year or month. ARPA allows for the analysis of a company’s revenue generation and growth at the per-unit level, which can help you identify which products are high or low revenue-generators.
To calculate the ARPA, a standard time period must be defined. Most subscription businesses operate monthly, but you can always calculate it annually or quarterly according to your plans and billing options. The total revenue generated by all customers (paying subscribers) during that period should be divided by the number total number of customers.
ARPA = MRR / Total # of Customers
You know how to calculate MRR, ARR and ARPA — so what?
Here are four actionable ways you can generate more MRR/ARR for your business:
- Increase your net customer acquisition: You can create more MRR/ARR for your business by getting more qualified people through the door. Optimize your Customer Lifetime Value or Customer Acquisition Cost (LTV / CAC) ratio to a point where your customer acquisition cost is low and acquisition strategy is efficient.
- Increase your expansionary revenue through upgrades and value metric: There’s a lot of money to be grabbed off the table from current customers. Give them incentive to upgrade within your product by aligning the product with your value metric. Here’s a bit more on how to find and optimize your Subscription Model Value Metric.
- Increase your retention to boost your LTV: Retaining customers means that your product is aligned properly with a value metric, and you are in tune with your customer personas. This naturally paves the way for more MRR/ARR by expanding the width of retained customers as well as expanding the length of the customer lifespan.
- Reduce your customer acquisition costs: Subscription based business models are normally low cost from the start, and typically reducing costs is only a big deal for cost heavy industries. However, let this be a last resort if you’ve already done everything else and still need to tweak your MRR/ARR metric to bring in more value through the door. Also keep in mind that because your costs aren’t in your MRR calculation that this won’t physically move your MRR number. Instead, a reduction in CAC will allow you to be more efficient with your MRR.
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Banner image from Anna Vital, Creator of Adioma. https://medium.com/@annavital/top-startup-metrics-visualized-7ecc1c602ad6#.n70a5dh57