The SaaS market is expected to reach $164.29 billion by 2022 — which means the key innovations of this business model are about to inspire even more businesses. And with more popularity comes more confusion, especially over what metrics are most important to drive the best results.
We’ve done a lot of work with B2B SaaS companies, and over the years, we’ve seen a number of them struggle to get off the ground and grow quickly. And that’s due to one glaring misconception: SaaS business models are just like traditional business models.
In reality, SaaS companies often have more complex finances compared to traditional businesses. Why? Because SaaS companies often rely on sustained growth, and that looks very different for software-as-a-service companies. To put numbers to it, a traditional company can sustain growth at less than 20% YOY, but a SaaS company with only 20% growth has a 92% likelihood of not making it past their first few years of business. It’s a harsh reality because on the other end of that growth is this fact: Only 15% of high-growth SaaS companies (so those companies that did manage to make it out of those first few years) can maintain consistent growth. Yikes.
Which takes us back to our first point: Measuring the right metrics at the right time is more critical than ever because the margin for error is so slim when it comes to building a successful B2B Saas company. And we’re here to help.
With this guide, our goal is to make understanding the most critical SaaS metrics easy and clear, so that you can move forward and make the biggest impact in this competitive market as quickly as possible (because your business depends on it).
1. SaaS Metrics #1: Annual Recurring Revenue (ARR)
ARR is a representation of the Recurring Revenue a subscriber has with you over a 12 month period. Explicitly used by SaaS and subscription businesses with a defined contract length, it’s most useful as an indicator when term agreements have a minimum duration of 12 months. The math is simple and can be calculated in many different ways across different contracts.
Example 1: Customer A has a subscription for $14 a month on a one-year contract. Their ARR value is $168 per year.
Example 2: Customer B has a subscription for $12 a month on a two-year contract. Their ARR value is $288 per contract, or $144 per year.
Those are two straightforward calculations, but they cover what’s essential: ARR, particularly the critical categories of your ARR — New, Lost, Expansion, Contraction — and the trends and velocities in those numbers, is a good measure of the health of your business because it highlights what you can expect to repeat and what you need to improve.
2. SaaS Metrics #2: Monthly Recurring Revenue (MRR)
Monthly recurring revenue, or MRR, is the measure of your predictable revenue stream, and is designed to accurately deliver performance reporting across a number of different subscription terms and types.
For example, your company may have many different kinds of customers depending on term length, promotional rates, upgrades, renewals, etc., and this makes it difficult to measure your actual growth, or even your ARR. With MRR, you can arrive at a rate to easily and quickly diagnose the success of your efforts.
There are two primary examples of MRR:
- Average revenue per user: Calculate the average amount of revenue per customer per month by the number of paying customers you have. For example: If you have 20 customers with a monthly fee of $24, your monthly revenue is $480.
- Customer-by-customer calculations: Calculate the amount of revenue per customer per month. For example, one customer pays $12 a month, one customer pays $14 a month, and three customers pay $10 a month, your monthly revenue is $56. Because of different terms and contracts in a SaaS model, this is often very difficult to manage manually, so we recommend a management software.
For your business: Your future investors will be very interested in MRR for two main reasons: it allows for accurate financial projections and makes planning your business easier, and it also measures not only the growth, but the momentum of your SaaS business.
3. SaaS Metrics #3: Churn Rates
When we talk about churn, we talk about a lot of factors that can be measured by their attribution or loss. For example, you can measure loss in customers, contracts, booking, contract value, GAAP revenue, and MRR. This is typically expressed as a ratio or rate, but can also be described as a whole number.
Across the board, this is one of the most popular metric discussions for SaaS companies, and it’s highly relative. No matter what you’re measuring, churn is defined by your unique company goals, and whatever is acceptable to your stakeholders. However, that doesn’t mean that there aren’t a few standard churn metrics to take note of.
Here are three of the most common churn metrics we see, and ones you should keep tabs on:
- Customer (or logo) Churn: Plain and simple, this is the loss of customers. It’s known by a lot of other names: customer attrition, customer turnover, or customer defection, and it’s one of the most important “fitness” measures for your business. Here’s what it looks like:
4 subscribers lost/100 starting subscribers = 4% churn rate
If there is a consistent drop-off point in your solution, then you know there’s something that needs attention in your process or service. Typically, SaaS companies report anywhere from 5-7% customer churn rates, so you’ll know when you need to re-evaluate.
- Revenue Churn: Revenue churn takes a look at the rate of lost revenue over a period of time and is calculated similarly to customer churn rates. You start by choosing a time frame, and take out all of the new revenue you earned over that period.
For example You earned $100,000 in revenue last quarter, and in this quarter you earned $90,000 in revenue. Here’s the simple math:
(100000-90000)/100000 = 10% Revenue Churn
For your business: If you offer different products and services, you will need to track churn for each of these differentiators to get better insight into the success of your offerings.
- Recurring Revenue (ARR/MRR) Churn: Recurring Revenue Churn takes a look at the monthly recurring revenue (MRR) and measures how much MRR (from both canceled customers and downgraded customers) was lost in the period. Here’s an example:
% MRR churn rate = Churned MRR/Previous Month
So, if a company had 50 customers in January at $200, and 45 customers in February at the same price, this is what the revenue churn would look like:
January: 50 x $200 = $10,000MRR
February: 45 x $200 = $9,000MRR
Revenue churn = (10,000-9,000)/10,000 = 1,000/10,000 = 10%
4. SaaS Metrics #4: Customer Lifetime Value (CLV)
The literal customer lifetime value (CLV) is the total of actual revenue minus expenses for a customer. But in a subscription-based model, CLV typically refers to the estimate of the projected total value of a customer, and in practice, it is more like estimating both the revenue and the cost to provide a net value of the customer’s pre-tax contribution.
In practice, once your churn or renewal rate and average MRR are calculated, it’s easy to make an accurate report of your CLV. At SaaSOptics, we have a custom CLV report that manages the complexities of accurately managing churn and renewal rates and automatically pulls those figures into a streamlined report.
For your business: Customer Lifetime Value is important because it ensures that your business model isn’t supporting a model where the customer is spending less than the cost it took to acquire them. If that is the case, it’s important to lower your CAC and reconsider.
5. SaaS Metrics #5: Renewal Rate
Renewal rate is simple to explain: It’s the measure of customer retention and is expressed as a percentage. When it comes to calculating the renewal rate, you may look at these groups: customer renewal rate, revenue renewal rate, MRR renewal rate, and booking renewal rate.
What’s not simple is how to calculate renewal rates since a count-based ratio works best with similar clients and contracts, but doesn’t work as well for a diverse grouping of clients and contracts.
For example, if Customer 1 has a subscription of $100 per year and cancels, where Customer 2 has a subscription of $1000 and renews, the count ratio will be 50%. But in reality, the value of the renewal rate is much higher.
For your business: The more diverse your groupings are, the harder this value is going to be to calculate, but it’s important to understand how these figures can help you focus your company toward growth. If you see a drop-off in a level of service that seems worrisome compared to your other segments, you know where you need to focus.
6. SaaS Metrics #6: Revenue Retention
At first glance, revenue retention may look the same as the customer retention rate — but revenue retention is focused on the amount of revenue you retain from existing customers in a given period (regardless of how many customers you lose in that period). As a health indicator of your business, these are the two important metrics to consider:
Net Revenue Retention (NRR) refers to the overall change in recurring revenue from a specific group of customers over time. It accounts for all the revenue, minus revenue churn, plus any income from expansions or up-sells. It can be estimated monthly (or yearly) and indicates that you have a good product-market fit. Here’s how to calculate it:
NRR = Current MRR from a group of customers/MRR from the same group one year ago
If things are going well, your NRR will exceed 100%. If it’s a lot closer to 0% instead, it’s time to re-focus on the challenges your current customers are facing.
Gross Revenue Retention (GRR) is a higher-level look at how a company is doing at retaining your customers by eliminating factors like up-selling, price increases, organic customer growth, and more. It is always equal to — or lower than — your NRR, and is always between 0% and 100%. Here’s how to calculate it:
GRR: (Current MRR from a customer group – up-sells)/MRR from the same group one year ago
Just like your school grades, the closer your rate is to 100%, the better prepared your business is to maintain healthy growth over time.
7. SaaS Metrics #7: MRR Growth Rate
Put simply, the MRR growth rate tells you how much your revenue generation is improving over time. It’s a critical metric to measure as you try to figure out how much momentum and market traction your company is experiencing. When your MRR growth rate continues to rise steadily, it’s one of the best indicators that your business is expanding.
Here’s the calculation:
MRR growth rate: Current net MRR – Last month’s Net MRR/Last month’s net MRR
For example, if your net MRR this month was $790,000, last month’s net MRR was $660,000, then your company is growing at a monthly rate of 16.45%.
While there are no real benchmarks for SaaS growth rates, if you’re a post-Seed or Series A start-up, you’ve hit traction with your market if you land with a double-digit percentage. With a 10% MRR growth rate, you’re in a good place, and if you’re at 15%, you’re experiencing robust growth.
Stay on Top of Your SaaS Metrics by Making Sure You’re Calculating Correctly
Across these metrics, it’s critical to understand how important it is not only to calculate them but to ensure those calculations are done accurately and consistently. We’ve seen a lot of SaaS companies, both new and established, make the mistake of trying to manage these figures manually ultimately sacrificing accuracy and consistency in the process. We’ve also seen many companies change the way they calculate a metric for one purpose or another without a clear process or reason. And, when they do so, they lose comparability. “Is this the new CLV or the old CLV?” is not something you want to get asked.
At SaaSOptics, we’re equipped to manage the in’s and out’s specific to the SaaS industry: revenue recognition, billing and invoices, customers and renewals, metrics and analytics, and so much more. With the power to calculate 100+ SaaS finance and analytical metrics at the touch of a button, we’re here to make sure you have the numbers you need when you need them.
This blog was originally authored by SaaSOptics. Republished with permission.