Presented by Klipfolio
Over the years, I’ve had the honor of listening to and learning from many smart business leaders. I’ve even been fortunate enough to participate in a few of their conversations.
But while there are many worthwhile conversations happening in the SaaS (Software as a Service) industry, I struggle to patiently listen when debates surface around key SaaS business metrics. To me, there is no debate. This is one aspect of SaaS that is cut and dry.
So when I watch SaaS leaders become argumentative with each other as they discuss the finer points of fundamental concepts such as MRR (monthly recurring revenue) or churn rate, I find myself wondering:
What are they really arguing about?
Most SaaS topics should be open to debate. Such debates often spark opportunities (if we’re willing to listen) to learn from the collective swirl of each other’s ideas.
But today I’d like to share a few things I hope SaaS leaders will find helpful. Our company is fresh off a Series B round of funding, and one of the many aspects that helped us get this far is how focused we’ve remained on three specific business metrics. They can be applied to any SaaS business.
In narrowing our focus on growth as opposed to efficiency, we only have two fundamental values (accounts and recurring revenue) that we need to know before digging into our three business metrics.
Together, these two values tell us how many customers we have and how much they pay us on a recurring basis. These are the building blocks necessary to understand how a growth-oriented company like ours is doing. You should know these numbers in your sleep.
This is simply the number of customers you have — the sum of existing accounts and accounts gained, minus cancellations.
This is the money generated on a regular basis by the customers who have signed up for your service.
Recurring revenue is usually reported as either monthly recurring revenue (MRR) or annual recurring revenue (ARR).
There are only four things that can happen to your recurring revenue: you get new MRR from brand new accounts; existing accounts upgrade and pay you more MRR; they downgrade and pay you less; or they cancel altogether.
Both of these basic building blocks — accounts and recurring revenue — can be looked at over time or in their totality. Here’s an example of each:
“We added 10 new accounts today but lost two for a total increase of eight.”
“We have a total of 5,000 accounts as of today.”
Now that these two basic values are locked in stone, we can move on to understanding how the business is growing.
Without further ado, here are the 3 business metrics SaaS leaders must master to understand how their company is growing:
1. Recurring revenue growth rate
Recurring revenue growth rate measures velocity by taking the net increase in the amount of money we take in from subscriptions each month/year (New + Upgrades – Downgrades – Cancellations) and dividing this by the total recurring revenue at the beginning of the month or year.
This tells us how quickly we are growing and what kind of a growth curve we’re on. The bigger you get, the harder it is to grow (doubling $50K MRR is very different from doubling $500K MRR). I’ve heard Neeraj Agrawal of Battery Ventures say that a company’s recurring revenue growth rate should go like this over its first five years of operation: triple, triple, double, double, double. (Sounds like an order at Tim Hortons…)
Example: 6.5% Month-over-Month MRR Growth, or 110% YoY MRR Growth
2. Churn rate (for number of accounts and recurring revenue)
Churn rate is the rate at which you lose customers. A subscription service can lose customers very easily, and it can be bad news if you lose even a small number of customers regularly.
With a monthly account churn rate as low as 4 percent, you’ve lost half your business within a year. This is one of those metrics that will catch up with you as your base grows and can, in the worst of cases, mean that you’re losing more customers than you are able to win.
Churn rate needs to be calculated both for accounts and for recurring revenue. And by the way, churn rate is often also expressed as retention rate — which is simply how many customers you retain versus how many you lose.
Example: 2.4% monthly account churn or 14.7% annual account churn
Example: 1.9% monthly MRR churn or 9.2% annual MRR churn
3. Net recurring revenue retention
Net recurring revenue retention (usually just called net revenue retention or net dollar retention), is a bit more complex. It’s basically a way to measure whether your base revenue is growing. Again, we measure it over a time period — a month or a year — and it is the total change in recurring revenue from your existing customers with upgrades, downgrades, and cancellations factored in.
The best-in-class companies have a model where upgrades from existing customers outpaces downgrades and cancellations. Do that, and growth will be much easier.
Example: 100.5% monthly net revenue retention or 130% annual net revenue retention
The SaaS business model is relatively new and there’s much to learn, so it’s understandable that many in the industry struggle to grasp how it all works — or wind up in arguments over these metrics.
After all, we’re not in the clothing store business where we sell customers a sweater and never see them again. It’s more like we’re in the notoriously difficult newspaper business, where we have to repeatedly prove our worth to garner another subscription renewal.
At Klipfolio, we’re not doing anything radically different on this front. But we are obsessed with these two fundamentals: keeping our customers incredibly happy so that they stay with us, and increasing our reach so we can grow our base. These are the three business metrics that show us how good a job we’re doing at both.
Allan Wille is a co-founder of Klipfolio, and its president and CEO. He’s also a designer, a cyclist, a father, and a resolute optimist.
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