August 27, 2021
When it comes to increasing business revenue, attracting as many new users as possible might seem the most obvious decision. However, as studies show, the probability of selling a product or a service to a new customer is 5-20%, while the probability of selling it to an existing customer base is about 60-70%.
This makes even more sense as a company grows. Take Salesforce as an example: 73% of a company’s new orders come from the existing customer base.
So, we can see the importance of retaining the existing users as it greatly helps SaaS companies achieve sustainable growth.
With a common shift from attracting as many users as possible to increasing customer retention, a new metric has come into play - the Net Revenue Retention, or NRR.
In this article, we will look at the benefits of measuring retention performance through the NRR versus the traditional metrics.
Tracking certain growth metrics helps Saas business owners understand how a company is performing, and what can be improved. In addition, these metrics prove to be useful when communicating value to the potential investors.
Let’s look through the common SaaS business growth metrics.
Monthly Recurring Revenue is one of the most common metrics for subscription-based services. With a monthly subscription, the MRR represents the price that customers pay for a month of use. If customers pay for more than 1 month (for example, 12 months), simply divide that amount by the number of months in the subscription period.
Churn Rate is the percentage of users who stop being a customer of a company within a certain period. For the SaaS business model, these are users who have canceled their subscriptions.
While this is one of the key metrics for customer retention assessment, focusing on the Churn Rate primarily has a significant downside. This metric tells you nothing about which customers you are losing exactly. Are you losing low-value or high-value customers?
For that reason, along with the Churn Rate measurement, more and more SaaS businesses are starting to track Revenue Churn Rate.
Revenue Churn, or MRR churn, occurs when customers do not renew their subscription, or switch to a cheaper plan.
To determine the Revenue Churn Rate, you need to take all of your current monthly revenue at the beginning of the month and divide it by the average monthly recurring revenue before that, minus any updates or additional revenue from existing customers.
In addition to the Revenue Churn metric, an inverse metric is used - Revenue Retention Rate.
Net Revenue Retention can be measured as follows:
NRR = (MRR of the last month + Upgrades MRR - Downgrades MRR - Churn MRR) / MRR of the last month * 100%
Let’s take a closer look at the factors used to calculate the NRR:
The good news is that you don’t need to worry about tracking the NRR manually. With customer success management platforms like Userlot, you can automate tracking this and other revenue-based metrics. Whenever you need to assess the NRR, you can see it on a dashboard as well as in the reports.
Let’s illustrate how the NRR metric works.
Say, a company has 10 customers who are paying $500/month. Hence, the MRR is $ 500 * 10= $5,000 per month
One of the customers cancels subscription in the next month (Churn MRR = $500 per month), two of them downgrade their plan to $100 per month (Downgrade MRR = $400 * 2 = $800 per month), five users stay on the old plan for $500 per month, and two more customers make upgrades to a plan of $1,000 per month (Upgrades MRR = 2 x $1,000 = $2,000).
Now, let’s calculate the NRR:
NRR = ($5,000 + $2,000 - $800 - $500) / $5,000 = $5,700 / $5,000 = 114%
As this example shows, although a company loses one customer, and two of them switch to a cheaper plan, the remaining users still bring the company an extra additional $700 per month (+14%)!
Such a situation is also known as “net negative churn”, and this is what most SaaS business owners should strive for. If the expansion revenue from the existing customer base exceeds the lost revenue from customers who left or downgraded, it is a clear indication that a company can grow without acquiring new customers.
While the MRR metric provides an estimate of the company's monthly revenue, it is not adjusted for upgrades, downgrades, and customer churn. Contrary to that, the NRR measurement provides you with insights into whether your business is growing or losing revenue every month from your existing customer base.
Some of the customers use your product more intensively and utilize its features to the fullest, while others are satisfied with just a basic set of functions. Some of them may order additional features and services, or switch to a more expensive plan, while others can downgrade to a cheaper plan, or even to a free version of the product (of course, if you provide such an opportunity).
Tracking the NRR metric will show you how much revenue you receive after taking into account all the extensions, downgrades, and churn.
To grow, a business needs to cover the churn somehow - for example, with the revenue from the new customers every month. And here is the thing: the larger your customer base is, the more difficult it will be to cover the revenue churn with new sales.
If the NRR is positive, your SaaS business can grow in revenue (for a while), even if marketing and sales efforts are completely turned off. Such a favourable situation occurs when customers are getting value from your product, and are willing to pay more. This is what every SaaS business owner should strive to achieve.
If the NRR is negative, downgrading and leaving customers cuts the monthly revenue to a higher degree than the upgrades increase it.
Let’s illustrate this with an example. Say your MRR was $100K per month last month, and your NRR was -3% this month (meaning you lost 3% of those customers' revenue or $3000 per month). This means you need to make new sales of just $4000 per month to achieve the MRR growth of at least 1%.
But if your MRR is $10M per month, to cover the NRR of -3% and to get revenue growth of at least 1%, you need to sell subscriptions to new customers for at least $400K per month.
You might be already tracking your overall retention rate. Nevertheless, it's important to consider not only the total number of customers who have retained your product subscription but also how much money each of them brings to you.
Unlike the Churn Rate, the NRR lets you see if you are losing low-value customers or customers who are paying you the most.
For example, if the NRR is -1%, and the Churn Rate is -5%, we can conclude that the majority of leaving customers are not high value, and losing them won’t be that painful for the business.
But if the NRR is -5% with the Churn Rate at -1%, then you are losing customers who pay more than others - and this is a serious problem to be fixed.
One more advantage of the NRR over the MRR is an opportunity to look at a business from a broader perspective and to think about the entire customer retention strategy.
Knowing how much revenue you are getting from retained customers will show you how effective your marketing efforts are in increasing sales, upselling and cross-selling. This, in turn, will help you identify weaknesses in the product that are causing people to switch to cheaper plans and/or even quit using your services.
So, with a focus on improving the NRR metric, SaaS business owners can significantly improve their sales and marketing strategy. Having obtained certain insights from tracking the revenue-based metrics, you may want to start finding answers to the following questions:
These questions are fundamentally different from the common “How can we reduce the number of clients leaving us?” question.
Which NRR values are considered to be safe? Let's look at the industry benchmarks.
Actually, the NRR higher than 100% indicates sustainable growth - in particular, a company’s capability to increase revenue from the existing customer base.
As a rule, the higher an annual contract value, the higher the NRR. Therefore, enterprise software providers often enjoy 125% and higher NRR. Just a few examples:
The company growth stage also matters. That is, for later-stage companies, a 116% NRR is generally good, while early-stage startups should aim at a higher value.
Typically, the NRR <100% speaks about issues with the ability to grow revenue from your existing customers. There are certain reasons for that.
One of the possible reasons is having one single product and therefore, facing difficulties with making upsells. If this is the case, consider creating a “light” version of a product with a lower price to acquire more users, and expanding with those new users further. In addition, be sure to work on additional paid features to upsell.
Another reason for a low NRR can be found in the organizational structure. In particular, sales representatives reaching out to existing customers to offer additional products or features can push them away. Hiring dedicated customer success representatives is often a good way out. That is, customer success reps are well aware of the current customer lifecycle stage of this or that user, and they are well equipped to make a relevant offer as an upsell.
Customer churn is an inevitable reality for any business. While you won't be able to completely eliminate it, you can still make this process manageable and therefore minimize losses.
Retaining the existing customer base is the key to ensure sustainable growth. To assess revenue retention, the Monthly Recurring Revenue metric isn’t enough - it doesn’t take into account such factors as upgrades, downgrades, and customer churn.
Measuring Net Revenue Retention will help you see a more comprehensive picture - in particular, whether you are losing low-value or high-value customers. With that data at hand, you can further build the overall customer retention process way more efficiently and help your SaaS business find new growth strategies.
August 27, 2021