So, you’re running a SaaS startup that finally managed to get on track. New customers keep coming your way, registrations turn into paid subscriptions, month-on-month, and all team members feel relieved. It was really worth the effort, right? Besides, your well-thought-out excel doc to bring revenue is the ultimate proof of this positive outcome; or is it? Is your net revenue retention strategy aligned with this positive change, at all?
No one can deny that increased paid subscriptions do mean a lot for a startup business, as it starts getting traction. But, the truth is, that’s just the first step. The game has just begun and you need to know more about the rules and how to achieve a high score. That is, you need to be sure whether you’re (currently) winning or losing, in terms of revenues. That will help you readapt your actions and your overall strategy, as well. A useful tool for that is the net revenue retention metric. Let’s get to know more about it, then.
Net revenue retention: why you need to get it right
Net revenue retention is a metric that helps you get a better understanding of your revenue status. To put it another way, it helps you get the bigger picture, regarding customer flow, in terms of revenues.
What is net revenue retention?
Let’s take a look at a definition.
Net revenue retention or NRR is a macro metric that measures the total change in recurring revenue from a pool of customers over time. The calculation factors in, not only revenues from existing customers, but also expansion revenues, downgrades and cancelations, as well.
Now, it would be helpful to break this definition down into the sum of its parts; and then illustrate each one with a few tangible examples. So, here’s how it’s analyzed into its different aspects:
Revenues from existing customers
It refers to initial revenues that you already have at the starting point of the period you’re about to make your calculations. For the same period of time, you’ll also need to track all the revenue factors that follow.
Business expansion revenue increase
More or less, it’s the part of your revenues that has been generated from new customer subscriptions.
Subscription upgrades revenue increase
It refers to the revenues that come from existing customers who decided to upgrade their subscription plans.
Subscription downgrades revenue decrease
Contrary to the previous point, unfortunately, there will be customers that will decide to downgrade their subscription plan, for whatever reason. As a tip, try to find out what those reasons are. You may get a chance to turn the ship around, at some point.
Revenue decrease by subscription cancelations
A worst-case scenario — which is, of course, part of the game — when existing customers cancel their subscription and withdraw. This is also known as a customer’s end-of-life, with regard to your product. And, in this aspect, lies the value of the metric we’re examining. We’ll further explain how you can organize your strategy, below. For now, just keep this in mind that there are things you can do.
Now everything has become a bit clearer, hasn’t it? If not, let’s go straight to the calculation formulas that will help us get the bigger picture.
Calculating your net revenue retention
So, how do we calculate this useful macro-metric? Well, first of all, to get a better understanding of the total change, in terms of revenues, it would be helpful to calculate its rate. You may find this term as “net revenue retention rate” with a quick search. And, here, we’ll focus on exactly that.
The net revenue retention rate is the following quotient:
[Initial MRR – Churned (Cancelled) MRR – Downgrade MRR + Expansion (Upsell or X-Sell) MRR)] / Initial MRR
An alternative formula that may also be useful is the following:
NRR = [The sum of recurring revenues from renewing customers)] / The sum of recurring revenues of customers due to renew)
When should you be happy with your net revenue retention?
A short answer to this question is when your net revenue retention is greater than 100% you’re doing great. And, in practice, it means that the growth you’re achieving offsets losses. All in all, as expected, the higher the net revenue retention, the better.
Now let’s take a look at a few examples that will help us better understand how the net revenue retention metric works. In particular, we’ll see why increased revenues coming from new subscriptions is not necessarily a success indicator. At least, that is usually the case when additional revenue factors, as the ones examined above, are not being taken into consideration.
Before we focus on real numbers, let me set the ground first. In the beginning of our article, we mentioned that focusing exclusively on new customer subscriptions is not a good practice. Then, we explained in detail how useful a metric “net revenue retention” is; and also stressed on how great it is to score more than 100%. But, is that all enough to get you out of the woods? Well, not quite.
On to the numbers then:
Let’s say that we have two startups or you may also think of the following as two instances of your own startup at two different points of time.
Startup A has a 115% NRR that comes from the following changes:
- 20% loss of NRR, coming from churn that is customers withdrew
- 5% loss of NRR from downgrades
- 35% increase of NRR, coming from expansion and upgrades
Similarly, startup B has 95% NRR, shaped by the following:
- 5% churn
- 15% downgrades
- 5% expansion and upgrades
Now, you’re probably thinking that startup A with a 115% NRR is probably doing much better, as compared to startup B. But, what if the churn rate for startup A continues to increase, expansion remains stable or drops and upgrades from existing customers freeze as the majority of them may have already changed their subscription plans, according to their needs, in the past months? Well, with a high churn rate, even if expansion rates seem to be high — at a specific point in time — you can by no means rest assured that you’re doing well. In any case, a high churn rate is cause for alarm.
Net revenue retention: how to make the most out of it
Net revenue retention, as explained above, helps gain a clear understanding, regarding the recurring revenues for your SaaS startup, as a whole. But, the truth is, the most useful insights come from breaking it down into parameters and examining them separately.
In particular, you’ll need to focus on increased revenues coming from business expansion or upgrades and decreases caused by churn. Both of these indicators will help you take steps to improve your revenues, in the long term.
For example, accounts that get upgraded can help make powerful parts of your business that will help you grow further. It might be helpful to readapt your focus on new vertical markets; such as the ones that bring in the most revenue. This type of increase shows that customers stick to your solution and that’s why a repetitive thrusting on that part is crucial. Focusing on churn rate, on the other hand, will help find out why customers are leaving your service. How can you make them stay? What improvements do you need to make to your product? Since you’re offering a SaaS product it’s easier to re-examine customer interactions with your service; and your business, as a whole. Keep in mind that it’s much more difficult to gain a new customer than retain one that has already given you a chance to prove your value proposition.
TL;DR — Do the math and watch your steps
Net revenue retention is an essential SaaS metric that helps you keep track of your recurring revenue flows. A high net revenue retention may be a strong indicator of growth, but it may also indicate a nominal state. In any case, keeping track of how its parameters change over time, may help you take crucial steps towards a direction that will benefit your business, over time.