Monthly recurring revenue is a crucial metric for subscription-based SaaS companies. Understanding it can help you grow your company and improve customer satisfaction. Those who are new to the software industry, or those who are looking for a better understanding of MRR, will find this guide to be extremely helpful.
Software as a Service (SaaS) companies are becoming increasingly commonplace. The modern business model is shifting towards a more digital and customer-centric approach, which can be seen in the rise of SaaS companies. Subscription pricing also offers many benefits for consumers who are looking to switch services at any time without penalty or expiry date.
When it comes to the long-term success of any SaaS company, it is crucial for them to understand monthly recurring revenue (MRR). MRR can be defined as the total of all future payments made by customers who are currently subscribed.
The most important metric that needs to be closely monitored at a subscription business is monthly recurring revenue (MRR). Before calculating MRR, it is critical for the company to define and accurately measure it. It’s important to get your MRR calculations right because doing so will tell you the rate at which your company is growing and keep you honest with investors.
This guide will discuss MRR in detail, including its various components such as New MRR, Net New MRR, Churn MRR, Expansion MRR, Reactivation MRR, etc. We will also talk about how to calculate the monthly recurring revenue and methods of improving it.
What Is The Monthly Recurring Revenue (MRR)?
According to Investopedia, “recurring revenue is the portion of a company’s revenue that is expected to continue in the future. Unlike one-off sales, these revenues are predictable, stable, and can be counted on to occur at regular intervals going forward with a relatively high degree of certainty.”
Monthly recurring revenue is a part of a business’s total income that is likely to continue on a monthly basis. As a form of predictable revenue, MRR is a valuable number for companies to keep track of.
MRR refers to the revenue generated from subscriptions and other customer contracts with a monthly cycle, such as Amazon Prime or Netflix. MRR does not include any one-time payments like annual fees, installation charges, and setup costs.
MMR is what drives SaaS businesses and provides insight into the overall business health. It’s like a power plant that spurs growth for these companies!
What is The Annual Recurring Revenue (ARR)?
Some companies offer annual or multi-year deals to their subscribers. As the annual version of the Monthly Recurring Revenue, the Annual Recurring Revenue (ARR) is the annualized version of MRR.
Monthly recurring revenue is a measure that subscription-based SaaS companies should use. The definition of MRR and the factors it consists of, and how to calculate this metric are essential knowledge. Improving your MRR will depend on your budgeting, customer retention, and improving your product – among other things.
The only difference between ARR and MRR is when they’re normalized within the year or month, respectively; long-term vs. short-term view. A company’s ARR provides a long-term view while MRR provides a short-term view indicating changes in business performance over time.
Why Should Businesses Track Their MRR?
Firstly, Monthly Recurring Revenue is significant because it helps your business control and plans your future growth by providing a monthly cash flow and budget forecast. In addition, MRR gives you a clear picture of how your software business is performing. And this can help your organization grow and develop.
In addition, MRR helps with customer acquisition and retention. It’s a sign of customer satisfaction that will lead customers to stay with your company in the long run and increase future MRR revenue by upselling existing products or services.
MRR is also crucial for planning purposes. Your business can track how much money they have each month (New MRR) and compare that amount against their expenses. They can see any profit margins left over after paying for overhead costs like software development, hosting fees, etc.
The importance of MRR, or the monthly recurring revenue, is that it can aid your business in areas such as tracking growth, forecasting expectations of future financial needs, motivating staff, and assisting budgeting.
How to Calculate MRR
Calculating MRR is pretty simple and straightforward. Businesses need to multiply the number of monthly subscribers by the average revenue per user (ARPU).
Number of subscribers under a monthly plan X ARPU = MRR
For example, if there are ten subscribers on a $150 monthly plan, the MRR will be 10 X $150 = $1,500.
Calculating monthly recurring revenue for an annual subscription plan involves dividing the yearly price by 12 and multiplying the result.
The Different types of MRR
The MRR establishes a correlation between customers and their accounts, highlighting their subscription behavior.
When a company experiences an increase in its MRR, it may represent profit growth or customer acquisition. However, the cause of this influx can vary as companies see different gains. Among these include an increase in new customers, plan upgrades from your existing customers or a combination of both.
A drop in monthly revenue means that customers are downgrading, canceling their subscriptions, or churning. If MRR sharply drops, this can signal an upcoming company-wide financial catastrophe.
Understanding the causes of fluctuations in monthly recurring revenue is complicated, but there are ways to identify specific factors that cause this. When you break down the MRR into more specific MRR types, each offers distinctive insights about revenue, customer behavior, and business health.
New MRR – The new MRR is the additional revenue generated from all new subscriptions. This can be determined by multiplying the total MRR for a time period and dividing it by that same period’s total number of paying customers.
Upgrade MRR – Upgrade MRR is the total revenue generated from all customers who have upgraded to a higher level of service. This can be calculated by multiplying the number of upgrades for a time period and dividing it by that same period’s total number of paying customers.
Churn MRR – Churn MRR is the amount earned in lost revenues due to customer cancellations or downgrades, which is calculated as (the churn rate multiplied by) average monthly recurring revenue per customer.
Expansion MRR – Expansion MRR is any increase in new subscribers over previous periods with no change in pricing plans, such as through an email campaign or social media advertisement. Expansion MRR is also generated through upselling, cross-selling, and add-ons. When there is positive Expansion MRR, companies know that they can retain their customers through satisfaction and loyalty. This is good news for the SaaS business bottom line as there is no Customer Acquisition Cost (CAC) involved in these sales to existing clients.
To calculate the rate of growth in expansion MRR for a month:
(Expansion MRR in the current month / Total MRR at the beginning of the month) X 100
Downgrade MRR – Downgrade MRR is the total number of subscribers that were downgraded in a given month. This can include people who switched to lower-priced plans or upgraded from one tier to another, which both reduce revenue for SaaS companies.
To calculate the rate of decline in downgrade MRR for a month:
(Downgrades at the end of the current period – Downgrades at the beginning of this period) X 100
Reactivation MRR – The Reactivation MRR is the total number of subscribers who reactivated their accounts in a given month. This can include people who forgot to cancel after the trial period or those suspended for not meeting payment obligations.
To calculate the rate of growth in Reactivation MRR for a month:
(Reactivated subscribers at the end of this period – total reactivations) X 100
Contraction MRR – This represents the amount that the business loses as a result of cancellations and downgrades. If a customer cancels their subscription, downgrades it, pauses it, uses a discount, or spots a recurring add-on, then the MRR will be affected.
The rate of growth in Contraction MRR for a month is calculated by:
(Cancellations and downgrades at the end of this period) X 100
Net New MRR – This is the new revenue that a business generates by acquiring new customers and retaining old ones. It indicates how much the company’s revenue has grown or shrunk compared to the previous month.
To calculate the Net New MRR:
Net New MRR= New MRR + Expansion MRR – Churned MRR.
If the sum of your New MRR and Expansion MRR receded to below the Churn MRR (a negative value), it means you lost more revenue than you gained. If the Net New MRR is positive, then that means you’ve gained revenue.
The Net MRR Growth Rate
Aside from the useful SaaS metrics mentioned above, businesses must also pay close attention to their Net Monthly Recurring Revenue Growth Rate as a means of determining their business growth.
A positive Net MRR Growth Rate means a business is experiencing monthly growth. On the other hand, a negative value indicates that these businesses are steadily losing revenue month after month.
To calculate your company’s net MRR growth rate: divide the sum of all your Expansion and Churn MRRs by the starting amount before you started to take into account churned customers (i.e., excluding any changes from New or Reactivated).
This number should be expressed as a percentage; if it isn’t, multiply it by 100%. The higher this figure goes up, the better business owners can feel about their prospects regarding expansion into new markets or increasing product prices because they’ll still have enough committed dollars coming through every month.
To get their Net MRR Growth Rate, SaaS companies should follow this formula:
[(Current Net MRR – Previous Net MRR) / Previous Net MRR] X 100
Say, for instance, the company’s Net MRR in October was $12,000, and its Net MRR in September was $15,000. The Net MRR Growth Rate = [($15,000-$12,000) / $12,000] X 100 = 25%
According to Redpoint Venture Capitalist, Tomasz Tunguz, an MRR growth rate of 15-20% is a pretty good target for post-Seed/pre-Series A SaaS startups to have.
MRR Calculation Mistakes to Avoid
The monthly recurring revenue is an essential financial metric, so it’s crucial to get the total figure right when calculating it. There are a few common mistakes that need to be avoided for MRR to always be reliable. Among these, we can include the following:
- One-time payments – The MRR calculation can be thrown off when a company receives one-time payments. For example, if the sales of an annual subscription were made on February 15th and March 16th but totaled $200, then those two transactions are considered as separate purchases rather than being added together for the monthly recurring revenue
- Non-recurring payments – Non-recurring payments can also throw off MRR calculations. For example, if you’ve received a one-time payment of $500 and this is your only sale for the month, then that will be recorded as an extra zero in the total revenue
- Deferred payments – Deferrals often lead to inaccurate monthly recurring revenues because it means customers are paying over several months rather than all at once. To solve this problem, calculate how much they should pay upfront instead of deferring their payment or selling them on credit
- Expired subscriptions – Expired subscriptions not being removed from MRR calculations will mean there’s more money coming through than was generated. To avoid making these mistakes, remove any expired subscriptions from the calculations.
- Free trials – Free trials typically lead to higher-than-expected MRR calculations because people are often registering multiple accounts. To avoid this, use a conversion rate (for example, .03%) as the assumed percentage of all free trials which will convert and pay.
- Multiple packages – If you have more than one package price for your product or service, then you need to make sure that these are being calculated separately to figure out overall revenue across different plans
- Renewals – Renewals can be tricky, especially if they’re paid upfront instead of on a monthly basis. To calculate them accurately, divide their ongoing charge total from the year against how many months those charges cover.
- Promotions – When customers are provided with a promotion code, this should be separated from the MRR and then subtracted from the monthly subscription price for the duration of the promotion.
How to Increase Monthly Recurring Revenue?
Knowing how to calculate the MRR is an essential first step. The next phase, however, is to understand how to increase the MRR. There are several strategies that companies can employ to increase the monthly recurring revenue.
Increased Efficiency and Better Budgeting – To increase your MRR, reduce costs and expenses. Doing this will increase revenue because it takes away from your income. In addition to that, you should discover potential pitfalls as soon as you start strategically planning, which will save you money, time, and effort.
Unbundling Features – The average customer uses a subset of the functionalities available to them in their current package. For that reason, it may make sense for you to experiment with splitting your product’s features into add-on services so customers can pick and choose. As long as core functions will not be removed and the product’s overall value will be maintained, your customers will not miss these features. And if they do need them, they will be willing to pay only for their use.
Changing the Price – Most marketers are fully aware that a product or service’s price is an excellent quality indicator. While a low price may attract more customers, a too low of a price might indicate to potential customers that there’s something wrong with the product. Saas companies need to play with their prices until they find the right balance to bring in the most total MRR without increasing customer churn.
Reconsidering the Free Plan – While free plans are excellent in raising brand awareness, they do very little in MRR. Renouncing the available free program may result in losing the free customers. Although, those who have seen the value that your product has to offer will continue on the paid plan.
Focusing on Customer Retention – For subscription-based SaaS companies, there’s another way to increase MRR that doesn’t involve a price hike. Focusing on customer retention can be done through outreach emails and upsell offers after their trial period is over. This will help retain customers who might have churned from your service or product.
Continuous Product Improvement – Continuous product improvement is another option for retaining and generating MRR. By constantly improving the service or product you are offering, your customers will feel that they’re getting a better value for their money.
Conclusion
At the end of the day, metrics are just numbers. What matters is how you use those numbers to help your business grow. A SaaS business should constantly be working to improve its MRR to grow and succeed.
Strive to keep your customers happy and optimistic about your company’s future by providing incentives for their dedication and acknowledging their purchases.
Without the proper tools to get the job done, keeping track and understanding any of these metrics would be impossible. Consero is a provider of Finance as a Service which is a robust financial solution that can help leaders make highly informed decisions to grow their organization. We are a reliable partner that can help you stay up-to-date on your company’s financial health, freeing you from the accounting process. Feel free to request a demo today!
