Day to day, my role involves speaking to SaaS founders. The question “how do I calculate my MRR?” comes up regularly. If you google “SaaS metrics” MRR (Monthly Recurring Revenue) holds a prominent position within the results.
I want to take a step back and look into whether this strong focus on MRR is justified. With such a wide range of SaaS metrics (LTV, CAC, Churn etc.), each touching on a different aspect of a business, is MRR the most important one decision-makers should be using?
Health metrics vs decision metrics
MRR tells you, at any given point in time, how much recurring revenue your business can expect to earn in a month from its existing subscribers. Regardless of which subscription billing software you use, MRR graphs more or less look like the below examples (in both cases, we’ve used snippets from our own platform to demonstrate how an MRR graph with a positive or a negative trend looks like):
MRR is an indicator of where a business stands, but it doesn’t indicate what is going on in itself. Looking at the above, you can’t tell if the trend you’re observing is due to customers churning or to customer acquisition slowing down. Or whether it’s thanks to winning lots of new business or to expanding your existing customer base.
The only thing we can learn from these graphs is that the steeper the slope the more drastic the situation. A positive trend graph indicating things are going well; a graph pointing downwards ... well, that’s something we all want to avoid.
We call metrics such as this one “health metrics” because they signal how healthy a business is overall, however they aren’t detailed enough to help you actively make any decisions off the back of them. Other such metrics are Average Revenue Per Account and Life Time Value.
Take on the other hand Retention, New MRR and Contraction. These metrics are what we call “decision metrics”, the numbers that serve as the underlying mechanics of what makes a SaaS business. They’re the metrics that give you visibility into the reason(s) of why a number such as your MRR is curving upwards or down, allowing you to focus your efforts. In short, decision metrics are those numbers that can really drive a company forward but, if ignored, the impact on a business can be grave.
A great example of using a decision metric to inform future growth strategy is Salesforce. Almost 15 years ago, during the golden era of the company, the executive team were very quickly brought back to reality as Dr. Doom highlighted the churn issue they were faced with.
Stating “churn was killing Salesforce” in this situation is not an overstatement; although the business seemed “healthy”, churn was the metric that drove the company to change the way in which it would grow moving forward.
How to use decision metrics to grow
In the case of Salesforce, building a strategy to lower churn became the focus for the company in the quarters following Dr. Doom’s presentation. Salesforce worked hard to reduce what at the time was a churn rate of 8% per month to a healthier 3% - 5% annual churn rate, which is reported on average in the industry. (In reality, most SaaS companies experience a much larger churn rate, but that’s a topic for another blog post.)
This is just one successful example of a SaaS company focusing on the metrics that matter, therefore ensuring longevity and growth (becoming a company with over $13b in revenue). But what about thousands of software businesses out there that aren’t at that scale - how can they handle the situation when things are not on the up?
Let’s take a step back and make a hypothesis that your MRR curve is stagnant, so it looks more like a flat line. Sure, things do not look bad… but they don’t look great either, do they? No unicorn came about with a flat MRR line. So what now?
Looking into what metrics MRR can be further broken into, we end up with four metrics that can prove much more valuable in the decision-making process.
New MRR → Recurring revenue generated from first-time customers
Expansion MRR → Existing customers increasing their recurring expenditure
Contraction MRR → Existing Customers reducing their recurring expenditure
Churn MRR → Existing Customers ending their subscriptions either voluntarily or involuntarily
These are four levers that can actually make or break a SaaS company and formulate Net MRR.
Below we have included a snippet from the MRR Movements graph for one of our clients demonstrating how performance on each of these metrics affects the overall MRR movement for your business:
As a company, at any given point in time, you must rally against at least one of these metrics to drive the overall health metric of MRR upwards.
Although there are many strategies you could adopt in order to improve each of these four metrics, here we are going to attempt to give you a snapshot of what your top level activity should involve.
Low New MRR → Look into ways to optimize your sales and marketing funnels. Things like Trial to Paid or Checkout conversion rates are common starting points in these cases.
Low Expansion MRR → Review your strategy around upselling and upgrading existing accounts. Are you offering the right functionalities to cater for the needs of users under different tiers? Can your subscribers seamlessly add more seats to their plan?
High Churn → Focus on optimizing your customer success and/or customer flows. Start by reviewing cancellation reasons and retention trends. Companies that don’t get customer feedback right from the start struggle to retain customers for longer periods as they don’t know where to start improving.
High Contraction → Similar to low expansion. Are you offering the correct functionality at each tier?
What we see based on the above is that each decision metric is driven by and impacted by the performance of separate teams within a software business. Tackling one or more of the above metrics will allow you to influence your MRR curve. But just relying on a health metric, like MRR, to make decisions won’t allow you to decide on next steps and trigger meaningful change.
What should I do next?
Review what data points and metrics you want to focus on then match it against your longer-term strategic goals. Identify what your headline “health metrics” are and what underlying decision metrics will help you achieve the ambitious targets you set for yourself as a company.
At Paddle this is exactly what my team focus on: Partnering with our customers and working with them to identify what metrics will move the needle, then tackling the strategies and actions required to achieve them. Check out this case study to discover how we managed to achieve this with Renderforest or get in touch today if you want to discuss ways in which we can help your business grow.