April 2, 2021

Metric Deep Dive: ARR and MRR

What is Annual Recurring Revenue (ARR)?

Definition:

The recurring amount of money a customer has agreed to spend with your subscription business for a one-year period.

What is Monthly Recurring Revenue (MRR)?

Definition:

The recurring amount of money your company expects on a monthly basis.

Why are MRR and ARR important?

ARR and MRR are forms of recurring revenue measured in different time frames. Since SaaS companies rely on a subscription-based business model, ARR and MRR offer a predictable revenue model that can guide you in making business decisions for the future.

Not only will you be able to make operational decisions for your company based on the revenue you expect to make, but you will also be able to evaluate your product and the overall efficiency of your team.

Tracking MRR and ARR trends will lead you to insights about the efficiency of your sales and marketing, customer success, and research and development departments. For more, check out how recurring revenue affects the different segments of your business.

How to Calculate ARR and MRR?

ARR and MRR differ based on the duration of their contracts (yearly vs monthly respectively). However, both ARR and MRR share the same individual components that make them up: new business, expansion, contraction, and churned recurring revenue.

ARR

Formula: Beginning ARR + New Business ARR + Expansion ARR - Contraction ARR - Churned ARR = Total ARR for that year

Example: Company A begins the year with $200,000 (Beginning ARR = $200,000). They are able to on board 20 new customers each with an annual contract of $5,000 (New Business ARR = [20 x $5,000] = $100,000). Their customer success team made $50,000 worth of upgrades (Expansion ARR = $50,000). However, 3 customers downgraded their packages and lost a total of $5,000 from these 3 downgrades (Contraction ARR = $5,000). Unfortunately, 8 customers churned that had $5,000 contracts each (Churn ARR = [8 x $5,000] = $40,000). At the end of the year, company A has ARR = $200,000 + $100,000 + $50,000 - $5,000 - $40,000) = $305,000.

MRR

Formula: Beginning MRR + New Business MRR + Expansion MRR - Contraction MRR - Churn MRR = Total MRR for that month

Example: Company B begins the month with an MRR of $20,000 (Beginning MRR = $20,000). They get 2 new customers for $2,000 each (New Business MRR = $4,000) and are able to secure 2 product upgrades totaling $1,000 (Expansion MRR = $1,000). However, 1 customer decides to downgrade their product by $500 (Contraction MRR = $500) and 1 other customer decides to churn losing $2,000 from that contract (Churn MRR = $2,000). At the end of the month, company B has MRR = ($20,000 + $4,000 + $1,000 - $500 - $2,000) = $22,500.

ARR and MRR Benchmarks

You always want ARR and MRR to be as high as possible, but keep in mind that revenue benchmarks will differ based on your company’s product, size, level of maturity, and market. Make sure to compare yourself against your competitors for a better understanding on how your company is doing revenue-wise.

Also, tracking ARR or MRR from one time period to the next will be beneficial. Seeing a steady increase from one time period to the next is the goal. But if ARR or MRR do decrease, hunker down on which component of recurring revenue is bringing you down and work toward improving that for the next time frame.

How to Improve ARR and MRR

Increase Revenue

  • Raise prices to reflect the value you offer
  • Close new deals
  • Focus on expansion revenue i.e. upgrades

Reduce Churn

  • Improve new customer onboarding program
  • Have an effective customer success team
  • Maintain product efficiency

ARR vs MRR

Choosing between ARR and MRR depends on what type of contract works best for your company and product. Some products may operate better under yearly contracts while others are better suited toward a month to month contract.

Monthly contracts are convenient for users who are not yet willing to make a year long commitment to a product. Instead, customers continuously renew contracts as long as they find value in the product. If this is your company, make sure to set up self-service and automatic renewals that will be easier on your customer success team and for calculating MRR.

However, annual contracts do have some benefits over monthly ones. Annual contracts let you know how much cash you have for that year, whereas monthly contracts are only guaranteed for that one month and there is a risk a customer may not renew the following month. Your customer success team will also thank you as they do not have to chase down customers for renewals each month. Using ARR over MRR will allow you to make business decisions based on that guaranteed cash from annual contracts.

TLDR

ARR and MRR are the recurring revenue that you can expect on an annual or monthly basis. As a founder, the amount of revenue you have is a major component on how you run your business. Make sure you’re calculating it correctly and scroll back up!

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