August 18, 2020

Metric Deep Dive: Recurring Revenue

Updated: 5/5/2022

What is Recurring Revenue?

Recurring Revenue is the amount of predictable revenue your company expects during a period of time as a result of a SaaS or subscription business model.

Recurring revenue is the backbone of the SaaS business model because it creates a predictable revenue model that shows a company's long-term value.

You can measure your recurring revenue on a monthly, quarterly, or yearly basis. Monthly and annually are the most relevant in SaaS along with calculating the average amount of recurring revenue per customer.

Monthly Recurring Revenue (MRR)

Definition: The amount of predictable revenue your company expects on a monthly basis.

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.

Average Revenue Per Account (ARPA)

Definition: This metric tracks the average revenue (usually recurring revenue) generated from an individual account.

ARPA is a great way to monitor any fluctuations in your average revenue and customer retention.

Components of Recurring Revenue

Breaking down your recurring revenue into different segments will help you evaluate the effectiveness of each channel.

New Business Recurring Revenue: New revenue from new logos (customers) entering your business.

Example: Onboarding 3 new customers during that set time period will be considered as New Business.

Expansion Recurring Revenue: New revenue from existing customers - add-ons, up-sells cross-sells.

Example: One of your loyal customers decides to add on one of your product features meaning their price will increase and recurring revenue will increase.

Contraction Recurring Revenue: Lost revenue from existing customers (lost seats, dropped features) - but they are still a paying customer.

Example: One of your customers had to lay off employees, so fewer people in that company will be using your product. Seats are contracted lowering recurring revenue.

Churn Recurring Revenue: Lost revenue from logos leaving your business.

Example: One customer decides not to renew your service; this is a churned customer.

Once you've evaluated the segments, you can see the effect each has on your MRR.
Once you've evaluated the segments, you can see the effect each has on your MRR.

Recurring Revenue Formula

The net recurring revenue formula is a great indicator of how your new business and expansion compares to your contraction and churn recurring revenue.

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

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

ARPA Formula: Total Recurring Revenue / Number of Clients or Users

*You can use MRR or ARR for total recurring revenue

Watch Out!

  • Make sure you only use recognized revenue for that period. If you have a contract that provided an up-front payment for one year - only include 1/12 of that payment into your MRR calculation.
  • Do not include any non-recurring payments such as one-time fees, installation payments, or one-off upgrades. Stick to recurring revenue!
  • Do not include customers who are in trials. Remember, they are not recurring customers yet! Including them into your churn or new business calculations may not be the best way to measure your business.

Why is Recurring Revenue Important?

Like other SaaS metrics, recurring revenue tells a story about your business. It shows all the repeatable revenue the company is expected to generate in the future which can be used for insights on growth, forecasts, and business operations.

Having an idea about how your revenue will look months into the future will be beneficial in making business decisions in the present. The predictable revenue model can also be used for forecasting, so it’s vital to correctly calculate recurring revenue in order to get forecasts as accurate as possible.

Recurring revenue is also a great way to evaluate different segments of your business when you are using the net recurring revenue formulas. Your new business segment will be reflective of your sales and marketing team. Your churn, expansion, and contraction segments can evaluate the effectiveness of your customer success team.

Let’s be real - a company’s forecasted recurring revenue can either make or break a fundraising round. Optimizing your recurring revenue will make your company attractive to VCs and investors.

Recurring Revenue Benchmarks

You want your recurring revenue to be as high as it can be. However, comparing it to the rest of your revenue will give you perspective on how your company is doing.

The goal is to have recurring revenue make up 80% of your total revenue.

This will ensure that 80% of your revenue will be continuously generating revenue in the future and you do not have to rely on other one-time payments.

How to Improve Recurring Revenue

In a regular business model with one-time payments, increasing revenue is the main focus. The SaaS business model, however, also relies on customer retention and reducing churn rates to prolong recurring revenue.

Increasing Revenue

  • Adjust your pricing model
  • Increasing prices will increase revenue. However, too much of an increase will drive clients away - finding the perfect pricing model is key.
  • Focus on expansion revenue from your existing customer base
  • Cheaper than customer acquisition costs
  • Ditch freemium models
  • You’re giving up money and value with free plans. Start charging for these services!
  • Free trials, on the other hand, have potential in lead conversions. Keep them short and sweet.

Reducing Churn

  • Smooth onboarding of new customers
  • Effective customer success team
  • Monitor leading indicators of churn (e.g. usage) so you can try to fix problems before a customer is up for renewal
  • Focus on retention
  • Create and maintain great customer engagement/experience
  • Be product-led
  • Simple - if your customers can’t live without it, they won’t leave it

ARR or MRR?

Measuring your recurring revenue on a monthly or annual basis depends on the nuances of your SaaS business structure.

MRR - popular in SaaS

  • Good for companies with high volumes of month to month contracts
  • Forecasts on a monthly basis

ARR

  • Good for companies with annual or multi- year contracts
  • High annual contract values (ACV)

Recurring Revenue in your Company

Recurring revenue is the foundation of your SaaS business - so make sure all your employees are working toward optimizing it.

Sales Team

The sales team is, of course, responsible for converting leads into paying customers. Having an effective sales compensation plan that incentivizes sales representatives to go above and beyond quotas will definitely increase new business recurring revenue. Check out this article by SaaStr about crafting your sales compensation plan to fit your company.

Marketing Team

Marketing goes hand and hand with the sales team with generating new leads and increasing new business recurring revenue through branding and content marketing.

Another way to increase recurring revenue would be to have the marketing team evaluate which channels produce churned customers. Focusing time and money away from those channels will decrease the churn recurring revenue segment and save cash.  

Customer Success Team

The customer success team contributes the most toward customer retention and expansion.

Tomas Tunguz explains that expansion revenue carries the company in maturing startups. There are a lot of upsides to expansion revenue. Not only are you selling to your already loyal customer base, you won’t have to endure acquisition costs. Having your customer success team focus on upgrades and add-ons will fuel your company and increase expansion recurring revenue.

Your customer success team also directly impacts your churn rate. Having good customer engagements and experiences will keep your customer retention high and reduce churn. A smooth and informative onboarding process, as well as frequently checking in on your customers’ satisfaction will keep them happy and locked in.

Engineering Team

The engineering team plays a big role in customer retention as well. Creating a product that is customer centric is key for retention. Make sure to add user-friendly features and conduct UX interviews to maximize customer experience. This will retain customers and reduce churn recurring revenue.

TL;DR

Recurring revenue is what makes a SaaS business so attractive. Its repeatable, predictable revenue model allows founders to create forecasts and make business decisions. Not only is it important that you calculate recurring revenue accurately, it’s also crucial that your teams are collectively working toward maximizing recurring revenue. Eventually, recurring revenue from expansion revenue will fuel your company, so aim to have 80% of your total revenue come from recurring revenue and not just one-time payments.


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