There are many interpretations of MRR, floating around the web, and we have learnt ours by trial & error.
We thought of documenting it again as a primer for understanding basics of SAAS Metrics for our customers.
Here is an attempt to make things simpler.
What is MRR?
Monthly Recurring Revenue (MRR) is the predictable recurring revenue earned from subscriptions in a particular month. It includes the recurring items in your subscriptions such as coupons, discounts, recurring add-ons, etc. One-time charges like setup fees, non-recurring add-ons, any non-recurring ad hoc charges, and the amount charged towards taxes are not included.
If you are new to building a Subscription business, you may be hearing the term MRR often associated with your financial reports. You may be wondering, doesn’t monthly revenue indicate what is necessary about the startup’s financial health?
What is so special about this term MRR? It is a fair question to ask.
The spikes & troughs of traditional revenue method hides too much information about how well the business is doing. MRR gives the true picture of health of a Subscription / SaaS Business.
Consider this simple scenario:
- Annual plan charges for Plan A is $1200.
- Monthly plan charges for $100 for Plan B.
Say, you have 1 customer on Plan A and 10 customers on Plan B. In the first month your revenue is $2,200. The next month the Plan A customer does not pay as he has pre-paid for the period. So that makes your monthly revenue $1,000 [10 * $100, only Plan-B customers would pay].
Does this mean that your revenue is going down?
On the contrary, it is stable because you are still serving the same number of customers as last month. Because the monthly revenue is not giving the true picture of a Subscription Business, MRR gives you the true health of your business.
How do you calculate MRR?
Generally speaking, here’s the simple way to calculate MRR,
Sum of all the money received from your paid subscriptions/customers.
MRR = Sum(Monthly Recurring Charge of all paying customers)
If you know your ARPU (Average Revenue Per User), you can then multiply it with the number of paying customers to find your MRR.
MRR = ARPU * Number of paid customers
Let us take a deeper look at how to calculate MRR for the above example.
As the name indicates, MRR is calculated for a monthly “duration”. Any payment other than a month’s duration needs to be normalized for a month. As in our example, a $1,200 paid annually should be normalized as $100 per month in MRR.
It is fairly simple for a plan based charge alone. But as a subscription business you tend to have a mix of one-time & recurring charges for a customer and it helps to understand what should be considered as part of MRR calculation and what should be excluded.
What is included in MRR calculation:
- All recurring plans & add-ons.
- Coupon discounts.
What is excluded in MRR:
- Setup fee.
- Non-recurring add-ons.
- Credit adjustments.
- Any non-recurring adhoc charges.
- Tax line items.
To understand this better, let us look at another example of a Customer Subscription.
Example of MRR calculation:
Consider the following subscription having a:
- Plan with price of $100 per month.
- Recurring add-on of $100 per month.
- Non-recurring add-on of $100.
- Discount coupon for $50 per month.
Invoice amount for the above subscription is: $250.
But the MRR for the Subscription is: $150.
Here is how it is calculated: (Plan price of $100) + (recurring add-on of $100) – (Discount of $50) = $150 in MRR.
The non-recurring add-on is excluded in this case, as it is not part of the recurring revenue.
Some folks tend to exclude discount from MRR calculation, which we strongly disagree with because it is not money received. So it makes sense to factor discounts and subtract that amount in MRR calculation.
MRR for your business is the aggregate of all individual Subscription MRR.
This is just for the basic understanding of what MRR is and how it is calculated. Based on MRR, you can align your business decisions and there are some details that MRR does not reveal which only a CMRR does. We will cover those in a subsequent blog.
Why MRR is important for SaaS and Subscription businesses
MRR is considered by many, including investors, to be the most important metric a subscription business can track.
Investors prefer to invest in companies where the majority of their cash flow and total revenue comes from recurring revenue. It’s scalable and has lower margins since expenses are front-loaded.
It’s a safer and more profitable investment.
Tracking your MRR is essential for subscription businesses. You’re able to keep your finger on the pulse of your subscription business — you assess the financial health of your company at a moment’s notice. Using MRR as a guide, you can identify trends.
- If your MRR is growing, your business is growing.
- If your MRR is shrinking, your business is dying.
- MRR enables you to detect important trends.
- MRR incentivizes you to ask why your business is growing (or shrinking)
- You can project revenue out into the future.
One of the more important aspects that’s related to your MRR is customer churn. If your MRR is growing, your churn rates are decreasing. If MRR rates are declining, churn is increasing. Churn is a numerical representation of the customers and revenue lost in a given period.
This is due to events such as cancellations, refunds, or downgrades.
If MRR is an essential metric for subscription businesses, accurate MRR and churn data is a must-have. The more accurate your data, the more precise your understanding of the financial health of your business.
The 6 Types of MRR
Your MRR can be broken down further into additional subcategories. These categories give you a more precise, micro-level view, giving you a detailed look at the financial performing and well-being of your company.
1. New MRR
Net new MRR is the recurring revenue that comes from new customers you’ve acquired during the month.
If, in April, you receive 250 paying customers at $50 per mo. and 100 customers paying $99 per mo. your total MRR would be $22,400 per mo.
2. Expansion MRR
This is revenue from customers who upgrade their accounts, pay a recurring fee for add-ons, or purchase new products.
If you have 50 customers who upgrade from a $50 plan to a $100 plan, your new MRR would be an additional $2,500 per mo.
3. Contraction MRR
This metric measures monthly revenue lost due to customers downgrading to lower price plans, removing recurring add-ons from their accounts, or applying discounts.
It’s a helpful way to assess how good your business is at retaining your MRR from current subscribers. This is also an indicator that shows your ability to scale your product with your customers’ needs and demands.
4. Churn MRR or Cancellation MRR
This metric measures the amount of revenue lost due to cancelled or churned subscriptions.
Suppose you lost 10 customers paying $50 per mo. your churned MRR would be $500. Your MRR will decrease by that amount from next month onward.
Churn is helpful because it shows you whether your product is still relevant to your customers’ needs (or not). If your churn rate is high or growing, it may be a signal that your product or service is a poor product/market fit or that marketing is focused on the wrong target audience.
5. Downgrade MRR
This is another driver of contraction MRR. Downgrade MRR measures the reductions in MRR from current customers that are specifically due to downgrades; this does not include customers who have churned (cancelled their subscription).
This may be an indication that customers’ needs aren’t being served properly by your product, subscription, or service.
6. Reactivation MRR
Additional MRR from customers who had previously churned or canceled.
Let’s say 5 customers spending $50 per mo. reactivate their subscription, your reactivation MRR would be $250. Reactivation MRR is a subset of expansion MRR. An accurate assessment means customers who have reactivated their subscription have spent $0 in the previous month. This does not include free trials.
These MRR types are essential because they provide you with the financial data you need to make sound decisions.
These MRR subcategories are excellent indicators to show…
- The effectiveness of your marketing campaigns
- The success (or failure) of customer onboarding campaigns
- Poor product-market fit
- No/low market need
- Your burn rate (e.g., revenue is declining or spending is out of control)
- Customer acquisition costs, which could be too high or very low
- Pricing issues (i.e., customers don’t think your product is worth the price)
- Usability issues (i.e., the product is too difficult for customers to use)
- Whether you’re targeting your ideal customers
- How receptive customers are to your message
When analyzed, each of these MRR metrics leads to deeper insights about your business.
What is a good MRR?
A recent survey found that the average growth rate across 424 SaaS companies listed was 52%. Does this mean your subscription business has to grow by 52% to have a “good” MRR?
Not at all.
There are several approaches you can take regarding your MRR.
First, identify the stage of your business so you can maximize growth and safety, ensuring your business can grow safely over time:
- Stability: Your business is cash flow dependent. Your MRR and burn rate is about equal, so you breakeven on a monthly basis. If your burn rate is $50,000, you’re spending $50,000 every month.
- Expansion: Your business has three to six months (or more) of reserves. You’ve expanded your market budget, and you’ve decreased your customer acquisition costs considerably. You’re beginning to expand into new markets.
- Growth: You have a war chest (e.g., 2 to 7 years of reserves, a substantial line of credit, or venture capital). You’re preparing for aggressive expansion; you know ideal customers, and you have the resources you need to scale rapidly.
Identifying a good MRR depends on the stage of your business.
If you’re focused on stability, a good MRR means your burn rate is in the black.
At a minimum, you’re breaking even, your burn rate is stable, and you’re slowly building up your reserves.
If you’re focused on expansion, you’re making cash flow projections for the next 12 to 15 months. You know how much cash you’ll need to expand.
If you’re preparing to grow, you have done your forecasting, and you have a substantial amount of money available. You’re ready to scale your subscription business.
How to increase your subscription business’ MRR
Is it possible to increase your MRR systematically?
Not only is it possible, but it’s also a reasonable expectation for your business.
Here are a few strategies you can use to boost MRR.
1. Create a strong value proposition
Why should your ideal customers buy from you instead of a competitor? Your value proposition is a promise; you’ll deliver a certain amount of value if customers choose to buy your product. It shows customers why you’re the clear choice for them.
Maybe you have proprietary technology, or you have brand clout. Perhaps you have the lowest prices or a monopoly in specific markets. You’ll need to explain this to the customer base in a way that makes sense to them.
Do it, and your subscription business will be able to ward off the competition.
2. Invest in online reviews
Online reviews boost conversion rates and increase conversion rates.
A recent study found businesses with more than 82 reviews earned 54% more in annual revenue than their competitors. Brands with an aggregate rating between 3.5 and 4.5 stars produce more revenue than all other ratings.
A strong review portfolio boosts conversion rates, increases revenue, and reduces customer acquisition costs. It’s easier to convince customers that you’re the best choice for them when you have customers who are willing to vouch for you.
A strong review portfolio confirms your value proposition, motivating new customers to buy.
3. Increase your prices
Raising your prices is an easy way to boost your MRR.
This is low hanging fruit for many subscription businesses because many are underpriced.
And we get it. Many subscription businesses are worried about rejection. They are afraid customers will abandon them if they raise their prices.
That’s why we recommend offering prospective customers multi-tiered pricing options — it gives your customers the ability to adjust to changes while also providing you with the MRR boost you need.
4. Upsell and upgrade
Upsells and upgrades are easy ways to increase your MRR.
You can approach this from several angles:
- Offering recurring add-ons
- Offering additional features
- Premium support (e.g., faster, 24 hours, comprehensive) for a fee
- Offering more premium plans
- Increasing prices for new customers
- Upselling customers
If your value proposition is compelling, you can use all of these strategies and tactics successfully. Customers will see the value you’re offering and make a decision for or against. If customers decide against it, you can allow them to stay on their current plan, or you can take the MRR hit and move to replace them.
Monthly recurring revenue metrics
Tracking the right metrics / kpis gives you the data you need to improve your subscription business’ MRR consistently over time.
Here are several metrics that have a direct and indirect impact on your MRR.
- Subscription Conversion Rate: The number of visitors who’ve signed up for a free or paid trial.
- Customer Acquisition Cost: The amount you spend to acquire a new customer.
- Average Revenue Per User: The amount of revenue the average customer brings in to your subscription business.
- Customer Lifetime Value: The total amount of revenue you receive, on average, from customers over the life of the relationship.
- MRR Growth Rate: A measurement of the increase or decrease in your MRR each month. Analyse both gross and net.
- MRR Churn Rate: A measurement of the decrease in churn over a month.
Each of these metrics provides you with a high degree of granularity. You’re able to identify the drivers that make a financial impact on your subscription business from month to month.
Now that you have a detailed understanding about MRR, the next step is implementing these concepts and strategies for your business. Identify your baseline, then use these metrics to set goals and objectives so you can properly calculate your progress and measure success.
Using these metrics you’ll be able to identify problem areas along the way, areas to address and changes you’ll need to make to reach your goals.
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++ Some back-story on why credits are NOT included in MRR vs. coupons are included in MRR:
An interesting question that keeps coming up in our debates is, why are discounts included but credits are not included. Credits are generally applied for prorated adjustments of past payments. Say a customer is on a $200 per month plan & decides to downgrade in the middle of the month and a credit of $100 is applied immediately. The credit in this case is based on past payment already made and this credit should not be reduced from MRR.