With the distribution model of the software totally changed in the SaaS industry, there are many new concepts and metrics that have come to use. Net revenue retention is one of those that we will be discussing in this article today.
If you are into SaaS business then churn is the most common devil you must be fighting against. Customers have not committed to your business anymore. The moment they decide to quit, they can do so very easily by switching to your competitors. The lower switching cost has made it even easier for them to consider a new vendor.
No doubt, new customer acquisition is still a major need for any sustainable business, retaining existing ones is a new need specific to the SaaS industry. The concept is that instead of recovering your ROI on a SaaS business through a one-off purchase, the customers are expected to pay the recurring cost in a longer duration. This keeps the business growing in a steady and consistent manner.
Yet there are few pitfalls that businesses have to avoid in their growth journey. The choices that customers have while staying in your business have become more. So few of those choices are good for you while others are perilous to your business.
To keep your business safe from such perils you have to use the right metrics to measure your business health accurately. Based on those metrics you can take corrective measures to keep your growth graph rising.
What is Net Revenue Retention?
It is one of the widely used customer success KPIs to measure the performance of a SaaS business. It measures the overall impact on the revenue generation from your existing customers. Now, through existing customers, the following are the cases when your revenues are impacted:
- When customer churns or leaves your business.
- When customer downgrades to a lower-paying plan.
- A customer buying a new product from your company.
- A customer upgrading to a higher subscription plan.
All these above cases have a direct impact on your total revenue generation on a monthly or annual basis. When you consider all these changes along with the recurring revenues your customers are paying, you get a clear picture of the revenues that are generated from these existing customers. This metric is called net revenue retention.
What does SaaS Net Revenue Retention Indicate?
If this KPI has a value over or under 100%, it shows the health of a business through its existing customers accordingly. When it is above 100%, it means the business is healthy and is able to grow even without acquiring new customers. It also shows that the revenue generated from upgrades and cross-sells are more than the revenue lost due to churn or downgrades.
Just a slight change in net revenue retention can result in big numbers in a longer period. The reason is obviously the compounding effect over years.
Hence, this is a clear indicator of any negative impact of customers on business while also capturing their positive impact.
How to Calculate it?
To calculate net revenue retention, we need to have following 4 different values:
- Monthly recurring revenue of the last month (A)
- Revenue generated through upgrades and cross-sells (B)
- Revenue lost through downgrades (C)
- Revenue lost through churn (D)
So, the formulae for calculating net revenue retention rate is:
NRR = (A + B – C – D) / A
To put this in an example, let’s assume company A had a monthly recurring revenue of $50,000, they expanded their business through upgrades and cross-sell at $5000. Few of their customers downgraded which resulted in a loss of $2000 and another $1000 in churn.
So, NRR = (50,000 + 5000 – 2000 -1000) / 50,000 = 104%
This shows that the company is still growing after the losses incurred through churn and downgrades. This phenomenon is called net negative churn. Every SaaS business must aspire to achieve this goal. This shows that a company can still grow without acquiring any new customer.
Net Revenue Retention vs Gross Revenue Retention
Gross revenue retention (GRR) includes the recurring revenue from your existing customers including downgrades and cancellations. The only difference between GRR and NRR is that GRR doesn’t include business expansion through upgrades and cross-sells. It indicates how a company is doing in retaining revenues from its customers. It will be always less than 100% and will be equal to or less than the NRR.
GRR is one of the major metrics investors check to measure the health of a business. Low GRR shows your business is not viable over the long-term. If you are not able to retain customers over the long term that means your business has serious challenges to address.
Which is the Best?
When it comes to choosing NRR or GRR, it is best to use both for the different information they reveal about your business. NRR gives you a more realistic picture of how much growth can you expect from your existing customers. While GRR gives you the amount you could have made through your existing customers if they didn’t churn. GRR is especially helpful to measure the long-term growth of your business.
Final Take: Grow your Net Revenue Retention
It is a well-known fact that a happy customer is more likely to spend more on your business than a new customer. If you are selling your software for say $50/month, then your goal as a SaaS expert should be how can you grow that number from $50 to $100/month. You need to find ways to expand your business with the existing customer. This is the most important shift in the business model that SaaS has brought.
When it comes to business expansion through existing customers, retaining the recurring revenue, which means preventing revenue churn is of course the foremost important goal. But that’s not the end of the story.
Apart from upsell and cross-sells, you must also revise your SaaS pricing on a regular basis. But that must be supported with some rationales behind it. Inflation is no doubt the most obvious one but nothing could be more convincing to the customers than regular product updates and improvements.