Metrics are the keys to success in any business. One of the most significant financial metrics used to measure the health of a subscription-based business is the MRR.
What is MRR?
MRR is short for Monthly Recurring Revenue. It is a normalized metric that tells you how much you can expect to earn in a given month from paying customers. A SaaS business that uses the subscription model does not depend on one-time sales as a product-based company does. Instead, its business model depends on a steady income stream from subscribers. Customers should see enough value in the product to keep paying month after month.
In a subscription business, new customers sign up, and existing customers leave (churn out). This happens continuously. Thus, the MRR keeps changing. The month-to-month MRR trend indicates how healthy, or otherwise, the business is.
How to calculate MRR – MRR formula
The MRR calculation is quite simple. It is the product of the total number of subscribers and the Average Revenue Per Subscriber (ARPU).
Let us look at an example. Say you have 50 subscribers who have purchased a $100 monthly subscription plan.
Number of subscribers = 50
ARPU = $100
MRR = Number of subscribers X ARPU = 50 X 100 = $5000
Now, all your customers may not be on a monthly plan. You may have 80 subscribers on annual contracts paying $900/year. In this case, we would first calculate the monthly revenue by dividing the yearly revenue by 12. Then we would calculate the MRR:
Number of subscribers = 80
Annual revenue per subscriber = $900
So, monthly revenue per subscriber = ARPU = $900 / 12 = $75
MRR = Number of subscribers X ARPU = 80 X 75 = $6000
And, if you have 30 subscribers on a monthly fee of $100, and also 40 subscribers paying $600/year, then:
Total MRR = 30 X 100 + 40 X (600/12) = 3000 + (40 X 50) = 3000 + 2000 = $5000
What are the different types of MRR?
Breaking the MRR down further helps spot trends that give you actionable insights into your business. Here are some of the main areas that MRR can be broken down into:
New MRR: this is the MRR generated from brand new customers. So, if your sales team signed up 5 new customers in a given month, and they are on the $60/month plan, then the New MRR for that month = 5 X $60 = $300. When a brand-new customer signs on, the contract value is also called a booking.
Upgrade MRR: is the additional MRR generated from existing customers when they upgrade to a more expensive subscription. If you have 5 customers on a $60/month plan, and they all upgrade to the $100/month plan, then the Upgrade MRR = 5 X (100 – 60) = $200.
Reactivation MRR: is the recurring revenue earned from customers who had canceled their subscription but then resumed. This MRR refers to a churned customer who has returned. The customer acquisition cost, in this case, is less than getting a brand-new customer.
Expansion MRR: is the additional MRR generated from existing customers. Note that Upgrade MRR is one component of Expansion MRR. Other reasons for expansion could be the reactivation of a canceled customer, a customer moving from a free trial plan to a paid one, or opting for add-ons.
Note that all the components listed above – New, Upgrade, Reactivation, and Expansion - result in an MRR increase.
Churn MRR: is the monthly revenue lost from cancellations when subscribers cancel. If 5 customers paying $60/month, and 8 customers paying $90 cancel, then the Churned MRR = 5 X 60 + 8 X 90 = $1020. This gives a clearer picture of the impact on the bottom line rather than simply saying that 13 customers canceled. Because remember, in the SaaS world, all customers are not equal.
Downgrade MRR: This refers to the decrease in MRR compared to the previous month due to some subscribers downgrading (changing to a less expensive plan). If you track the Downgrade MRR, you may spot trends and take preventive action. For instance, your Downgrade MRR may spike every time you raise the price of your service. If so, you may need to do a better job of communicating the rationale behind the hike.
Contraction MRR: is the total loss in revenue because of downgrades and cancellations in a given month. (Downgrade MRR is one component of Contraction MRR.)
Observe that the Churn, Downgrade, and Contraction components cause the MRR to decrease.
Net New MRR: This is the amount by which your monthly revenue has increased (or decreased) compared to the previous month.
Net Expansion = Expansion MRR – Contraction MRR, and
Net New MRR = New MRR + Net Expansion
Why is tracking MRR important?
The MRR number is very instructive for companies. It provides monthly trends. A month is a reasonable period to assess a SaaS company’s performance. A week is too short and a year too long.
The MRR helps in financial forecasting and planning. If consistent, it is a predictable revenue source that the company can use to estimate its upcoming cash flows.
You can assess the company’s growth rate and momentum from the MRR trends. If the MRR is steadily rising, the company is doing well.
The MRR also helps you calculate the Customer Lifetime Value (CLTV) for all your clients. The CLTV helps focus your attention on the most valuable clients. You can provide them with fabulous service and make sure they stay with you. It is easier to retain and upsell existing clients than get new ones.
You can budget more confidently and plan your expenses better because you have a good idea about your income.
You can act quickly to troubleshoot problems if you see a decrease in the MRR.
How to analyze MRR
Investors love the MRR metric because it provides insights into the company’s performance and cash flow.
An analysis of the MRR components can guide the company on how to increase revenues.
Some customers, for instance, may be using your services to do well for themselves. Consider a storage service whose free-tier client has used up all the provided space. This client may be amenable to upgrading to a paid account with more storage.
Some other paying customers may hardly use your services even though they are paying for them. They may churn out, so you could consider giving them a discount or down-sell them to hold on to them.
Retention of existing customers is crucial because the cost of acquiring new ones is high. So, churn rates should be kept as low as possible. If monthly churn is on the increase, you should investigate the cause and take corrective measures.
A high Expansion MRR indicates that the business has managed to retain its clients and kept them happy.
An analysis of the MRR provides concrete indications of whether your business is growing, shrinking, or staying the same. Irrespective of whether revenue is increasing or sliding, MRR analysis will tell you why.
How to optimize MRR?
There are proven methods for increasing your MRR. These include:
- Charging more for your service. This is not as intuitive as it sounds. Most products tend to be underpriced. You should not underestimate the value that your product provides to users.
- Upselling and upgrading your existing customer base. Identify and target the subscribers who use your offering the most.
- Preventing churn or reducing the churn rate. You do this by reinforcing the value of your product.
But there is a limit to how far these measures will take you. For instance, if you keep raising the pricing plans on your services, you are likely to drive current customers away.
So, what else can you do to ensure MRR growth?
You could focus on the other side of the MRR equation – the total number of paying subscribers. If you increase the number of customers, your MRR will increase. Some strategies to do this:
Rely on word-of-mouth advertising. Include testimonials from your clients on your web page.
Keep growing your email list. Get emails in exchange for giving away valuable material like white papers or e-books. Then use an automated email funnel to convert the email leads into paying subscribers.
Consider targeted ads based on business size, revenue, and industry.
Common mistakes companies make when calculating MRR
The MRR is an important metric. However, it loses much of its meaning if incorrectly calculated. Here are some common mistakes made when computing the MRR.
Not considering non-monthly billing intervals: Not all subscribers want to pay on a monthly basis. Subscriptions with a different billing interval, like quarterly or annually, need to be normalized into a monthly amount. (See the example given earlier.)
Including non-recurring revenue: You should only club recurring income under the MRR. One-off earnings are good for cash flow but should not be added to the MRR.
Treating MRR as an accounting figure: MRR is an indicator of how the business is doing. It is representative of, but not actual, revenue. It is not an accepted accounting term (not recognized by the GAAP or IFRS), so your accountant will have no use for it.
Assuming conversions before customers sign up: You may offer your product to consumers on a trial basis. Remember, these people are not yet your customers. They will become your customers only if they convert and become paying subscribers. Don’t add their expected payments to the MRR until then.
Ignoring MRR components: We have seen there are different types of MRR. All of them should be understood, not only the top-level MRR number.
Not taking discounts into account: If you have offered a customer a concession (like 50% off for the first 6 months, or 25% off for the year), include only the discounted amount in the MRR and not the sticker price.
Annual Recurring Revenue (ARR)
The ARR is like the MRR, except it looks at the expected annual revenue. It is sometimes more relevant as it helps to even out fluctuations in the MRR caused by one-off events. This provides a more representative long-term view of the company’s performance.
MRR – the vital SaaS predictor
As we have seen, the MRR is a valuable metric that provides an accurate and real-time picture of your business’ health. It is an indicator of growth or contraction. If correctly calculated, you can use it and its components to forecast how your business will fare in the coming months.