The key metric most founders and investors focus on within the Software as a Service (SaaS) vertical is MRR (Monthly Recurring Revenue). On the surface, it's a very simple metric, yet it's surprising how many start-ups fail to think about this metric in the right way. Inaccurately understanding your MRR can be costly and will be a bit of a red flag to anyone looking closely at your business.
Before diving in, we will quickly define MRR for those who are unfamiliar with the term -
Monthly Recurring Revenue (MRR) is the amount of predictable revenue that a company can expect to receive on a monthly basis.
MRR is critical to understanding the cash flow of subscription businesses, and does not include non-recurring revenue (e.g. setup costs). An example of a subscription led business model we all know is Slack or Zoom.
Most businesses pay a monthly subscription to access their software services.
Whilst the calculation for MRR might be as simple as counting the monthly revenues made in one month, the simple way to calculate it and extrapolate growth off the back of it is to take the Average Revenue per User on a monthly basis and multiply it by the number of users in the given month.
Monthly ARPU x Total # of Monthly Users = Monthly Recurring Revenue
E.g. £200 per month per user x 483 users = £96,600 in MRR.
Pretty simple right? Many people will just divide total annual revenue by 12 or include non-recurring revenue here to make the numbers look better. Be sure not to do this as you're only kidding yourself.
Once you know your MRR, you will most likely be keen to understand your Net MRR Growth.
Investors track successful SaaS companies MRR for two primary reasons:
In the Software as a Service (SaaS) business model, you’re able to make accurate financial projections because of the predictable nature of subscription revenue. As you gain subsequent months of consistent revenue data, you are able to model estimates of where you’ll be and then can plan your business accordingly.
If you’re on the investor-backed track, the growth in your MRR on a month-over-month time period is absolutely critical. MRR is a key indicator of the growth of a SaaS business and the month over month growth percentages will clearly indicate whether you're on route to hypergrowth or still a long way away.
The table below, credit to SaaS Capital, offers some benchmarks for SaaS businesses within certain Annual Revenue:
It's worth bearing in mind that MRR in the very early days is a bit of a false indicator of growth. As you win early contracts and clients your MoM growth will look extremely strong, but this growth is (most likely) unsustainable over the long run. As per the table above, as ARR increases, growth rates slow across the board.
Investors track other metrics alongside MRR to paint the full picture of success and growth for a company.
Churn Rate: Also known as the rate of attrition or customer churn, is the rate or number of customers that stop doing business with your company. It is most commonly expressed as the percentage of service subscribers who discontinue their subscriptions within a given time period. This metric is important for investors to evaluate the stickiness of the product.
CAC: Customer Acquisition Cost is the cost of winning a customer to purchase a product/service. This is usually quite hard to calculate as you need to take averages and understand it over a reasonably long period of time.
LTV/CAC: The Customer Lifetime Value to Customer Acquisition Cost (LTV:CAC) ratio measures the relationship between the lifetime value of a customer and the cost of acquiring that customer. The metric is computed by dividing LTV by CAC. It is a signal of customer profitability, and of sales and marketing efficiency.
These metrics are important to investors when considering how strong the potential MRR growth will be in the future.
If you're business follows a recurring revenue model, then calculating metrics such as MRR and ARR will assist you in understanding the health of the business and enable you to set future goals on revenue and growth. Leading with MRR as the main metric to predict success has its benefits.
After finding the initial product-market fit through user testing and activity, you can measure MRR as the main compass metric to track growth within a SaaS organisation. This is because MRR is the purest measure of your revenue in a SaaS business, indicating how your revenue is building or waning over time.
MRR will also help build a better product, by being incentivised to prevent MRR churn, this will improve product over time.
Put simply, it is the month over month increase in MRR. Each month you will inevitably lose and gain new customers, and this metric will examine the overall net growth.
(£) Existing MRR + (£) new business + (£) reactivation + (£) expansion - (£) churn - (£) contraction = (£) Net MRR
E.g. (£20,000) Existing MMR + (£2,000) New Business + (£200) Reactivation + (£500) Expansion - (£1,000) Churn - (£200) Contraction = £21,500 Net MRR
To calculate the Net MRR Growth, you will need at least two adjacent months of data. If the above example equates to the March Net MRR being £21,500 and for this example February Net MRR is £12,000.
(£) Net MRR March - (£) Net MRR February / (£) Net MRR February x 100 = (%) MRR Growth Rate
(£21,500 - £12,000) / (£12,000) x 100 = 79.1%
MRR is a huge metric for subscription businesses, so you'll need to be wary of some common mistakes when calculating it.