While figuring out whether your SaaS company optimizes its existing installed-based customers through up-sell and cross-sell, you most likely tackled the Net Revenue Retention (NRR) rate. Since expansion potential is one of the main factors in evaluating growth companies, you must have adopted NRR as one of your KPIs.
NRR’s formula is quite simple (see below):
- Start with your existing MRR. That’s your baseline.
- Add Expansion MRR, which is upselling and cross-selling within existing customers.
- Subtract Contraction MRR, which is the amount existing customers reduced their MRR.
- Subtract Churn MRR, which is MRR that you lost due to churned customers.
- Divide the sum of items 1-4 (above) by item 1 (i.e. your baseline).
- Multiply by 100 since it’s a percentage rate factor.
When NRR > 100, customers’ expansion covers their attrition, which is a good growth sign.
When NRR < 100, customers’ attrition is higher than expansion, which indicates “shrinkage” or a “red flag”.
Example:
Beginning MRR - $550K
Expansion MRR - $130K
Down-sell MRR - $65K
Churned MRR - $30K
Sounds simple, right? Yet to avoid a “garbage-in: garbage-out” (GIGO) situation which can lead you to calculate a misleading NRR and draw the wrong conclusion, here is what I advise you do (see "Polishing NRR" below):
- Choose the relevant revenue stream - once a company becomes more mature, it faces various revenue streams. It would be best if you separate those streams. Not all of them are SaaS revenues. Non-SaaS revenues, such as Services or Implementations, should be extracted from your calculation. Otherwise, it all becomes one big “fruit salad”.
- Focus on your core/primary product - your SaaS revenues could include other streams like an MVP whose pricing you tested via “trial and error”. Those are unnecessary “noises” which should be removed from your NRR calculation.
- Separate Customers per size - sometimes, Enterprise or Large customers behave entirely differently than Small or Medium (SMBs) ones (e.g. expansion trends, stickiness, upsell). You should calculate two NRRs and draw conclusions from each separately in those instances.
- Basic statistics’ rules – your NRR is meaningful only if the number of customers is large enough (at least 15-20). If that’s not the case, calculate your NRR for each customer separately (manually) on a “one-by-one” basis.
- Lagging/Leading Indicators - despite NRR’s importance in helping monitor your business, keep in mind it’s still a Lagging Indicator. That means that once you measure it and notice the writing on the wall, it’s already “water under the bridge”. It’s very challenging to bring back a customer that left.
What can you do? Leading Indicators will allow you to act proactively to improve customer retention and increase upsell trends. An example of a leading indicator is Customer Satisfaction Measurement, like Net Promoter Score (NPS).
I advise measuring your NRR at least quarterly.
