Understanding your subscription business revenue
If you run a subscription business, or have any form of recurring billing, MRR (Monthly Recurring Revenue) is a critical metric to track. It’s the lifeblood of your company, and one of the key reasons we all love subscription models – the “recurring” in Monthly Recurring Revenue is quite appealing. Understanding the impact of MRR and calculating Monthly Recurring Revenue accurately and routinely provides you with a snapshot of the revenue, performance, health, and momentum of your business. It also enables you to act intelligently when you see a change in the numbers.
In this article, we’ll cover the following:
- What is monthly recurring revenue (MRR)?
- Why should you care about MRR
- How to calculate MRR
- Types of MRR
How can you improve your business’ MRR?
What is MRR?
Simply put, MRR is an acronym for Monthly Recurring Revenue and is a measure of recurring revenue realized through a contract or commitment. In more technical terms, MRR is the measure of money (as a dollar amount) paid monthly for subscription product or service. The primary purpose of MRR as a measure is to enable comparative reporting across different subscriptions. It represents predictable Gross Revenue based on active subscriptions and therefore provides valuable insight into sales and cash flow. It’s important to note that while MRR represents revenue, it’s not an expression of exact revenue numbers. MRR is not GAAP (generally accepted accounting principles) revenue, and it is not an alternative for recognized revenue. Don’t try taking MRR to your accountant, they’ll look at you funny.
Why you should care?
As a leading health indicator, calculating Monthly Recurring Revenue helps you keep your finger on the pulse of your business. In addition to the importance of tracking monthly revenue, charting MRR helps you recognize month over month trends in order to assess customer satisfaction and potentially reduce churn. Once you establish your baseline MRR, you can answer forecasting questions like how much new business you need to bring in to meet projections, and how to budget for sales and marketing to ensure you are allocating resources efficiently.
How MRR is calculated?
The Monthly Recurring Revenue (MRR) calculation incorporates all recurring debits/charges and credits/refunds/chargebacks from active subscriptions.
The following are not included in MRR calculations:
- One-time charges (e.g., straight sale for $120) one-time credits
- Usage-based billing amounts (e.g., $2 per GB usage)
How MRR is ‘normalized’ across various subscription terms?
What’s with this word “normalize?” If you’re not familiar with the term, it’s pretty simple. All you need to know is that the primary purpose of normalization of data is to permit comparative reporting across dissimilar subscriptions. If you have a subscription business, you most likely have a variety of subscription terms. Calculating MRR means normalizing across dissimilar data(i.e., subscription types). Normalizing is important to produce a consistent and trustworthy measure of subscription performance.
A few scenarios of how and why normalization is critical and how it works:
- Customer A → Subscribes to 12-month term with a $345 total contract value, so they have an MRR of $28.75 [$345 divided by 12]. That’s pretty easy to wrap your head around.
- Customer D → This customer subscribes to a $200 6-month contract, but updates & extends the contract at the same time, establishing a new end date. In this instance, you need to normalize this contract, and the math gets a bit complicated.
The table below displays the challenge with maintaining a clear sense of subscription performance and the importance of knowing your MRR–note how the terms, contract value, and contract status can vary from customer to customer. MRR normalizes the subscription contract revenue, so growth rates, churn rates and additional critical measures can be used to assess subscription business performance accurately.
Table: Various subscription scenarios
Types of MRR
On the surface, understanding MRR is pretty straightforward. (And LimeLights’ MRR Dashboard does all the heavy lifting calculating monthly recurring revenue for you). Knowing your monthly recurring revenue enables you to answer questions including: Is recurring revenue increasing or decreasing each month? How much recurring revenue can I expect every month? Am I hitting monthly recurring revenue objectives? To get these answers, you’ll want to break down MRR into buckets.
New MRR — from new customers: MRR contributed to an account in this month when the account contributed $0 last month AND had never contributed MRR in the past.
Expansion MRR — from existing customers: A positive change in an account’s contribution to MRR when compared to the previous month. Common reasons for Expansion MRR include subscription upgrade, a coupon or credit being exhausted and causing the total subscription amount being paid to increase, or an account adding a second subscription. Basically: congratulations, your customers love you!
Churn MRR — Lost revenue from canceled customers: MRR that was contributed by an account last month when the account has now contributed $0 this month. This number reflects the amount of lost MRR. Because you will not know whether an account will contribute MRR or not until the end of the month, churned MRR is calculated once the current month is complete.
Contraction MRR — Lost revenue from existing customers: A negative change in an account’s contribution to MRR when compared to the previous month. Common reasons for Contraction MRR include subscription downgrade, a refund, coupon or credit being applied to bring the subscription amount paid down, or an account removing one of their multiple subscriptions.
How to impact MRR?
Once you have a good picture of your MRR, you can start to make informed business decisions to increase MRR and reduce any MRR churn. “Negative churn” is a hot topic and a bit of a holy grail of late in the subscription startup world. It is a great goal, but you shouldn’t get too distracted by the terminology – focus instead on where you can directly impact MRR and what business decisions will have the most significant impact. Here are a few areas affected by MRR:
Up-sell or cross-sell to your existing customers
Money earned from existing subscribers directly contributes to your MRR. By encouraging customers to upgrade to a higher subscription tier or purchase additional products, you can get more value from the same number of customers. You’ve already spent time and energy cultivating these customers, and you know they like you – maybe they would be interested in additional product or services. Can’t hurt to try! Note: Depending on your business (B2B or B2C) your tactics will be different. You also may require a slightly different skill set – in the B2B universe this may mean having a Customer Success team focused on upselling. In B2C it may mean specific promotions via email. There is no one size fits all approach- spend the time to figure out what adjacent products and methods work best for your business. It’s worth it!
Invest in customer engagement and measure it
Encouraging more customer engagement can extend your customer lifetime value [CLTV] and increase your MRR. The more customers you retain for the long haul, the more revenue sources you can forecast. Are you engaging with customers on a regular basis? What is your email strategy? Do you communicate with them where they live? Social Media? Elsewhere? Do you measure engagement? You’ve spent time and energy finding customers – it’s smart business to hold them close. If customer retention is unusually low, you may need to re-examine your pricing structure or product market fit. Engagement isn’t only the purview of marketing. Are you ready focusing energy on customer success post-sale? Maybe it’s time.
Churn can be caused by a number of factors. However, before you dig too deep, a simple way to reduce churn may be right in front of you; implement a delinquent credit card dunning system. Roughly 20-40% of churn is actually because of failed credit cards. That’s simply leaving money on the table if the reason you are losing this revenue is because of a customer’s expired credit card. Be proactive and put a dunning system in place (humblebrag: LimeLight’s Account Updater feature handles this for you!).
Churn is inevitable, but don’t let customers walk before attempting to understand where you can improve. A common theory in the customer churn world is that churn is often a result of bad customer service. For this reason, it’s a good idea to set up short exit surveys to assess why your customers are leaving.
Refine your messaging
Your marketing and sales messaging needs to have an impact. On the B2C side, this can get refined in branding and campaigns. If you run a B2B business, you’ll want to check in with sales to ensure you are hitting customer pain points along the decision cycle. Test your messaging, make sure you have a rock solid understanding of your target market and are creating messaging for your various personas. If you are new to developing persona’s, here’s a simple worksheet [in progress] to help you identify ensure you are getting to the pain points of your customer and what drives them.
Increase lead generation efforts
You can increase your lead generation efforts, and therefore your recurring revenue, in a variety of ways—marketing (direct, paid acquisition, content marketing), focused sales efforts, events, partnerships. You get the idea. Expand the size of your funnel, but make sure not to go too far afield. Use your personas and pain points as a litmus test as you expand and test the boundaries of your target market!
As you can see, MRR is a very important and handy metric. We know first hand that it is one of the core metrics that your board and investors will ask you about on an ongoing basis. You’ll want to have a trustworthy number at your fingertips, that you can explain and act on insightfully. Spend the time to evaluate and analyze your recurring revenue trends over time and use these insights to adjust your strategies and tactics to increase revenue and grow your business. We believe our MRR dashboard does just that by providing a clear and accurate breakdown and trends over time.
We look forward to helping your company gain actionable insights as we continue to roll out analytics improvements over the coming months. Our team works hard building an intuitive interface and accurate metrics. We value your feedback as we continue to iterate. Let us know if there is anything else you would like to see on our analytics roadmap. And if you have any questions, please drop us a line. Don’t hesitate to reach out—we’re here to help!