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The subscription-based business model is increasingly transforming how companies operate. Subscription businesses have grown 5-8 times faster than the traditional ones, and the model is progressively redefining the relationships between firms and their customers. According to the SEI report, in 2020, subscription businesses exhibited revenue growth of 11.6%, while product-based peers declined by 1.6%.
With consumers' preferences progressively shifting from ownership to usership the subscription economy is set to more than double by 2025, reaching a market size of 1.5 trillion dollars.
This growth will only be advantageous to companies that use the relevant metrics to boost their performances. I cover in this article some of the most important metrics subscription businesses should keep an eye on.
What are subscription metrics?
Subscription businesses typically use metrics to track their progress toward growth targets. These metrics help companies answer questions such as: Are we heading in the right direction? are we meeting our targets? should we focus on marketing or product development? Let's explore some of these metrics, what they mean, why they are important and how to use them.
Monthly Recurring Revenue (MRR)
Monthly recurring revenue (MRR) is a billing metric that shows how much revenue a business expects from subscription customers every month. MRR is the lifeblood of subscription businesses. It is quite simple to calculate MRR: Multiply the number of active customers by their average monthly subscription charges. For example, if you have 100 customers paying an average fee of $99 per month, your MRR would be $9900.
As a rule of thumb, if your business generates a high MRR with a positive cash flow, it will continue to grow. But if your MRR isn't enough to maintain the business on track, things might start to slow down. MRR data can be tweaked in many ways to get a deeper insight into your business. For instance, you can keep track of new monthly recurring revenue to determine how many new subscribers join every month or forecast your annual recurring revenue.
Annual Recurring Revenue (ARR)
Similar to MRR, annual recurring revenue (ARR) gives you a bigger picture of how much income you can expect from your subscription business throughout the entire year.
To calculate it, multiply your base monthly rate by the number of customers and by 12. For instance, if you have 100 subscribers paying an average fee of $99 every month for the next 12 months, then your ARR would be 100 x $99 x 12, which is $118,800 ARR.
Why would you calculate both ARR and MRR? MRR provides a close to real-time insights into growth performance, while ARR gives you a bigger picture required for yearly reporting and forecasting.
Most investors prefer ARR over MRR since it provides clear projections for long-term growth. Tracking an increase in ARR can help you predict your future cash flow and give you a ballpark figure on how much profit to expect. Knowing what type of growth to expect from your business is essential to strategising and making the necessary changes to meet your monthly, quarterly or yearly objectives.
Average Revenue Per User (ARPU)
When you provide different subscription tiers, such as basic, pro and premium, the average revenue per user (ARPU) gives a clear picture of how much the business generates on average per subscriber within a specific period. The goal here is to increase the average revenue per user by converting basic subscribers to premium ones by nudging them to upgrades.
For example, suppose you have most of your subscribers registered on a basic plan. In that case, you can entice them by offering more features at an affordable price on a premium plan. This will not only increase the number of premium subscribers but also generate more revenue for your business.
To calculate your ARPU, you simply divide your total revenue by the total number of users in a given period. For example, if your 100 users across your three tiers, basic($39), pro($59) and premium($99), generated $6,500 in the first quarter of 2022, then your ARPU is $65. Furthermore, because this number is higher than what a typical pro subscriber pays, it also tells you that most of your users are in the upper tiers of your subscription plans.
Churn rate or customer churn is the number of customers who have cancelled or terminated their subscriptions over a given period of time. It indicates the rate at which users leave your business. What represents a good or poor churn varies across industries. Nonetheless, the main purpose of churn is to determine how fast or slow your business is losing subscribers.
For example, here is what the data from 13,000 anonymised SaaS companies and interviews from growth people showed when Lenny asked them what they consider GOOD and GREAT monthly churn:
- For B2C SaaS: Between 3% and 5% monthly churn is GOOD, and less than 2% is GREAT
- For B2B SMB + Mid-Market: Between 2.5% and 5% is GOOD, and less than 1.5% is GREAT
- For B2B Enterprise: Between 1% and 2% is GOOD, and less than 0.5% is GREAT
You can calculate customer churn by dividing the number of cancelled subscriptions in a given period by the overall number of customers during that period and then multiply the result by 100 to get it in percentages.
For example, if you notice 10 out of 200 customers churn or cancel their subscriptions in the first quarter, your customer churn will be 5%. Although churn can't be avoided, it would be good to investigate why customers are leaving if the churn rate reaches certain percentages below your industry standards.
Customer Acquisition Cost (CAC)
It doesn't matter how many customers you have gained if it costs you more than what you are making. It is always important to ensure that you are not spending more than what you are bringing in. Customer acquisition cost (CAC) is one metric that often overlaps with other business metrics.
It is important to track your customer acquisition cost because it helps you understand the sales and marketing efforts that are generating more revenue and to let go of the ones not worth pursuing. For example, the numbers may reveal that email marketing is generating more income compared to Facebook Ads which gives you information on how to plan your future campaigns.
CAC is calculated by dividing the amount of money you are spending on acquisition activities (advertising, marketing, sales personnel, influencers etc...) within a given period of time by the total number of new subscribers acquired from every activity within the same period.
For example, if you spent $5,000 on marketing and advertising and brought in 2000 new customers, then your CAC will be $2.5. This number is not quite useful on its own and needs to be combined with other metrics such as your customer lifetime value(CLV).
Customer Lifetime Value (CLV)
Customer lifetime value (CLV) ranks among the top metrics for subscription businesses. It's a metric used to determine the amount of revenue an individual customer is likely to bring over their whole relationship with your business. Calculating CLV can vary across sectors because of the many variables such as profit margin, average gross margin per customer, or rate of customer retention used to determine the real ''value" of a customer. However, in a much simpler way, your customer lifetime value can be computed by taking your annual ARPU and multiplying it with the projected customer life span and then subtracting the CAC from that figure.
The objective is to ensure that the customer lifetime value is considerably higher compared to your CAC. You can use this calculation to refine your sale and marketing strategies and drive long-term profitability. You can also use it to foster relations with existing customers to increase their loyalty to your business.
Let's take an example to illustrate the relationship between CLV and CAC.
- Suppose your CAC is $20 per customer.
- And that the average customer stays with your business for 5 years.
- Your annual ARPU is $600; thus, the average amount spent by each customer over their lifetime is $600 x 5 = $3,000
In this case the CLV would be $3,000 - $20 = $2,080. This means if you acquire 1000 customers in a year, your CAC would be $20,000; however, as each customer will bring $2,080 throughout their lifetime, this cost is offset by nearly 104 folds, which is quite an impressive ROI.
Knowing and tracking your CLV can help you decide whether or not to raise prices on certain products and services, adjust your marketing expenses, or create new products within the same niche to increase overall revenue and lower churn.
Retention rate is another important subscription business metric. It is basically the opposite of churn rate as it refers to the number of customers that have chosen to renew their subscription. Just like customer churn, you can calculate retention rate as the number of customers or the amount of revenue retained or renewed.
As a business owner, you will want to have a higher retention rate and a lower churn rate. You wouldn't want to incur extra expenses acquiring more customers to replace those that have churned. This is not optimal because it may cost you 5 times more to acquire a new customer than to retain an existing one.
A high customer retention rate could mean that users are satisfied with your product or service and will continue to buy from your business. It can also be a way of determining whether any changes you have made to your service or product improved overall satisfaction. Similarly, there is another metric called cohort retention which looks further into the issue of customer retention by helping you understand the percentage of new users that are still active after X days/weeks/months later.
To calculate your retention rate, you ideally need 3 pieces of information: the number of existing customers at the start of the period, the number of total customers at the end of the period, and the number of new customers acquired within the period. With this information, you can compute your retention rate by simply subtracting the newly acquired customers from the number of customers at the end of the period and dividing the whole number by the number of customers a the beginning of the period.
Consider the following number of customers:
- at the start of the period = 1000
- at the end of the period = 1500
- new customers added within the period = 700
Your retention rate will be (1500 - 700)/1000 = 0.8, which is 80%.
Measuring how many users stay with your business is essential for growth and can tell you how effective your strategies are at keeping users happy.
Trial Conversion Rate
The trial conversion rate measures how well your business can convince potential subscribers. The trial conversion rate is almost similar for subscription-based businesses and for traditional businesses that depend on one-off sales. By measuring and tracking the number of prospective buyers who may switch from a lead to a paying customer within a given period, the trial conversion rate shows how effective your target audience is moving through the sales funnel.
In subscription-based businesses, the conversion rate is often related to the number of customers that transition from a free version or free trial to a paid subscription. This metric is vital when it comes to monitoring the health of your business, accurate evaluation of the pipeline, and projection of future growth. This data is especially useful when used alongside a user feedback survey that helps you learn more about your customers in terms of what they like and dislike about the service or product.
Growth Efficiency Index(GEI)
One of the most challenging things you can face as a business owner is how to allocate resources. Growth efficiency is often referred to as the "magic number" since it can tell how much revenue can be made from different marketing strategies used in the business. Most businesses like using growth efficiency metrics to assess their performances.
Essentially, GEI looks at how much it costs to earn $1 on your net ARR. When developing your growth strategies, it can help you determine how much you need to spend to achieve a certain number in new ARR. To determine GEI, you divide your sales and marketing expense by your net new ARR. Revenue acquisition with a GEI value under 1.0 is optimal, whereas, for any value over 1.0, revenue acquisition is suboptimal.
Lead Velocity Rate
Lead velocity rate (LVR) is a real-time metric used to determine whether your business is doing the right job in growing the pipeline. In predicting future revenue, LVR is often considered one of the most reliable metrics. In contrast, metrics such as net sales or operating cash flow are affected by the time of year and the quality of a company's management team.
You can calculate LVR by subtracting the number of qualified leads in the current month from those in the preceding month. More formulaically: LVR = (Number of qualified leads in the current month – Number of qualified leads last month) ÷ Number of qualified leads last month x 100.
This metric can help you understand the types of channels you should be using for your marketing efforts, and the higher the rate, the better. For example, if you use PPC campaigns and the number of leads you get is not high enough compared to other channels, it could be worthwhile to experiment with different channels. Although an increase in qualified leads can be deemed a positive signal, it doesn’t speak to how many actual sales or revenue are produced from these leads.
Operating a subscription business is not a walk in the park. There are tons of decisions to be made almost every day that require factual data to help your business realise sustainable growth.
Fortunately, there are many subscription business metrics that can help you measure performance. But the fact is that these metrics can sometimes make it difficult to decide which one to use for your business. It is essential to take time and select a metric in line with your business model to avoid confusion.Follow on LinkedIn
Singh, Ram & Bhagat, Avinash & Kumar, Navdeep. (2012). Generalization of Software Metrics on Software as a Service (SaaS). Proceedings: Turing 100 - International Conference on Computing Sciences, ICCS 2012. 267-270. 10.1109/ICCS.2012.37.
Bernazzani, S. (2022). 15 Metrics Every SaaS Company Should Care About https://blog.hubspot.com/service/saas-metrics
Mersch, E. (2020). SaaS Glossary | SaaS Terminology, Metrics, Key Ratios, Benchmarks | FLG. https://flgpartners.com/saas-glossary-metrics-benchmarks-ratios/
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