While business is business, subscription models differ from traditional models and require their own unique metrics. Two such metrics—monthly recurring revenue (MRR) and annual recurring revenue (ARR)—are similar enough to evoke the question: Which should my SaaS business use to measure growth?
Monthly recurring revenue and annual recurring revenue: The difference is simple
Calculating MRR and ARR is easier than you think. MRR, for example, is the sum of all revenue generated by subscriptions in a month.
MRR = $ generated by one month’s subscriptions
For businesses interested in digging a little deeper, it’s also possible to measure types of MRR, such as new business, expansion, contraction, and churned. We’ve discussed how to do this in an earlier post. This level of detailed measurement is great for certain types of SaaS businesses or at particular stages of business growth. For others, ARR makes more sense.
ARR = $ generated by one year’s subscriptions
For businesses offering multi-year agreements, a customer’s ARR is determined by dividing the total cost of their agreement by the term length. For example, a four-year agreement at $20,000 means that subscription generates $5,000 in ARR, regardless of additional, non-recurring charges that occur during the contract term.
Many businesses with shorter term lengths multiply their MRR by 12 to get their ARR. While it may be common practice, be careful with this method. If your business experiences seasonal fluctuations or has just signed a lot of customers after a promotion, you may overestimate your ARR by using temporarily inflated subscription numbers. Additionally, because customers are not contracted to stick around for a year, this calculation may not accurately account for month-to-month churn.
It’s important to note both MRR and ARR are calculated only with recurring revenue generated from subscriptions. One-time charges and pricing that flexes with usage is not recurring revenue.
ARR gives a business a broader picture of financial health. It’s the forest to MRR’s trees, creating its own unique insights.
While both ARR and MRR are important metrics, which is right for your SaaS business?
Choosing ARR or MRR means considering five factors
1. Subscription length.
Whether you offer subscriptions that run for more or less than a year is one indicator of which metric may be right for your SaaS business.
“Accounting purists suggest that when you calculate ARR, it should only be done in relation to annual terms, so the minimum contract size has to be one year,” Nicholas Holmes at Nickelled explains, and many agree.
He continues by pointing out, however, that most modern SaaS businesses with shorter terms simply extrapolate ARR by multiplying MRR by 12.
2. Business model complexity.
As a SaaS business scales, it’s common to see increasingly complex subscriptions models. While calculating both MRR and ARR focuses on recurring revenue, ARR’s “bigger picture” affords an opportunity to assess other factors alongside revenue and make helpful predictions MRR can be too focused to provide. As an example, check out Stéphane Nasser’s “Roadmap to a SaaS IPO: how to unicorn your way to $100M revenue”. ARR factors into every phase of the roadmap.
3. Business size.
In case the previous points haven’t given it away, ARR is typically used by enterprise businesses. As Dave Kellogg, enterprise tech executive, wrote in his piece about the CAC Payback Period, “most enterprise SaaS companies should use annual recurring revenue (ARR), not monthly recurring revenue (MRR), because most enterprise companies are doing annual, not monthly, contracts.”
4. Investor interest.
If your business is seeking investors, it’s worth knowing they love ARR. Holmes points out it’s “a better indicator of how you’re doing than monthly recurring revenue, and it’s the most important metric almost all investors in the space will want to know when evaluating a business.”
Your valuation will be based on annual, not monthly, recurring revenue.
Lastly, and perhaps most importantly, whether you use ARR or MRR comes down to intention.
“ARR is a helpful tool to predict long term growth and visualize the size of your business,” Baremetrics explains.
Conversely, MRR is great for short-term planning, gauging the success of recent rollouts or strategies, and monitoring seasonal fluctuations.
Looking to increase your ARR or MRR?
Besides simply gaining more customers, there are a few ways to increase your recurring revenue.
- Reduce CAC. Customer acquisition cost, or CAC, can be a drain on revenue if not well-managed. Reduce CAC through your marketing with automation, funnels, improving your target audience, and leveraging existing resources such as your website, social media presence, and reviews.
- Tap into expansion. Expand your recurring revenue by tapping into your existing customers. Upsell users who are looking for a feature available in the next tier of your subscription. If the next tier up is too big a financial jump, meet them in the middle with an add-on charge for just the feature they’re looking for. Still not quite the solution? Cross-sell to another product you offer that may meet their needs.
- Increase retention. Acquisition costs five times more than retention. Before spending more on new customer acquisition, ensure your business is proactively addressing retention. Dunning management can take care of expiring credit cards or failed payments before they result in churn. Put effort into transparency and improving the customer experience, and the retention rates will have positive impacts on your recurring revenue.
The choice is yours
Ultimately, every SaaS business is unique and needs to make decisions based on that uniqueness. Some enterprise businesses charge monthly rates and likely track seasonal changes through MRR to inform decision-makers. Smaller businesses may offer annual contracts with monthly usage-based pricing, meaning ARR has its place. Both metrics are useful in their own way; which one you choose to focus on will depend on what’s right for your business.