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Cracking the MRR Code: A Guide to Monthly Recurring Revenue

by
in
Maciej Wilczyński
Managing Partner, Founder Valueships
June 12, 2023
revenue

MRR: three letters, but way more challenges. We understand the struggle - the confusion between different types of MRR, the pitfalls in the calculation, and the constant pressure to boost this crucial metric. 

That's why we've created this guide. 

Today, we'll dissect the complexities, debunk the myths, and deliver practical, actionable strategies to enhance your MRR. We'll address the pain points you face, from dealing with churn to optimizing pricing, and provide insights that are rooted in real-world Software as a Service experience.

What is MRR?

Monthly Recurring Revenue - MRR measures the predicted income that your business will receive from recurring sources. 

It is usually calculated by multiplying the number of customers paying for a service or product times the average monthly cost per customer. Therefore, MRR helps businesses understand their revenue streams in a more predictable and sustainable manner. 

Thanks to focusing on recurring revenue sources, like those from annual contracts, the MRR growth rate provides a clearer picture of a company's financial health compared to relying solely on one-time sales or sporadic transactions.

How MRR is Calculated

MRR is a measure of the predictable and recurring revenue components of your subscription business models. It is typically calculated by multiplying the total number of paying customers by the average revenue generated per user (ARPU).

Here's a simple MRR formula:

MRR = Total Number of Paying Customers x Average Revenue Per User (ARPU)

Let's look at a few examples:

Example 1: If you have 100 customers, each paying $50 per month, your MRR would be 100 customers x $50 = $5,000.

Example 2: If you have 50 customers on a $20 per month plan, 30 customers on a $50 per month plan, and 20 customers on a $100 per month plan, your MRR would be:

(50 customers x $20) + (30 customers x $50) + (20 customers x $100) = $1,000 + $1,500 + $2,000 = $4,500.

Remember, MRR should only include recurring revenue. One-time payments, such as setup fees or non-recurring add-ons, should not be included in the MRR estimate.

Also, if you offer discounts, the discounted monthly price should be used in the MRR calculation, not the full price.

💡 MRR is a simplified metric. It doesn't account for factors like monthly churn or the time value of money. However, it's a useful tool for understanding the overall health and growth of subscription and SaaS companies.

What is the Difference Between MRR vs. ARR?

MRR takes into account any price changes and upgrades/downgrades in services throughout the given month. It can be represented as a dollar amount (for example, $100 per month) or a percentage of total revenue. 

Annual Recurring Revenue (ARR), on the other hand, is a measure of the predicted income your business will receive over a 12-month period from recurring sources. 

It is usually calculated by multiplying the number of customers paying for a service or product times the average annual cost per customer. It takes into account any price changes and upgrades/downgrades in services throughout the year. ARR is used often as well, and it can be represented as a dollar amount (for example, $1,200 per year) or a percentage of total revenue. 

Both ARR and MRR provides many insights and are important figures for businesses to measure and track, as they can be used to gauge customer loyalty, forecast revenue growth rates, and help allocate resources. They are also useful when it comes to making decisions about product development or pricing changes. 

For instance, if you’re considering changing prices for monthly fee services, it could make sense to compare the MRR of customers who have been subscribed for a certain amount of time vs. those who just signed up. 

This way, you can get an idea of how a price change might affect customer loyalty and revenue over time.

Different Types of MRR 

#1 New MRR

This is the revenue that comes from new customers. 

⏩ For example, if a software company gains 10 new customers in a month, and each customer subscribes to a $100 per month plan, the New MRR for that month would be $1,000.

#2 Expansion MRR

This is the additional revenue that comes from existing customers who upgrade their plans or purchase additional services. 

⏩ For instance, if 5 existing customers of the same software company decided to upgrade from the $100 per month plan to a $200 per month plan, the Expansion MRR indicates for that month $500.

#3 Net New MRR

This describes how much new MRR you have generated during a month as a result of new customers and new expansions, minus churn. 

⏩ Suppose a software company acquires 50 new customers per month, each paying $100 per month. They have secured $5,000.

However, during the same period, they experienced churn and lost 20 customers who were paying $80 per month. A company lost $1600, and the Net New MRR generated $3400.

#4 Reactivation MRR

This is the revenue that comes from previous customers who decide to reactivate their subscriptions. 

⏩ In this case, if 3 customers who had previously canceled their $100 per month subscriptions decide to reactivate them, the Reactivation MRR for that month would be $300.

#5 Contraction MRR

This is the lost revenue that comes from existing customers who downgrade their plans or reduce their services. 

⏩ Accordingly, if 2 customers of the software company decided to downgrade from the $200 per month plan to the $100 per month plan, the Contraction MRR for that month would be -$200.

#6 Churned MRR

This is the lost revenue that comes from customers who cancel their subscriptions altogether. 

⏩ Let’s say, 4 customers on the $100 per month plan decide to cancel their membership, the Churned MRR for that month would be -$400.

The Importance of Monthly Recurring Revenue for SaaS Business

Predictable Revenue

MRR is an important metric for Software as a Service businesses as it provides a predictable and stable stream of revenue.

Tracking MRR, businesses can forecast future revenue and make informed decisions about growth and investment.

Growth Indicator

MRR growth is a vital indicator of a SaaS business's success and scalability.

Consistent month-over-month growth in MRR demonstrates the business's success in customer acquisition, retaining existing ones, and effectively monetizing its annual or monthly subscription plan.

Valuation and Investor Confidence

MRR is one of the crucial players in the valuation of a Software as a Service company. Investors often evaluate a business based on its MRR and its potential for long-term growth.

Higher MRR figures can increase investor confidence and attract funding opportunities for expansion and development.

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Mistakes Companies Make when Calculating MRR

#1 Including One-Time Payments

Only recurring payments and recurring incomes are included in MRR.

This means that any one-time payments, such as setup fees or one-off purchases, should not be included. Including these can inflate your MRR and give a false impression of your company's financial health. 

#2 Ignoring Discounts

If a customer is given a discount, the discounted amount should be what's included in the MRR, not the full price.

Ignoring discounts can again lead to an overestimated MRR figure and can cause issues when trying to forecast future revenue accurately.

#3 Not Accounting for Churn

The loss of customers can have a significant impact on this metric as well, but it's often overlooked.

Companies need to subtract the MRR of churned customers from their total MRR to get an accurate figure. And guess what? Not doing so is a bad idea, as it can cause a lack of understanding of the true customer retention rate.

#4 Misclassifying Revenue

As mentioned earlier, there are different kinds of MRR, including new, expansion, reactivation, contraction, and churned MRR.

Each of these should be calculated and tracked separately to provide a clear picture of where revenue is coming from and where potential issues may lie.

#5 Not Regularly Updating MRR Calculations

MRR is not a static figure; it changes as customers come and go, upgrade, downgrade, or cancel their subscriptions.

Therefore, it's a mistake not to update MRR calculations regularly. Companies should aim to estimate and review their MRR at least once a month to keep track of changes and trends. 

Not doing so can lead to outdated information and missed opportunities for growth or improvement.

What is a Good MRR in the SaaS Industry?

I wouldn't categorize MRR as good or bad, but rather, it depends on the market context.
Generally speaking, an early-stage subscription company might aim for an Annual Recurring Revenue (ARR) of around $1M, which translates to a Monthly Recurring Revenue (MRR) of approximately $83k. Meanwhile, a mid-stage SaaS company might target an ARR of $5M or more, equating to an MRR of around $417k.
However, the focus should be on the point at which companies start facing growth and pricing challenges.
From our experience, this typically occurs around the $150k MRR mark. At this stage, you have a certain scale, many customers have trusted your product, and growth starts to be driven by analytics, actions, optimization, and so forth.

Maciej Wilczynski, CEO Valueships

How Can You Increase Your Monthly Recurring Revenue?

Upselling and Cross-Selling

Upselling involves encouraging existing customers to upgrade to a higher-tier plan with more features or benefits. Cross-selling, on the other hand, involves selling additional products or services to existing customers. Both strategies can significantly increase your MRR by increasing the value of each customer.

Reducing Churn

Churn is the rate at which customers cancel their subscriptions. Reducing churn is one of the most effective ways to increase MRR. It can be achieved by improving customer service, regularly updating and improving your product, and proactively reaching out to customers who appear to be at risk of churning.

Implementing a Pricing Strategy

If you don't want to downgrade MRR, you should review your pricing plans strategy to ensure it's optimized for revenue growth. It might involve increasing prices, introducing new pricing tiers, or moving to a usage-based pricing model. It's important to communicate any pricing changes clearly to your customers and to demonstrate the added value they'll receive.

Encouraging Annual Subscriptions

Offering and promoting annual subscriptions can also upgrade MRR. Customers who commit to an annual plan provide a more stable source of revenue and typically have a lower churn rate. Therefore, offering a discount for annual memberships by a subscription-based SaaS company can be an effective incentive and may keep you away from a decrease in MRR.

Expanding into New Markets

Expanding your B2C or B2B SaaS product into new markets, or industries can significantly increase your customer base and MRR also. It may involve localizing your product for different countries or tailoring it to the needs of different industries. Market research and customer feedback can provide valuable insights to guide your expansion strategy.

Make friends with MRR

Top-level MRR comes in handy in many cases. Every subscription-based business is growing thanks to understanding and effectively utilizing MRR. Using MRR, you can utilize valuable insights into a company's financial performance by highlighting the recurring nature of revenue streams. 

If you try to analyze MRR and ARR, you can gain a comprehensive understanding of their billing and revenue generation patterns.

Embracing MRR as a guiding metric will empower companies to make informed decisions, optimize their models, and foster long-term sustainability in an ever-evolving business landscape.

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What is Monthly Recurring Revenue (MRR) and How is it Calculated in a Subscription Business?

Monthly Recurring Revenue, or MRR, is the predictable revenue a subscription business earns from its monthly subscriptions. To calculate MRR, multiply the number of subscribers by the average monthly subscription fee. This metric is vital for understanding the steady cash flow and overall health of a recurring revenue model in a SaaS business.

How Does Customer Acquisition Cost (CAC) Relate to MRR in a SaaS Business?

In a SaaS business, Customer Acquisition Cost (CAC) is a key metric that needs to be balanced against MRR. It's the cost associated with acquiring a new customer. A healthy SaaS business model aims to have a higher MRR compared to CAC, as this indicates that the revenue generated from customers significantly outweighs the cost of acquiring them.

What is Net New MRR and How Does it Reflect a Company's Growth?

Net New MRR is a crucial metric in subscription-based businesses. It represents the additional revenue generated from new subscriptions, expansion MRR, minus revenue lost due to churn MRR and contraction MRR. This figure helps companies gauge their growth and customer acquisition effectiveness, reflecting both new business and changes in existing subscriptions.

How Do Subscription Cancellations and Churn MRR Affect a Company's Revenue?

Subscription cancellations lead to churn MRR, which is the monthly revenue lost when customers discontinue their subscriptions. It's a critical factor in calculating net revenue retention and can significantly impact a company's total revenue generated. Effective customer retention strategies and pricing strategies are essential to minimize churn and maintain a healthy MRR.

What Role Does Customer Lifetime Value (CLV) Play in Assessing the Success of a Recurring Revenue Model?

Customer Lifetime Value (CLV) is a key metric in assessing the long-term viability of a recurring revenue model. It estimates the total revenue a business can expect from a single customer over the duration of their relationship. A high CLV compared to CAC indicates a successful subscription business, where customers pay more over their lifetime than the cost to acquire them.

How Can SaaS Companies Use MRR to Optimize Their Pricing Strategy?

SaaS companies can use MRR as a benchmark to refine their pricing strategy. By analyzing trends in MRR, including expansion MRR and contraction MRR, companies can identify which pricing tiers or features are most lucrative. This insight allows for strategic adjustments to maximize average monthly revenue and overall subscription revenue.

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Maciej Wilczyński
Managing Partner, Founder Valueships

Expert in B2B pricing, monetization and value-based selling strategies. Over the past year, he has completed over 40 consulting projects in Europe. Prior to founding Valueships, he worked at McKinsey & Company, mainly in the TelCo, software, and banking industries. He completed his doctorate in pricing in SaaS start-ups at the University of Economics in Wrocław, where he also lectures.

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Maciej Wilczyński
Managing Partner, Founder Valueships

Expert in B2B pricing, monetization and value-based selling strategies. Over the past year, he has completed over 40 consulting projects in Europe. Prior to founding Valueships, he worked at McKinsey & Company, mainly in the TelCo, software, and banking industries. He completed his doctorate in pricing in SaaS start-ups at the University of Economics in Wrocław, where he also lectures.