Are you calculating 'Net Retention' to determine the health of the subscription-based businesses you advise?
If not, you should be! (Murph)
You know me, I love everything to do with 'metrics.' That's one reason I was involved with writing and editing a textbook on Business Analysis for QuickBooks.
Well, metrics have changed over time because business has changed. Today, more businesses than ever are using 'subscription plans' as part, or all, of their revenue model.
If you work with businesses that use subscription-based businesses you really should be computing 'Net Retention' and using that metric when evaluating the financial health of their business.
Net Retention (NR), also known as Net Revenue Retention, is a key business metric related to the ability of a business to retain or expand customers.
Recently I was listening to a business present a list of their metrics, and they mentioned that their Net Customer Retention was 109%. I asked myself, "how can a business retain more than 100% of their customers?"
Well, I soon realized that the 109% figure was actually 'Net (Customer) Revenue Retention', what I'm calling for this discussion 'Net Retention.'
Net Retention calculates total revenue (including expansion revenue) less revenue churn (such as contract expirations, cancellations or downgrades).
From a Metric Formula standpoint:
So, you might be wondering why this metric is so important, especially since not long ago you probably wouldn't even have found this metric in a business analysis class or textbook.
The reason is that examining revenues in a way that directly relates to subscription-based businesses, like those providing Software-as-a-Service (SaaS), which is almost all software companies today, necessitates a look at revenues in a totally different way than typical sales.
Net retention must be a key metric for subscription based businesses.
The reason is that even small improvements in Net Retention can represent a significant increase in profitability. By working on ways to improve net retention, subscription-based business can significantly impact their company growth and financial standing.
When a subscription-based company focuses on just their gross revenues and the patterns associated with those revenues, they can miss out on how gross revenues may actually increase while net (customer) retention decreases.
Substantial changes in income stream revenues, driven by price hikes, might produce increased gross revenues while actually causing a business to lose customers.
But, Net Retention is a comprehensive metric that is more informative than Gross Revenue Retention because it measures expansion revenues and upsales as well as lost revenues resulting from customer churn.
From a Metric Formula standpoint Gross Revenue Retention is:
While NR can be greater than 100%, GRR can never be greater than 100%.
Even though, GRR may highlight issues associated with declining Monthly Recurring Revenues (MRR), NR can sometimes mask this if revenue upsales among existing customers are significant.
The value of the NR metric can be seen in these numerics:
- NR scores higher than 100% generally represent revenue growth in addition to customer retention.
- NR scores of 100% generally indicate that a subscription business is doing a good job at retaining their customers.
- NR scores of 90% or higher typically mean that a business is retaining most of its customers.
- NR scores of less than 90% may indicate that a business is still retaining a majority of its customers but is loosing revenues (likely due to declining upsales).
Not a lot of Business Analytic software applications are computing Net Retention as part of their core metrics, although applications geared toward 'Revenue Recognition' in accordance with subscription revenue reporting are likely to have this metric available.
Nevertheless, if you are providing 'trusted advisor service' to subscription-businesses, you really need to be computing this metric using a calculator, spreadsheet or good old pen and paper. It's every bit as important, if not more so, than Gross Revenue Retention.