Subscription businesses are hotter than ever.
Subscription is a business model that works for any industry, from software to children’s books. For business owners, recurring subscription fees mean guaranteed money in their pocket every month. Cha-ching.
But how do you grow a subscription business? Let’s discuss five subscription metrics to steer toward sustainable growth.
Subscription businesses use metrics to measure progress toward growth goals. These metrics help you answer questions like “Are our numbers where they should be? Are we headed in the right direction?”.
The challenge here is that there are many, many metrics out there. It can be tempting to track each of these metrics to discover helpful information, especially if your company is just starting out.
But when it comes to metrics, less is always more.
Instead of spending time crunching numbers and worrying about all the metrics, it’s best to track a small number that focuses on your business’s revenue growth and ability to retain customers using subscription analytics software.
Businesses can measure success by comparing how they stack up against other companies. Metrics are a straightforward way to do just that.
Subscription metrics cut through the noise of running a business and provide perspective into a company’s numbers at different growth stages. They also help forecast business demands.
It’s worth repeating that tracking a select few metrics is better than tracking a dozen. Aim to get tangible insights from your metrics.
When deciding which metrics to track, consider the following:
Monthly recurring revenue (MRR) is recurring revenue normalized into a monthly amount. It averages different pricing plans and billing periods into a singular number you can track over time.
In other words, MRR measures how much money you can expect to make every month. It’s the lifeblood of any subscription business.
“We just hit 10K in MRR!” Sound familiar?
Annual recurring revenue (ARR) is simply MRR multiplied by twelve to reflect a yearly amount. Businesses primarily use ARR for anticipating future revenue and visualizing their size.
For example, if someone says they have a $2 million business, it most likely means they’re currently earning $2 million ARR.
To calculate MRR, multiply the number of customers by your average billing amount.
MRR = Number of customers x Average revenue per customer
To calculate ARR, simply multiply your MRR by 12.
ARR = (Number of customers x Average billing amount) x 12
Besides giving you a snapshot of your predictable revenue, MRR and ARR provide critical signals about how well your subscription business is growing or not. Because MRR and ARR reflect the same numbers, they’re used interchangeably.
Subscription businesses always aim to increase their revenue. Below are three tried and tested ways for subscription businesses to increase MRR and ARR.
Charging more for your product is an underused strategy. Many subscription companies decide on prices early on and leave them as-is, often underpricing their subscriptions.
This is largely because pricing subscription products can be very challenging. Whether based on features, usage, number of users, or a combination of these, the perceived value of your product can be difficult to translate to a monthly amount.
A great way to experiment with higher prices is by running A/B tests. Here’s a quick example.
On your marketing site, increase your prices by 1.5 to 2x. Leave everything as-is. After four weeks, check if your conversion rates were impacted. You’d be surprised at how often both the conversion rate and the MRR increase in these tests.
While pricing, you might want to avoid one subscription tier with “unlimited” usage. It all comes back to the value you’re providing your customers. Why would you offer them unlimited value but limit the amount they pay you for it?
Customers who use an unlimited plan can pay a reasonable amount for it. Charge them accordingly, or run the risk of depleting resources like customer support.
Increasing revenue by retaining existing customers is remarkably less expensive than acquiring new customers. After all, these customers already use and love your product.
Revenue earned from existing customers is referred to as expansion MRR or customer expansion.
Here’s a visual explaining the differences using ice cream. Unsure how to decide between these strategies? Learn more about cross-selling and upselling.
The average revenue per user (ARPU) measures your business’ revenue from active customers. ARPU focuses on earnings on a more granular, per-user basis than MRR/ARR, which looks at your company’s incoming revenue as a big picture amount.
To calculate ARPU, divide your MRR by the number of active customers within a particular month.
ARPU = MRR / Number of active customers
“Number of active customers” include your customers on a free plan (if you offer one). By including free users, the final ARPU value can help you understand if your free plan is sustainable.
The equation is the same if you calculate ARPU with just your paying customers. Divide MRR by “active, paying customers”. This value is referred to as average revenue per paying customer (ARPPU).
ARPPU = MRR / Number of active, paying customers
ARPU provides a high-level overview of how much you earn from each customer. It helps answer the question, “Does my pricing work with my operational expenses?”
If you want to get more granular, you can compare ARPU with different plans to understand each plan’s relative popularity. A positive or negative change in ARPU tells you which part of your business is growing faster.
If your ARPU is trending upward, it indicates that your customers on more expensive plans are increasing. Likewise, if your ARPU is trending downward, your customers on cheaper plans are increasing. This isn’t necessarily bad since you’re still earning revenue, which you can monitor using an operational financial model.
Subscription businesses should always aim to increase ARPU. Here are three ways to get started.
Tiered pricing helps businesses appeal to customers with varying needs and budgets through corresponding plans. The more expensive the plan, the more value a customer gets.
Structure your pricing to draw customers to more expensive plans. After all, when customers get more features and value from a product, it’s much harder for them to cancel their subscription.
Think critically about your pricing page to draw customers to these more expensive plans. Be sure to highlight how the plan’s features benefit them and consider adding a colorful tag that says “Recommended” or “Popular” for an additional push.
UXPin’s SaaS pricing page is a great example of this. Notice how they manage to articulate:
Free and freemium plans are a surefire way to get customers to sign up for your product or service. However, they can overwhelm resources like customer support and engineering without generating any revenue when managed poorly.
If you offer a free or freemium pricing plan, make it your goal to upgrade to paid plans as many users as possible. One way to do this is by teasing the value of paid plans. CloudApp does this really well. Their free users can use all of CloudApp’s core features, but only in minimal quantities.
Imagine you’re a CloudApp free plan user, and you use the screen capture tool multiple times a day. You can only create 20 screen captures a month on the free plan. This limitation could be enough to motivate you to upgrade to the paid, individual tier.
Add-on features fill ad-hoc needs for customers on any plan, providing you with more ways to make revenue per customer.
Here’s an example from Pipedrive.
Pipedrive’s core product is a customer relationship management (CRM) tool for sales and marketing teams. They offer the below add-on features to enhance their customers’ experience and get more value.
Customer acquisition cost (CAC) is an important metric that nearly all businesses should consider. Unlike MRR/ARR and ARPU, CAC isn’t exclusive to subscription businesses.
That’s because the CAC formula doesn’t involve recurring revenue. Instead, it measures how much it generally costs you to get a customer to sign up for your product or service.
To calculate CAC, add your customer acquisition expenses and divide that value by the number of new customers within the same period.
CAC = Customer acquisition expenses / Total number of new customers
Customer acquisition expenses should include any expense made at every step of your marketing and sales funnel.
CAC is commonly used to evaluate the performance of different marketing channels. With this information, marketers can identify the channels they should be putting more effort and resources into.
CAC can also be used to determine a business’ profitability. If your CAC exceeds the amount a customer spends on your product before they cancel (in other words, their “lifetime value” more on that later!), you have a much harder time breaking even and growing your business.
The ideal ratio of LTV to CAC is around 3:1.
The lower the CAC values, the better it is for a business. If your CAC is higher than you’d like, first look at your sales funnels.
Losing customers is an inevitable part of running a business. While it hurts to see customers leave, you should track how many are leaving. This value is your customer churn rate. Expressed as a percentage, customer churn reflects the rate by which your customers cancel their subscriptions on a month-to-month basis.
To calculate customer churn, first decide on a period. Then, divide the number of customers who churned during that time by the number of customers at the start of that period. Multiply this value by 100 to get a percentage.
Customer churn = (Number of churned customers / Number of customers at the start of a period) x 100
Simply put, lost customers means lost revenue. Below are two key reasons why subscription companies should prioritize reducing customer churn.
An increasing churn rate can signal big-picture things that aren’t working right in your business. Common examples include product issues, poor customer support, and product-customer fit.
Product-customer fit refers to how well your product is suited for your customer needs. If you notice an increase in churn among a specific customer segment, you should reevaluate your marketing efforts and who you’re qualifying and bringing in.
With a consistent churn rate, you get a more accurate understanding of your earnings and answer questions like, “Is our growth consistent month after month? Why or why not?”
Although every subscription business should expect some churn, a lower churn rate means more revenue in your pocket and good customer retention.
Trying to reduce churn is like fixing a stubborn leak. No matter how hard you try to fix the leak, some water always gets through.
Fortunately, you can use a handful of proven tactics to get ahead of churn and prevent it as much as possible.
Your relationships with your customers don't end after they sign up for your product.
Regular check-ins help you proactively check in with your customers and solve their problems. And with the many SaaS tools that automate customer success emails, providing a personalized touch has never been easier (or faster!)
As part of your customer success efforts, consider establishing criteria for customers in danger of churning. To do this, monitor the previously churned customers’ activities and find patterns in their behavior.
For example, a software company’s criteria might include the following:
Tools like CRMs help monitor customer behavior. Once you identify a customer at risk of churning, get in touch and offer an incentive to bring them back to your product.
Let’s say you’ve already put customer success emails on autopilot and have criteria to intercept disengaged customers. And yet, customers still churn. Now what?
At this point, feedback is your best friend. By understanding why your customers leave, you can identify and prioritize areas for improvement.
As you prepare to collect feedback, keep in mind that the timing of when you ask matters. Aim to ask your customers within 24 hours of their cancellation. This way, they’re more likely to respond since it’s still top of mind for them.
Like customer success emails, you can also automate cancellation feedback.
After gathering enough responses, you can evaluate which reasons garner the most cancellations. Here are some example insights you could draw from trends in this data:
Customer lifetime value (CLV) or LTV is the predicted amount a customer spends on your product before churning. LTV helps you see your customers’ long-term value compared to other metrics.
The simple formula for CLV takes your average revenue per user and divides it by your customer churn rate.
CLV = ARPU / Customer churn rate
As a general rule, the higher your customer churn, the lower your lifetime value. That’s why it’s crucial to monitor both!
Subscription businesses primarily use CLV to evaluate spending and target customers.
When you know your CLV, you can calculate how much you can afford to spend to acquire new customers. Look at CLV as a ratio with customer acquisition. For subscription businesses, a ratio of CLV to CAC ratio of 3:1 is considered ideal.
If your ratio is above three, then the amount you spend acquiring new customers outpaces their lifetime value. To put it another way, you’re spending too much.
When you know CLV for all of your customers, you can identify those with the highest value. With this information, you can adapt your customer acquisition strategy to find similar companies.
It’s worth noting that when modeling CLV in statistical settings, it’s common for the CLV estimates to be off by as much as 50%.
This is because the churn metric itself is sensitive to changing populations, even though the number of customers has nothing to do with a lifetime value of an individual customer.
TLDR: CLV isn’t always 100% accurate. It’s best used as a big-picture financial health barometer: Is CLV increasing or decreasing?
Now that we’ve discussed why CLV is an important metric as well as its drawbacks, let’s talk about ways to increase CLV.
Again, CLV isn’t a perfect metric. But it can guide you to high-value customers.
One way to do this is by breaking down CLV by customer segments. For more subscription businesses, customer segments often refer to the plan type they’re paying for.
These numbers are pretty standard for a software-as-a-service (SaaS) company this size. Their lowest plans have significantly less LTV, despite having the most customers.
Generally speaking, customers on lower-priced plans tend to churn more and pay less. Customers on higher-priced plans tend to stick around longer and generate more revenue. This suggests that it’s probably smart to prioritize medium-large-sized customers in prospecting.
Once you identify customer segments with the highest CLV, you can talk to them and learn why they stayed.
Given that ARPU is part of the CLV metric, it makes sense that a higher ARPU means higher CLV.
You can track subscription metrics with spreadsheets if you’re familiar with standard spreadsheet functions. Another option is to use subscription metric tracking tools. These tools help you calculate metrics using your payment provider data and accurately track the key performance indicators (KPIs).
Running a subscription business is no easy feat. With so many decisions to make every day, you need data to guide sustainable growth.
MRR, ARR, ARPU, CAC, customer churn, and CLV are five essential metrics to include in your data toolkit. Focusing on these five metrics helps you increase scalability, retain high-value customers, reduce churn, and more.
Customer success plays an important role in getting the performance metrics right. Learn more about key customer success metrics for SaaS.
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