For all businesses, using the correct metrics to understand financial health is key. These metrics can identify where your organization currently sits financially, and also help you predict future growth, and create strategies to enable you to achieve that growth.
While product-based companies might focus on total revenue and overheads, SaaS and tech-enabled companies usually focus on different formance indicators (KPIs). For these companies, metrics like revenue and churn are often the ones to focus on to understand the future direction of the company.
What is revenue retention?
Fundamentally, SaaS and tech-enabled companies want to understand their ability to grow their client base. Due to the typical recurring nature of revenue in SaaS businesses, profitability is fundamentally based on retaining and growing the client base.
Churn is another metric that’s frequently considered by SaaS businesses, and relates to how many clients are lost over a given period of time. Revenue retention, therefore is the opposite to revenue churn. Creating strategies that impact on one of these metrics is likely to effect the other one, too.
Revenue retention can be defined in two different ways, and each one can be used differently to help understand the financial health and potential growth of your business. These are gross retention and net retention. So what’s the difference?
What is gross retention?
It might seem obvious that gross retention, or gross revenue retention is how much of your revenue you retain over time. Effectively, this measures the amount of churn in your revenue, which SaaS and subscription businesses are constantly aware of and working to minimize.
To calculate gross retention rate, use this formula:
Gross Retention = (total revenue - revenue churn)/total revenue) x 100
This will give you a percentage gross retention rate.
For example, if your business makes revenue in a month of $100,000 and you have a revenue churn of $10,000 in that same month, then your gross retention rate will be:
((100,000 - 10,000)/100,000) x 100 = 90%
One of the key differences in gross retention vs. net retention is that with gross retention, you do not factor in any expansion revenue like upgrades or cross-selling. This metric is looking to understand exactly what a specific offer’s retention looks like.
It obviously does take into account downgrades, however, as these would be factored into revenue churn.
What is net retention?
Net revenue retention does include any revenue expansion, and so takes into account any upgrades, upsells or cross-sells. Some would argue this allows you to track the future growth of the company better as it considers customers who stay with you and enjoy your product so much that they stay with you but in other formats than the way they originally came into your organization as a customer.
To calculate net retention rate, or net revenue retention rate, use this formula:
Net Retention = (total revenue +revenue expansion - revenue churn)/total revenue) x 100
This will give you a percentage net retention rate.
For example, if your business makes revenue in a month of $100,000 and you have a revenue churn of $10,000 in that same month, and you also have revenue expansion of $20,000 in that month, then your net retention rate will be:
((100,000 + 20,000 - 10,000)/100,000) x 100 = 110%
A net revenue rate of at least 100% would be seen as a healthy rate, as it would suggest that your upsells and cross-sells and general revenue expansion was larger than your revenue churn.
Net retention vs. gross retention - what is best
Ideally, both these metrics are used by a company to understand their financial health, as they both represent different aspects of an organization’s potential growth and profitability. Which one an organization focuses more on, however, can affect the strategies they put in place as they look to maximize future growth.
Gross retention identifies the customers who are content with your offering and stick around the longest. This can be useful to understand in relation to marketing your product and looking at the success of your customer support department.
It can also be useful information for your sales team in customer acquisition when identifying your ideal customer persona.
Net retention is a better metric to understand growth potential, as it can help you assess not just your churn, but also if you are growing your customer base.
If a significant number of customers are upgrading or purchasing upsells, then this can also help you to identify when you should be marketing these offers to current customers to maximize that ladder and allow you to focus on selling to existing clients rather than just looking at new customer acquisition.
In a time of market uncertainty, understanding these metrics and your potential to nurture both new and existing customers can be essential information.
Gross vs net retention for SaaS - understanding the benchmarks
As a SaaS business, it’s important to understand metrics like net retention vs. gross retention and also to know what to benchmark against in relation to your industry, niche, or competitors. If you’re not aware of the standard benchmarks that are relevant for your company, then it’s key to identify these.
Capchase, for example, have Growth Advisors who work directly with customers to provide insights into your business health, and can help you identify the most relevant benchmarks for your specific business, and work with you to scale and support your growth.
Research suggests that for SaaS businesses in 2021, the median gross retention rate was between 88% and 90% and the median net retention rate was between 60% and 148%. Obviously that net retention rate is very wide, but this data also confirmed a median retention rate of 114$ for public SaaS companies.
When you’re creating strategies and planning for future growth, it’s important to understand where your organization sits in relation to benchmarks like these, what KPIs you’ll measure and why, and how you plan to use funding to support your growth.
SaaS businesses often experience periods of fast and intense growth and at this point it’s usually essential to bring in funding to support that growth, especially if the company had been bootstrapped to that point.
Traditionally most SaaS and tech enabled companies that don’t have a lot of assets would only have equity financing as an available option, but there are an increasing number of financial alternatives as the SaaS industry is growing in size.
Diluting ownership is not always the right move, especially if founders have worked hard to avoid equity financing up to this point, and understanding your key metrics and how they predict potential future growth can allow you to make a strong case for non-dilutive financing.
Knowing your net retention vs. gross retention rates and creating strategies for growth based on that can allow you to apply for funding like Capchase Grow or Capchase Extend, two models of financing specifically designed for SaaS and tech enabled organizations.
If you’re interested in non-dilutive funding and how much your SaaS or tech enabled company could obtain add your current metrics into Capchase’s capital calculator and we’ll send you more information.
