May 6, 2022

What is net revenue retention & how to calculate it

Net recurring revenue (NRR) is a key metric that SaaS founders need to understand to maximize their growth and obtain financing from companies who understand that physical assets are not the only indicator of a financially healthy company.

In the world of SaaS, there are many KPIs that are considered important to predict the health and stability of a business, and net recurring revenue (NRR), otherwise known as net dollar retention (NDR),  is one of the most important ones.

SaaS and other recurring revenue businesses can have a hard time obtaining non-dilutive funding like bank loans due to their lack of ‘traditional’ indicators of financial success. The number of alternative financing options are growing that don’t just look at things like physical assets and specifically cater to these industries.

NRR revenue is one of the key metrics that a financing company will ask for when determining if they should lend to a SaaS company, together with gross recurring revenue (GRR) among others.

If you want to identify the health of your SaaS or subscription model business, then understanding these metrics as a founder is key to understanding what types of financing might be available and on what terms.

How is NRR calculated?

The NRR SaaS calculation effectively determines not just the monthly recurring revenue (MRR) of a business but also the balance of new versus existing clients. This is an essential part of understanding a company’s health, as it identifies what revenue is being produced from new clients and what revenue comes from existing clients. The NRR formula effectively takes total business revenue into account.

Your NRR SaaS calculation requires you to know the following things:

  1. Your starting MRR 
  2. Your expansion MRR - i.e. how much you made in upsell/cross-sell or increased prices from EXISTING customers
  3. Your contraction MRR - i.e. how much you lost in downgrades
  4. Your churn MRR - i.e. how much you lost in cancellations and non-renewals

(Starting MRR + Expansion MRR - Contraction MRR - Churn MRR)/Starting MRR 

For example, imagine a SaaS company with a starting MRR of $25,000. In a given month, they bring in new upsell/cross sell income of $3,000. They also negotiate price increases of an additional $1,000. They lose $1,000 in downgrades and $2,000 in cancellations and non-renewals.

Their NRR SaaS Calculation is as follows:

((25,000 + 4,000 - 1,000 - 1,000)/25,000) x 100 = 108%

Their NRR is therefore 108%.

What is a good NRR for a SaaS company?

It’s generally accepted that, for a company to be financially sound, it should have an NRR of at least 100%. This suggests that the company is growing, and the larger the number, the faster it’s doing so. 

If your NRR revenue is less than 100%, then it would be advisable to understand what’s causing this number to be low and to work on that before approaching a financing company for funding. At the very least, you can address the problems and your plans to increase that number, and preferably you can move that number to higher than 100% before submitting an application for financing.

Many highly successful SaaS companies have had strong NRR revenues. For example, Snowflake’s most recent results include an NRR of 178%. Twilio’s NRR has remained around 140% during the period it scaled from $1B to $2B in ARR.

What is gross recurring revenue and is it as important as NRR?

Gross recurring revenue (GRR) is another important metric for SaaS companies. Unlike NRR, GRR doesn’t include any revenue earned due to price increases, cross-sells or up-sells. As a result, the GRR cannot be more than 100%, and it generally sits anywhere above 80% depending on the specific market involved. It also can’t be higher than the NRR.

GRR focuses more on customer retention on the existing subscription model. Analyzing GRR can tell you whether you have a strong value proposition. Aiming for 100% is probably not practical, as all SaaS businesses involve some level of churn, but understanding what benchmark is normal for your market, and ensuring your GRR is as close to this as possible, will ensure your health is in the best position when you approach a lender.

Why MRR alone is not used as a key metric for financial health of SaaS companies

While a high MRR shows that the company is profitable, it can mask the problem of high churn rate. If a company is able to bring in more new customers than it’s losing, then the MRR will hide the churn issue, but that doesn’t mean the business is a good bet for longer term funding.

As most founders are aware, customer acquisition cost (CAC) is often anywhere from 5 - 25 times higher than the cost of retaining an existing customer. Therefore it’s always preferable to work with existing customers, either on their existing subscription, or by offering upsells, cross-sells or price increases that increase your NRR.

How a SaaS company can improve it’s NRR revenue

Focusing on different parts of the NRR calculation will yield positive results in terms of increasing the NRR. By working with each of these parts of the formula, a SaaS company can improve their NRR, which will indicate a general increase in the company’s financial health.

Churn rate: If you can reduce your churn rate then you will improve your NRR (and your GRR). While some churn is inevitable, if this number is high, then it’s worth surveying your customers to understand why they’re considering canceling, in case there are any customer service issues or any user experience problems that’re causing them to look elsewhere. It can also be helpful to understand what alternatives they’re considering - are they looking to move to a competitor, or have they realized they don’t need a product of this type?

Downgrades: One way to reduce churn rate is to focus on downgrades as an alternative. While these have a negative impact on your NRR, they will allow you to reduce the total impact. Downgrade options can include changing your pricing model or offering more flexible pricing, reconsidering your packages, and strategizing on how and when you offer upsells and cross-sells.

Upsells/cross-sells/price increases: Anything you can do to increase these numbers will have a positive effect on your NRR. It’s worth considering what other things you can offer to your customers that relate to their current subscription, possibly allowing them to trial larger packages as their subscriptions are about to expire. Understanding how your customers use your service, their involvement with customer service, and what is the likely next step as their business grows is key to expanding your revenue to allow you, also, to grow.

Understanding your metrics to stay on top of your growth

While SaaS and recurring revenue models of business can have a hard time obtaining non-dilutive financing due to the nature of their business, there are financial lenders who understand this market, the key metrics involved, and what it takes to have a healthy, stable, and growing company.

If SaaS founders want to obtain these types of alternative financing, they need to understand their own financial health, what those metrics mean, and consider working to improve them before asking for funding. This can put your business in the best possible position to obtain products like Capchase Grow. We could plug into your financial systems to extract this data and have an optimized offer to you with precision and efficiency. 

Check out our runway calculator to see how much you could obtain with Capchase funding.