The health of a subscription, SaaS, PaaS, or IaaS business is measuring by having consistent revenue. To do that, businesses rely on monthly recurring revenue (MRR).
We are going to discuss what MRR is, how it works, and how it is calculated in a subscription company. There is more to growing an MRR company than just adding new customers.
But what is MRR exactly?
Monthly Recurring Revenue Definition
Monthly recurring revenue (MRR) or monthly recurring charge (MRC) is the consistent monthly amount that you can expect to have as revenue for your company. MRR and MRC are two different terms that are used to define and understand the world of recurring revenue, also known as predictable revenue.
MRR is the most important metric in a PaaS, SaaS, or IaaS business model. These can include items such as service contracts, support contracts, or maintenance contracts.
As a company grows its subscribing customers, so too will the MRR of the company grow, thereby increasing the value to the company’s investors.
Netflix, Disney +, Hulu, Spotify, Wall Street Journal, Apple App stores, and Liquid Web are all great examples of the subscription recurring revenue model."
Each of these examples are all using a subscription system to attract customers to pay a monthly price for their products and services. They use the subscription model as a way to gain long-term revenue by continuing to modify and change their offerings as a way to keep these customers.
Investors of these companies love the subscription model because there are primary finance functions that are calculated using an MRR model.
What are the Three Types of Monthly Recurring Revenue?
The three types of MRR are:
- The Lifetime Value of the Customer (CLV) - Customer Lifetime Value is a predictor of future revenue.
- Expansion MRR - Expansion MRR is defined as the ways you can increase revenue from your current customer base.
- Churn MRR - Churn MRR is defined as the amount of customers who have cancelled or downgraded their subscription.
In a subscription world, MRR is very important to understand in order to track and project future cash flow and earnings. The more subscriptions you have signed up, the more revenue you can record each month. The longer the subscription, the longer the period of revenue you will record.
If you are looking to show growth to your investors, the more subscriptions, and the higher MRR a company has, the more valuable it is.
The object of the MRR business model is to keep renewals high and avoid customer churn. Building long-term relationships with your customers, rather than one-off deals, will be more lucrative.
How to Calculate Monthly Recurring Revenue
Monthly Recurring Revenue (MRR) is calculated by taking the total amount of all annual, semi-annual, quarterly, or monthly recurring charges and dividing it by 12 months.
Monthly Recurring Revenue Formula
$12,000 annual customer is a 1,000 MRR customer = $12,000 / 12 = $1,000. You would receive $12,000 in cash on day one, and record revenue at $1,000 per month.
5 customers purchase 100 subscriptions each on top of the $1,000 above.
$100 x 5 = $500 + $1,000 = $1,500 in MRR
Annualized revenue would be 1,500 x 12 = $18,000
You would not include any one-time fees, set up charges, or any billing that would be billed in arrears. Other non-recurring charges could be items such as initiation fees or waived fees.
It is important to remember that MRR is not necessarily the amount of cash you will collect in a month, but the amount you will record as revenue in a month.
Why Is Monthly Recurring Revenue Important to Measure?
The following are reasons why a subscription business uses MRR as a target measurement:
1. Marketing Efforts Are Working
You need to understand what matters most to your customers, and you need to know how to meet those needs. You will need to learn the preferences and gain knowledge to refine your product or service offerings.
2. Sales Teams Are Working and Being Effective
Business owners need long-term relationships. The longer a customer stays, the more revenue they will bring. They are the gift that keeps on giving.
3. Determine Budgeting of Revenue
Being able to predict your revenue and match your company's expenses will give you better insight into making better decisions. You will be able to manage your routine costs, and plan for the unexpected ones. Being predictable is sometimes a great thing.
4. Positive Cash Flow
You can show a steady cash flow stream, which can help offset the company's expenses in a more consistent manner.
4 Ways to Grow MRR
If you are selling a subscription that is a product or a service, you’ll quickly be looking at ways to grow your customer base. Here are four ways to grow MRR:
Your product or service when selling PaaS, SaaS, or IaaS should be a primary focus. You need to show the value that exists by communicating to your current customers, as well as your future ones. Make sure this communication is clear and resonates with your intended audience. Inform the customers about this value, the benefits, and the impact it will have on their business.
2. Managing the Base
Increasing your pricing or offerings is very important to keep your current customers for the long-term. The longer they stay, the more money and revenue you will make and earn. Offering premium levels, extra features, upgrades, and even customizable plans are all great options to deploy. The goal is to create retention and reduce churn.
3. New Customers
Generating leads will lead to customer acquisition. It’s getting leads that is the difficult part. Knowing your target market and tailoring your messaging to this audience will help to get more leads in the door.
4. Customer First
Support is incredibly important in a SaaS business. All software sales, especially technology software customers, need helpful support. Creating a channel not only for your current customer base, but also the future ones, will be important to your MRR growth. This can be a benefit sales uses to get customers to see the value in your offerings. Customers flock to companies that show a high level of support for products, and treat their customers with respect.
How to Calculate MRR Growth
MRR Growth is calculated by subtracting Net MRR in the current period from Net MRR in the previous period, and dividing it by Net MRR from the previous period.
MRR Growth Formula
If you have 3 customers that upgrade from $100 to $200 per month, the growth would be $300 in MRR = $200 - $100 = $100 x 3 = $300
If you calculate the numbers incorrectly, you could show inaccurate growth or declines, and make poor business decisions based on that data.
Monthly Recurring Revenue is Important
Making great business decisions starts with having the right data. For businesses that rely on MRR for revenue, this is even more important than ever. With the above steps for growing your company, you will be on your way to success.
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David Gibb is the Financial Controller at Liquid Web. He has over 20 years of experience working in Finance. He is a CPA in Canada, CGMA in the United Kingdom, and a CPA in Australia.
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