With global SaaS revenue predicted to reach 50.8 billion by 2018, it’s no surprise as to why investors and venture capitalists have been drawn to these recurring revenue businesses. However, funding from these investors is often accompanied by a number of expectations, including a pitch deck replete with healthy SaaS metrics.
While, traditionally, monthly recurring revenue and customer retention rates were often the leading metrics used to provide insight into the health of any SaaS company, venture capitalists are now driving the use of an additional metric to benchmark churn against competitors in the SaaS space. To take the number of dollars retained or recurred into consideration, net dollar retention (NDR), or dollar retention rate (DRR) have become vital metrics.
The Basics of Net Dollar Retention
To provide both investors and companies with a more comprehensive overview, net dollar retention demonstrates revenue renewal values, taking into consideration up-sells, cross-sells or other expansion revenues. Conversely, this metric is also used to track losses in revenue due to down-sells, discounts, refunds, credits, or a reduction in use by customers.
When compared to new customer monthly recurring revenue or customer retention rates (CRR), net dollar retention may differ quite drastically depending on customer behaviour. For example, a company may face a decreased customer renewal one month, but see a growth in NDR through upselling the existing customer base. Similarly, committed recurring revenue may indicate a 100% customer renewal with 0% churn. However, by taking into consideration revenue losses such as down-sells, the NDR may indicate a company is actually losing money over that period of time.
NDR is best calculated on a cohort basis, with each month or year representing a new customer cohort. For example, if a group of your customers renew their subscription, but downgrade from a $100 per month package to a $50 per month package, the revenue generated by this group of subscribers will decrease dramatically, despite customer retention remaining consistent.
To expand on this further, a company achieving a 90% CRR may have 50% of their customers’ downgrade from a $100 subscription to a $50 subscription at their renewal date. After which, half the customers remain at the original value (45%) while the other half are now only producing half of the value (22.5%), making the company’s NDR a mere 67.5%.
Why it Matters
Unlike monthly recurring revenue, which does not effectively track value erosion, NDR presents companies with the ability to track progress with respect to churn. Exemplified in the scenario above, oftentimes companies are faced with customers renewing, but losing revenue.
To identify why, savvy companies have begun looking deeper into cohort-based dollar retention and behavioural changes within their customer base. By effectively tracking net dollar retention, companies can spot issues in customer development efforts early on. Conversely, if the NDR is substantially higher for one cohort than another, companies can delve deeper into the difference between the two customer groups and replicate what they did differently with the higher cohort.
Ideally, companies should aim to achieve a net dollar retention rate over 100%, indicating month over month revenue growth from their existing customer base. Top firms such as Sequoia and Bessemer have indicated that, even with a customer churn of 5%, achieving a NDR of 110% can go a long way to compensate for subscription cancellations.
However, while net dollar retention is now on the radar for SaaS companies and venture capitalists looking to invest, it is essential to use it conjointly with traditional pitch deck metrics such as new customer MRR and CRR. By using these retention metrics hand in hand, companies can acquire a comprehensive understanding of their bottom line and construct sustainable revenue growth and success strategies.
Originally published at www.paymotion.com on September 23, 2015.