Annual Recurring Revenue (ARR)

• Definition: Annual Recurring Revenue (ARR) is the predictable yearly revenue generated from a company’s subscription-based services or products. It provides insights into long-term financial stability and customer loyalty, particularly for SaaS companies and other subscription models.

Examples of ARR in action

1. SaaS Company: A SaaS company with a subscription-based model charges $100 per month and has 100 customers. The ARR would be $100 x 12 months x 100 customers = $120,000.

2. Subscription Box Service: A subscription box service charges $50 per month and has 500 subscribers. The ARR would be $50 x 12 months x 500 subscribers = $300,000.

3. Membership Website: A membership website charges $20 per month and has 1,000 paying members. The ARR would be $20 x 12 months x 1,000 members = $240,000.

Why is ARR important?

1. Projected Future Growth: ARR can help forecast a company’s prospective growth, stability, and market standing. This not only attracts potential investors but also increases the chances of sustained success.

2. Financial Stability: Tracking ARR allows businesses to gauge their long-term financial stability by understanding their recurring revenue streams.

Calculating ARR

To calculate ARR, consider the following metrics:

1. Annual revenue per customer.
2. Revenue from product add-ons and upgrades.
3. Revenue lost due to downgrades.
4. Revenue lost due to customer churn.

Use the formula:

ARR = (Annual revenue from subscriptions + Annual revenue from add-ons and upgrades) - (Revenue lost through cancellations and downgrades)

Some considerations for calculating ARR:

1. Exclude one-time charges like setup fees, non-recurring add-ons, and late payment fees.
2. Define ARR within your organization for subscriptions that don't adhere to a 12-month norm.
3. Billing cycles don't affect ARR as long as the subscription extends for one year or more and you maintain consistent records.

MRR vs. ARR

Monthly Recurring Revenue (MRR) is distinct from ARR as it is measured on a monthly basis, while ARR is measured annually. To calculate MRR, use the formula:

MRR = Starting MRR + New client MRR + MRR from monthly customer upgrades - MRR lost from customer downgrades - Total monthly MRR churn

To project ARR from MRR, simply multiply MRR by 12:

ARR = MRR x 12

Relationship with Customer Retention, Churn, and Expansion

The dynamics of customer retention, churn, and expansion affect a company's ARR:

1. Customer Retention: The ability to retain customers for a set duration contributes to ARR growth.

2. Churn: Revenue lost due to customer churn decreases ARR.

3. Expansion: Additional revenue derived from existing customers beyond their initial subscription contributes to ARR growth.

3 Examples of ARR-fueled Growth

1. Retaining Valuable Customers: By using ARR, companies can identify their most valuable customers and focus on retaining them.

2. Preventing Customer Churn: ARR can help identify customers who are considering cancellation, allowing companies to take appropriate action to prevent churn.

3. Identifying Expansion Opportunities: Through tracked ARR, companies can identify potential opportunities for upselling or cross-selling to existing customers, increasing their revenue.