Business models with recurring sales (so-called subscription or subscription models) have become indispensable in the digital world. Investors, both in the public and in the private markets, love subscription-based business models, such as we find in SaaS (Software-as-a-Service) models. These tend to all work in a similar way due to how subscription models utilise standardized key metrics, which means comparing performance across companies is somewhat predictable.
In this article, we look at three relevant metrics related to subscription-based business models and show the implications for cash planning.
Let’s first get an overview of the most important key metrics for subscription-based business models:
- MRR (Monthly Recurring Revenue)
- Churn (Customer churn)
- CLTV (Customer lifetime value)
Monthly recurring revenue
The Monthly Recurring Revenue, MRR for short, shows how much revenue can be generated with the current customers each month.
- One-off sales, such as an onboarding fee, are not taken into account
- Subscriptions with an annual payment interval are taken into account for the calculation of the MRR at 1/12 of the annual payment
- ARR, or Annual Recurring Revenue, is sometimes used instead of MRR. For the ARR, the MRR is multiplied by a factor of 12.
The MRR or ARR plays a very important role in financing rounds and M&A (monthly & annyal) transactions , since the so-called revenue multiple refers to this annually recurring revenue.
If customers are not satisfied with a product, they usually cancel it. In this context, one speaks of so-called ‘churn’. Monthly customer churn is calculated as follows:
Example : We start the month with 100 customers.
7 canceled their subscription, one of which was reactivated.
The monthly churn is therefore ((7-1)/100)*100% = 6%.
Why is churn so important?
Churn is the make or break for any subscription-based business model and very often receives far too little attention in the business plan. At Tresio, we struggled with churn values of well over 10% in the early days – in plain language, this means that the average customer stayed with us for less than a year! For our business, this meant: before we could think about growth and scaling, we first had to fix this problem and make the product so good that our customers would not leave us voluntarily if possible. Today the value is below 4% and we are working hard to halve it again.
Here is an impressive table, also from our friends at Chartmogul , showing the monthly churn values over the year:
How high should the churn be?
What is considered a “good” churn value ultimately depends very much on the business model, the target group and the maturity of the service offered. According to this overview by Recurly, it can generally be stated that B2C business models suffer the most from churn, while in the B2B area a distinction must be made between offers in the SME and enterprise segments.
In the SME segment, a monthly churn of less than 3% is good , in the enterprise market 1.5% (enterprise deals often have minimum terms).
Jason Lemkin recently published a great article on churn in SaaS companies whose services are aimed at SMBs (small and medium-sized businesses).
Is Churn calculated monthly or annually?
Churn can be calculated on both an annual and monthly level. There is no standard for this.
At Tresio, we prefer the monthly view, as possible problems and difficulties present themselves much more quickly – however, this value can fluctuate relatively strongly from month to month, especially during the early phase of a company with a relatively small customer base. As with all key figures, it is important that the company agrees on a reporting standard and then maintains it constantly.
What is involuntary churn?
In addition to voluntary churn (the customer has actively canceled), there is also so-called involuntary churn: involuntary churn, or passive churn – an example in this case would be the credit card debiting fails. Baremetrics goes into the topic in depth in this article.
At Tresio, we find that up to 15% of all churn is unintentional – however, it is often very difficult to win back a customer who has churned and get them to provide new credit card details, for example.
What is negative churn and why are investors so keen on it?
The above consideration is limited to customer churn , i.e. the effective number of customers that we lose. This is naturally always positive, with the exception of reactivations.
However, there is a second approach, the so-called revenue churn .
Revenue churn looks at how much of the CHF 100 monthly MRR per customer is left at the end of the period.
In addition to customers who cancel (churn) there are also those who consume more at the end of the period. This means that the average customer can be worth more than the original CHF 100 MRR at the end of the period, despite all the customers who have left in the meantime. In this case we speak of negative revenue churn or (the corresponding reciprocal value) positive net revenue retention (NRR) .
Only very few SaaS companies achieve a positive NRR of well over 100%. The US company Snowflake, listed on the NASDAQ , has managed to push the NRR down to an almost magical 180% . That means: even without a single new customer, Snowflake would still have grown by 80% year-on-year in 2021 – a value that is unique in the software industry!
Customer Lifetime Value
The customer lifetime value, CLTV for short (sometimes also LTV or CLV), indicates how much revenue a customer brings us as long as he is a customer. The calculation is very simple:
Average Revenue per Customer* / Monthly Churn.
Example : if a customer brings us CHF 100 per month and we have a monthly churn of 5%, the customer value (CLTV) is CHF 2’000 (CHF 100 / 5%).
*To make things even more confusing and because we didn’t have enough acronyms yet, the correct term for LTV is ARPA, Average Revenue per Account. But it is ultimately the same as MRR / number of customers.
This formula beautifully summarizes what are the key drivers behind not only customer lifetime value and, ultimately, the underlying business model behind any subscription-based company:
- the monthly revenue (MRR) per customer, which in turn shows the added value that we can generate for the customer with our product, as well as
- the churn, which in turn shows how loyal the customer is or how good or “sticky” our product is in the end.
The CLTV is very relevant in determining how high the maximum acquisition costs per new customer (CAC, Customer Acquisition Cost ) may be.
Consideration of the MRR in cash flow planning
Firstly, the most important takeaway here:
MRR ≠ cash flow!
The MRR says NOTHING about the cash flow of a company and is therefore UNUSEABLE for liquidity planning!
Below is a screenshot of a desperate founder’s question, which sparked a lively discussion in one of the largest SaaS Facebook groups:
The “beauty” of the MRR in reporting lies in the simple comparability and standardization. For liquidity planning, however, this means that the value has no significance for the expected monthly cash flows.
Let’s take an extreme example (which actually applies to one of our customers): a Swiss cloud provider issues all customer invoices for CHF 1,200,000 at the beginning of the year and then receives this money in February (30 days payment target). He then has to manage with this money throughout the year.
His base scenario for three years in Tresio with monthly costs of CHF 95,000 looks like this:
If he wrongly based his liquidity planning on the “smoothed” MRR (CHF 100,000, calculation: 1.2m/12), his three-year chart (with otherwise exactly the same cost structure!) would look like this:
This is an extreme example, but it illustrates the importance of the time component in sales planning.
What we often see, and what was a major challenge in our own cash flow planning at Tresio, for example, is the correct consideration of the annual and quarterly subscription revenues in the corresponding months, and the subscriptions that have already been canceled (churn!) as real as possible. Its important to calculate the time in.
This was reason enough for us to build Tresio subscription planning :
Daily revenue planning for subscription-based business models
Subscriptions can be entered directly in Tresio for the most accurate liquidity planning possible. This is done either manually in Tresio or via the connection to Stripe, which can be used to import subscription data directly into Tresio. Further extensions with Chargebee, for example, are being planned, speak to our sales team .
The result is an accurate planning view that gives us a very accurate view of expected cash flows from subscription revenue, but broken down into monthly, quarterly, and annual subscriptions:
Tresio shows us the total of CHF 176,900 exactly per month.
The monthly turnover fluctuates between CHF 5,000 and CHF 27,500 – crucial for our liquidity planning!
If we were to calculate using MRR, we would assume a flat rate of CHF 14,740 per month and would therefore be massively over budget in February, for example, and we might already have a problem with liquidity in March.