What is ARR?
ARR stands for “annual recurring revenue” which is a metric used in subscription-based models to measure the revenue generated from each customer on a yearly basis. For example, if a customer signs up for a gym membership of $2,400 for 2 years, the ARR is $1,200.
Why is ARR Important for Subscription Models?
ARR is an important metric to track, because it reveals the underlying health of your business and allows you to perform various sales analysis techniques such as forecasting, product analysis and trend analysis.
Sales forecasts are crucial for businesses to manage their resources efficiently and ARR is crucial for sales forecasting. By analyzing the cost and duration of subscriptions as well as renewal rates, one can make accurate predictions about future income and make budget decisions accordingly.
Using a time series graph, one can visualize the growth or decline of a company, as well as observe dips & peaks during specific time periods (e.g. seasonality).
Team Performance Assesments
When doing a sales rep analysis, ARR or MRR (monthly recurring revenue) are two of the most important metrics to track. Every team performance dashboard should list ARR or MRR as one of the top metrics. Other metrics to include are:
- Number of new customers
- Number of new logos (or companies)
- Scheduled Meetings
- Onboarding calls
If your company offers multiple services or products, ARR can be used to analyze the top performing products.
In most cases, the 80/20 rule is followed: 20% of the products generate 80% of the revenue. So it’s important to identify what the top 20% are and make decisions on whether to discontinue the other ones, or improve upon them.
ARR for SaaS Industry
The SaaS industry is based on relationships, rather than one-off deals. These relationships change over time, so it’s important to evaluate relationship-change through cancelled subscriptions, downgrades or upgrades. ARR is one of the best metrics for measuring this.
How to Calculate ARR (Formula)
The formula for calculating ARR is:
ARR = (Total Cost of Subscription) / (Number of Years Subscribed)
So if I order a Netflix subscription for $19.99/month for 2 years (total cost: $479.76), the ARR = $239.88
What happens if a customer doesn’t renew their subscription?
In the case that a customer doesn’t renew their subscription, ARR should be calculated negatively.
For instance, if after 2 years I didn’t renew that netflix subscription, the ARR should be -$239.88.
What if the Contract is Less Than a Year? Use MMR Instead
ARR should only be used if your company offers yearly contracts. If monthly contracts are available, then MRR is the better choice.
ARR vs MRR
- ARR = annual recurring revenue
- MRR = monthly recurring revenue
MRR calculations can take into account stuff like 30 day cancellations which doesn’t apply to ARR, making it more accurate for calculations around monthly subscriptions.
How to Improve ARR (15 Methods)
ARR could be improved by acquiring more customers, reducing churn rate, and increasing the revenue generated from each customer:
Increase Revenue Per User
Depending on the industry you’re in, here are some strategies to improving the ARPU (average revenue per user):
- Teach your sales reps how to do integrative negotiations. This type of negotiation is focused on maintaining long term relationships and “expanding the pie.” It’s a must have for sales teams.
- Add more value to your products/services by building new features that solve an existing problem the client has.
- Add integrations with other products
- Change your pricing model
Reduce Churn Rate
Having unhappy customers who cancel or don’t renew their subscription can greatly impact ARR.
- Bug test. Also identify bugs before releasing new versions of the product.
- Offer training to customer service team.
- Conduct a competitor analysis to ensure your brand is one step ahead in terms of pricing and features.
- Improve onboarding calls
- Identify ICPs (ideal customer profiles) and ensure marketing teams are targeting the right audience.
Acquire More Customers
To acquire more customers, some things you can do are:
- Improve net promoter score
- Expand your audience
- Increase brand awareness
- Add a free trial or free tier
- Improve conversion rates by having a better website, and conducting a sales team analysis to ensure your sales reps are performing as best as they can.
Some other tricks to improving ARR are: utilize automatic renewals, build strong relationships, and offer limited-time discounts to incentivize customers to renew their subscription.
Revenue only tells half the story. Once you've taken the necessary steps to tracking and improving your ARR, you should look into improving your profit margins.
Using a tool like Polymer, you can take the data you've gathered and use the power of AI to find deep hidden insights that will guide your business to making profitable decisions. Polymer will turn data into easy-to-understand, actionable insights.