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Improving revenue and profit is the primary goal of many businesses. To ensure a sustainable form of recurring revenue, a company must maintain a sufficient number of active customers and keep them from churning.
Subscription business models target yearly or monthly subscription revenue by selling a product or service. The SaaS model focuses on securing multiple recurring payments for access to a good or service instead of a large one-off upfront fee. And just like for any business, it is usually more expensive and time-consuming for SaaS companies to acquire new customers rather than retain current customers.
If running a news app, you need to convince existing customers to renew their monthly or annual subscriptions, upgrade to premium-level services, and convince them not to churn.
The economy is trending towards more subscription-based consumption with the development of technology and growth of the SaaS-based businesses Recent research estimated that the global market for subscription business would grow to US$275 billion in 2022, rising from US$224 billion in 2021. And due to the COVID-19 pandemic, subscription businesses are becoming increasingly popular owing to increased customer needs, recurring delivery of critical items.
Therefore, a SaaS company needs to find a way to evaluate their customer loyalty: whether they are able to retain their customers and by extension their source of recurring revenue. And Net Dollar Retention (NDR) can help with this.
So what exactly is NDR and why is it so important for SaaS businesses?
What is net dollar retention?
Definition
Net dollar retention (NDR), sometimes also referred to as net revenue retention (NRR), is a SaaS metric that shows the growth or shrinkage of your annual recurring revenue (ARR) or monthly recurring revenue(MRR) during a particular period. It gives a revenue perspective about the existing customer base and the efficiency of current acquisition, selling, and retention strategies, including upgrades, downgrades, cross-selling, upsells, cancellations, and customer churn.
Net dollar retention typically consists of revenue renewal rate, plus revenue from upselling or cross-selling to existing customer base and minus revenue churn.
It gives you a holistic view of how many loyal customers are extending subscriptions, and in the meantime, how many are reducing or canceling services.
Formula to calculate net dollar retention (NDR)
There are different formulas to calculate net dollar retention, but the underlying logic is the same. It can be explained using the example below:
Let's say you are running a SaaS company that has 100 customers that pay $100. Your current MRR is $10,000. In the past year, 30 churned. But luckily, you launched a new function on the existing product (for an extra $40), and 40 customers upgraded/renewed their subscriptions.
Therefore, if you want to calculate the net dollar retention for the past year, you need to deduct your churn ARR (the loss from the 30 churned customers) from it and add the expansion ARR (the extra income from subscriptions expanded by the 40 customers) from the starting annual recurring revenue. And then, you divide the result by starting ARR and multiply it by 100 to get the net dollar retention rate.
It looks something like this
{($10,000 + ($40*140) - ($100*30)) / $10,000} x 100% = 126%
An NDR above 100% signifies that upgrades outvalue downgrades.
Why is net dollar retention (NDR) important?
SaaS businesses rely on customers.
A SaaS company needs to improve customer experience, build a loyal customer base and reduce churn.
Net dollar retention is an essential metric for a SaaS business. It measures not only a company's user retention rate but also its ability to keep existing customers engaged and provide valuable feedbacks that can help a company to improve its product or service further.
More importantly, net dollar retention is the metric most investors consider when evaluating a business. According to a study from SaaS capital, for every 1% increase in net revenue retention, the valuation of SaaS companies increases by 12% after five years.
Investors are now searching for enterprises that can grow sustainably, and net dollar retention shows them how sticky a company's customer is and, thus, how much potential the company has to grow.
What is a good net dollar retention (NDR)
In general, the net dollar retention rate of over 100% indicates revenue growth from existing customers. It means that a company can grow even without new customers.
Otherwise, if the net dollar retention rate is less than 100%, it reflects a revenue decrease from existing customers. In this case, you need to adjust your user retention strategies: for example, focus more on customer support services and customer experience to reverse the trend.
But this is not the standard that fits all. What is "good" depends on the scale of your business.
While net revenue retention above 100% is a good indicator of growth for your business, an net revenue retention rate of 90-100% is considered ideal for small and medium-sized enterprises.
Other key metrics to evaluate customer success for SaaS business
Besides net dollar retention or net revenue retention, there are other critical metrics to measure customer loyalty and how successful your user retention strategies are. Below we will introduce nine other SaaS metrics to evaluate customer success and their calculations.
Gross dollar retention
Gross dollar retention, also called gross revenue retention, measures how much revenue remained after a year. Unlike net dollar retention rate, gross dollar retention excludes upgrades. It only represents the customer churn in a year.
Customer lifetime value (LTV)
Customer lifetime value (LTV) measures how much value a company is estimated to generate from its customers during a given customer relationship. It is an important metric in optimizing revenues and profits, as it is a vital component in calculating the unit economy of a business. You should consider it when estimating the budget, analyzing monthly reports, forecasting cash flow, and more.
calculation
There are several methods to calculate LTV. For example, you can divide your monthly average revenue per user (ARPU) by monthly recurring revenue churn.
Or you can calculate your LTV by multiplying ARPU by gross margin and average time of customer relationship.
Customer retention rate
Customer retention rate is the percentage of existing customers who remains customers after a defined period.
Calculation
To calculate this metric, you'll need:
-the number of customers at the start of a given period
-the number of customers at the end of that period
-new customers acquired during the period
Customer retention cost (CRC)
CRC measures how much you spend on each customer to retain as long as possible. It tells you whether or not your investment in a customer is yielding returns.
Calculation
There are two mainly used formulas:
- Average CRC per customer = total CRC of all customers/ the number of all active customers in a defined period
- Average lifetime CRC per customer = average CRC per customer X average customer lifetime
However, this approach does not show how much you spend to support a particular current customer. Instead, it balances all customer retention costs, which is very inaccurate.
It is challenging to identify your most expensive or least profitable customers. In addition, it is hard to determine what discount rate to offer to those customers whose retention costs are low relative to their revenue.
A smarter way is to calculate CRC on a case-by-case basis to determine if you are generating enough revenue from each customer to retain them by using cost per customer. Therefore, you can have data driven insights about customer value.
Churn rate
Churn rate, also referred to as the rate of attrition or customer churn, is the rate at which customers leave you. This indicator measures how many customers discontinue their subscriptions in a certain time, and thus one of the most critical churn metrics to assess the sustainability of SaaS businesses.
Calculation
It is measured by the number of customers you lose or the dollar value represented by those customers. You can choose many ways to calculate it, as straightforward or as complex as you need it to be.
The formula divides the number of churned customers during the specified period by the number of customers at the beginning. The definition of churned customers depends on your business need.
Monthly recurring revenue (MRR) & Annual recurring revenue (ARR)
Recurring revenue is the north star metric for SaaS business. MRR is the recurring revenue gained from subscriptions every month. Recurring revenue includes recurring surcharges and coupons but does not include one-off costs such as set-up fees and non-recurring surcharges.
Annual recurring revenue shows the revenue earned from subscriptions in a year. Similar to MRR, ARR shows you how well your SaaS company performs annually. It can also be used to assess the predictability and repeatability in cash flow and to forecast future growth.
calculation
MRR= monthly charges from all the subscriptions of paying customers or
MRR= ARPU X number of paying customers in a month
ARR= amount of income from all the subscriptions in a year or
ARR= the sum of MRR in a year
Net promoter score (NPS)
Net promoter score (NPS) indicates how likely your customer will recommend your product or service on a scale of 1 to 10. NPS measures customer loyalty. Unlike the metrics we introduced before, it relies on customers' responses gained from an NPS survey. Customers will be asked to answer the question "How likely are you to recommend XXX to your friends/colleagues/ other people?" posted alongside a 10-point scale.
Depending on the result, you can categorize your customers into three buckets:
- Detractors (customers with a number between 0 and 6)
- Passives (customers with a number between 7 and 8)
- Promoters (customers with a number over 8)
calculation
Once you've collected responses from your NPS survey, it's a very easy calculation: NPS is the difference between the percentage of promoters and detractors. Scores vary between -100 and 100.
Customer satisfaction score (CSAT)
CSAT, similar to NPS, is based on customer feedback collected in a customer survey. It measures customer satisfaction with a business interaction. Simply ask your customers questions, such as " How satisfied were you with your experience using XXX?". You may also design questions for customers at different stages to test your support/onboarding process.
calculation
The formula for CSAT is very simple:
CSAT= total number of positive responses/ number of responses X 100%
