If you are a SaaS business, you must read this article to understand:
- What is Expansion MRR in SaaS Business?
- How To Use Expansion MRR for Revenue Expansion?
- How to Calculate SaaS Expansion MRR?
Many software businesses have transited to the subscription-based model in place of the ‘pay-per-product’ model. All thanks to the upcoming of SaaS and its widespread penetration among businesses both small and large.
The subscription economy enables a user of a software-as-a-service (SaaS) product to use the same on a subscription basis. In simple words, the SaaS user pays a regular subscription fee either monthly, quarterly, annually, or some other interval for using the SaaS product.
This is unlike the traditional on-premise software model where the user of the software paid for the software license only once. Such a model was a ‘Pay-Per-Product’ model.
Though, businesses have adapted to the SaaS model well because of the obvious benefits it lends. However, when it comes to SaaS accounting, it has not caught up to the accounting changes that the subscription economy has brought about.
There are still businesses that are selling SaaS products but are using traditional accounting principles to measure the performance of their operations. They fail to understand that a subscription-based business is significantly different from the ‘pay-per-product’ model.
For instance, a subscription-based business collects money for the products sold over a period of time. This is in contrast to the upfront payments that consumers make in the case of the ‘pay-per-product’ model.
Thus, in the case of a subscription-based business, a business owner suffers a loss initially but eventually gains profits as and when the subscription payments are realized from customers.
This means it is important for a SaaS business to use metrics that help it to track revenue momentum accurately. One of the key SaaS metrics to track revenue momentum is MRR and its components. Its components include Expansion MRR, Contraction MRR, Net MRR Churn, New MRR, Net New MRR, and Reactivated MRR.
In this article, we will discuss one of the key components of MRR and that is Expansion MRR. As a SaaS business owner, you will learn what is Expansion MRR, how to calculate Expansion MRR, and why it is important for a SaaS business to track Expansion MRR?
What is Expansion MRR?
Expansion MRR is a key SaaS performance metric that measures the growth in revenue generated from the existing customers of a SaaS business as a result of product upgrades. It represents the increase in the MRR of an existing customer as a result of such a customer upgrading his subscription plan or subscribing to added services.
In other words, Expansion MRR includes customers who upgrade to a more robust plan or those who pay for additional users or features.
Thus, generating revenue from existing customers is a good indicator of the added value that a customer receives from subscribing to the SaaS product and expanding their use.
A SaaS business reaches a state of Negative Churn when its expansion revenue surpasses the revenue lost from its existing customers.
What this means is that if a SaaS business reaches a point where it has a Negative Churn rate, it means that the business’ recurring revenue is increasing without bringing onboard new customers.
Note that it takes significantly more time and resources for a SaaS business to acquire a new customer than it does to retain and upsell existing ones.
In fact, even the investors track Expansion MRR and other upsell revenue metrics. This is because they consider businesses having a high Expansion MRR more valuable relative to others. That’s because such businesses have the capacity to grow organically through expanding their existing customer relationships.
Importance of Expansion MRR
It is important for a SaaS business to determine its Expansion MRR. This is because such a financial metric helps a SaaS business to understand the value of services that it is giving to its existing customers in addition to the existing services.
Such insights help a SaaS business to know the existing and the potential opportunities that it can create or grab to offer additional services to its existing customers.
It is important for a SaaS business to keep a track of such insights as it is significantly costly for such a business to acquire a new customer rather than selling upgraded services to the existing customers.
Thus, Expansion MRR insights will help a SaaS business in understanding how well or how poorly the firm is upselling and cross-selling its products or services. In addition to this, such insights will help the SaaS business to know the type of upgrades that existing customers acquire and at what price.
Note that Expansion Revenue as a performance metric becomes important for a SaaS business to track, especially when it reaches its maturity phase. This is because in the later years a SaaS firm becomes mature enough to up-sell, cross-sell, and drive deeper engagement within each customer account.
In addition to this, the Expansion MRR of a SaaS business also indicates the level of revenue sustainability as well as the quality of relationships with customers over time.
Also, SaaS businesses that can anticipate their Expansion MRR momentum with forecasting data and metrics can make more accurate financial projections. Further, such businesses can allocate resources and adapt processes in a better way.
Likewise, observing a reduction in the Expansion MRR of a SaaS business from month to month can indicate a host of issues. These issues may relate to customer churn, product shortcomings, or increased competition.
Note that every customer lifecycle is unique and any change to the subscription as a result of a product upgrade may impact revenues for a SaaS business. Thus, if a business fails to track its Expansion MRR properly, it may not have accurate metrics to guide the business.
Further, the SaaS business may not be able to undertake the right planning and decision-making. Since such trends have a compounding effect, it is important for a SaaS business to have a strong hold on MRR and its related metrics. This is because a small change in such metrics can lead to a snowball effect quickly, be it positive or negative.
How To Calculate Expansion MRR?
Expansion MRR refers to the growth in revenue that a SaaS business earns from its existing customers. Typically, a SaaS business can increase its revenue from existing customers either through up-selling or cross-selling its products or services.
Upselling refers to the practice of selling a more feature-rich and expensive product as an alternative to the one they have already subscribed to. Whereas, cross-selling refers to the practice of selling additional non-core products along with the core product in order to provide customers with a more comprehensive solution.
The following is the Expansion MRR Formula that a SaaS business can use to understand how well it is upselling and cross-selling its products or services. In addition to this, such insights will help the SaaS business to know the type of product upgrades that existing customers are acquiring and at what price.
Expansion MMR = Price of New Product Plan – Price of Old Product Plan
Expansion MMR (in %) = [(Expansion MRR at the end of the month – Expansion MRR at the beginning of the month)/ Expansion MRR at the beginning of the month] x 100
If the Expansion MRR of a SaaS business is low, it means that the business may need to rethink its up-and cross-sell strategy. For instance, the SaaS business needs to think if the current product package plans are as per the requirements of the customers. Further, they also need to analyze whether the product offering provides all the features and functionalities that their customers really need. Also, the SaaS business needs to determine whether it is easy for their customers to self-serve their accounts?
To understand what the customers really need, the SaaS business will have to take feedback from its customers. For instance, they can organize a customer focus group study that helps the SaaS business take feedback from customers. Once the business has customer feedback, it can utilize the insights to make improvements across the wider customer journey. Such improvements will help the SaaS business to connect with its customers.
Further, it will guide the SaaS business in the following key areas:
- Hiring and staffing decisions
- Product pricing and packaging strategy to upsell and cross-sell
- System selection and implementation, especially if it relates to revenue expansion
- Sales and marketing efforts to retain the existing customers
- Collection strategy and processes
How To Use Expansion MRR for Revenue Expansion?
There are three ways in which a SaaS business owner can use Expansion MRR for expanding its revenues.
Cross-selling is one of the great ways in which a SaaS business can expand its MRR. It is a practice in which a SaaS business offers its existing customers something that compliments the core product. That is, the SaaS business sells products or services related to their core product to their existing set of customers. This is in addition to selling the core product.
Let’s consider an example to understand how SaaS companies do cross-sell. Quickbooks online accounting software offers various plans to sell it’s for its core cloud-based accounting application.
This means a business can select the plan it wants to purchase as per its own requirements. Once it selects the plan, the SaaS provider asks the buyer to add a payroll plan to the selected online accounting subscription plan.
Thus, the business can either purchase only the online accounting application plan of its choice or it can buy an online accounting application plan together with a payroll plan.
Note that the payroll plan is a complementary offering to Quickbooks flagship online accounting software.
Thus, the SaaS provider asks the buyer to buy a related product like payroll software along with the Quickbooks online accounting software plan before cart checkout.
Add-ons refer to the extra features that a SaaS provider offers in addition to the existing product plan. These include additional features, extra user access, additional reports, etc. Such additional features help customers of a SaaS business to expand the capacity of their core package without upgrading to the next plan.
Canva is one of the few best examples that offer a tiered plan structure where each plan offers various features as per the need. However, a buyer of each plan gets a fixed number of users. However, if the buyer wants to get access to Canva for more users, it may have to pay them extra under each plan.
This is one of the common ways in which SaaS companies can increase their MRR. SaaS businesses sell higher grade plans to their customers in order to expand their MRR.
Typically, most SaaS businesses have a retired pricing model, where they offer different plans containing different features. Such SaaS companies aim to enable customers to upgrade from a lower to a higher grade plan.
Take for instance Slack, a SaaS-based business communication tool. It offers three pricing tiers including Pro, Business +, and Enterprise Grid. Each tier gives buyers additional features like unlimited workspaces, designated customer success teams, backup support, etc.
Note that these subscription plans are only for single-users. But, Slack also has business expansion figured into their pricing plans. That is, the buyers can always upgrade plans to increase the number of users.
Some companies only offer increased features in their upgraded plans and do not include business scalability in their pricing model. Both the strategies pay, however simply offering increased features in the upgraded plan requires extra effort for sales.
Benefits of Expansion MRR
One of the key benefits of having a good Expansion MRR is that it is four times less expensive than acquiring a new customer.
Acquiring a new customer means four times the cost to retain an existing customer through upselling.
This means that if a SaaS business relies on the strategy of acquiring more new customers, it will take a lot of time to recover its Customer Acquisition Cost (CAC). In other words, the CAC payback period is higher for a SaaS business in such a scenario.
However, having an Expansion MRR strategy in place through upselling can reduce the CAC for a SaaS business. Plus, the CAC payback period for such a business is quite low. This means their MRR expands at a higher rate and such businesses become profitable quickly relative to the ones relying on customer acquisition strategy.
Another benefit of having a good Expansion MRR rate is that the SaaS business has a lower churn rate. A lower churn rate prevents the growth of a SaaS business from plateauing or stopping.
Note that the customer acquisition strategy cannot stop a business to reduce the churn rate. Hence, it has a great impact on business growth. However, having a good expansion MRR strategy in place helps a SaaS business to prevent revenue growth from plateauing.
This means that a SaaS business must aim for having a negative churn. That is, a scenario where current customers stay subscribed and spend more money in the current month than they did in the previous month.
Need Help With Your SAAS Accounting / Tax?
We at freecashflow.io are an agency that focuses on helping online business owners like you. Our partners have worked in multi-billion dollar MNCs such as warner brothers, EY, and paramount. If you want a trusted partner to help you with your tax/accounting, Freecashflow.io is here to help.
Head over here to book a call: