How To Calculate ARPU For SaaS Companies?
If you are a SaaS business, here is why you need to know how to calculate ARPU.
- ARPU helps a SaaS business to analyze its growth potential on a per-customer basis
- It helps you develop a financial model to determine your business’ revenue generation capacity.
- Besides, ARPU also helps a SaaS business to track its performance.
Software-as-a-service (SaaS) and other recurring revenue-based businesses continue to gain popularity, specifically in the technology sector. Such businesses depend on recurring subscription revenue to sustain their business growth. Accordingly, these companies get most of their revenue from existing clients through renewals and upsell. Customers who churn after an initial contract purchase can greatly impact a company’s long-term financial prospects.
Thus, Saas businesses need to understand what makes a cloud business successful. To archive this, businesses must measure their performance relative to the key criteria for a great SaaS company. They need to track the key metrics and look to improve on their journey to success.
One such metric is the Average Revenue Per User (ARPU). This article will discuss ARPU in SaaS and how to calculate ARPU.
Average Revenue Per User (ARPU) is one of the key SaaS metrics that measures the average revenue each user generates over a given period. Such a financial metric enables busier customer growth potential on a per-customer basis. Further, ARPU helps businesses develop a financial model to determine their revenue generation capacity.
Note that businesses calculate this metric by taking into account their active users. Accordingly, the ARPU calculation is performed by dividing total revenue by average users during a specific period.
Typically, businesses with a recurring revenue model, such as subscription companies, or SaaS, use this metric to determine their growth. Since ARPU plays a key role in determining business growth, it is a key metric that SaaS businesses use to track their performance.
Customers make repeat purchases of the same Product and buy product upgrades during their lifetime. The SaaS business may offer them discounts, free access, or plan downgrades to retain them. All these actions have a great impact on the Average Revenue Per User.
As a result, a SaaS business needs to track its ARPU over time. Moreover, such a metric is also important to make revenue and growth projections for the underlying SaaS business.
Why is ARPU Important For A SaaS Business?
1. Analyse Growth Potential
The average revenue per unit enables a SaaS business to analyze its revenue generation capacity and growth at the per-unit level. Such a metric helps various stakeholders of the business to identify which products are high or low revenue generators.
ARPU is a useful metric for businesses particularly in the telecommunications, media industries, and SaaS-based businesses. That is, businesses that depend on subscribers or users for revenues and profits.
GAAP does not necessitate subscriber-based businesses to evaluate and track ARPU as a financial metric. However, various stakeholders of a subscription-based business track such a metric to understand the firm’s capability to generate revenues and its growth potential.
2. Take Key Strategic Decisions
ARPU as a financial metric helps a SaaS business identify customer trends in a specific segment compared to the other segments. This metric enables a business to understand the different price points at which customers purchase more products relative to the other price levels.
Further, it also allows executives to recognize the various trends in Product upsell and down-sell. As a result, all such trends help a SaaS business become more efficient. That’s because the managers can take important strategic decisions based on such trend analysis. These decisions may include which products to sell more and which to cease.
On the other hand, ARPU as a financial metric helps startup SaaS businesses more than the already well-established ones. That’s because startups typically have declining ARPU as they offer discounts to attract signups. In such a case, declining ARPU numbers are fine until the startup generates new customers. However, at a later stage, such a firm needs to transition from focusing on subscriber growth to revenue growth.
3. Make Projections
Another important aspect of evaluating and tracking ARPU is that it enables a business to forecast the future growth potential of the business. As a result, the business can plan for both the long and short term.
How? Well, ARPU projections can help executives to understand who are the higher paying customers or customers responsible for generating a major chunk of revenues for the business.
By determining such future trends and patterns, business managers can focus on increasing the Monthly Recurring Revenue (MRR) growth through higher-paying customers. Note that higher ARPU enhances a SaaS business’s Customer Lifetime Value (LTV) goals. LTV of a customer is the total dollar amount a business is expected to receive from an individual customer over the life of his account with the SaaS product.
Note that customers with higher ARPU are the ones that are recurring in nature. As a result, businesses need to retain such customers. Such efforts would ensure that the SaaS business is on the growth path essential for its long-term success.
4. Undertake Comparisons
Analyzing ARPU as a financial metric all alone can be misleading for subscription-based businesses. When tracked alone, such a metric may indicate positive growth, though the business may lose customers and witness declining revenues.
Therefore, SaaS businesses need to track ARPU along with other key metrics like Customer Lifetime Value(CLC), Customer Acquisition Cost ratio(CAC), Customer Lifetime Value (LTV), MRR, ARR, Churn Rate, and the like.
5. Make Pricing Decisions
ARPU numbers enable a SaaS business to price its products correctly. For instance, a SaaS business with increasing revenues and several subscribers may seem like a growing business. However, one needs to track ARPU numbers to understand the real position of the business.
Increasing revenues and subscribers but a stable ARPU may indicate that the SaaS products the business sells are not well-priced. In other words, such products are underpriced. Having an ARPU lesser than the cost of acquiring new customers may also indicate the same.
All these trends indicate that a business is losing money on every new customer. Consequently, the SaaS business may focus on other profitable demographics or explore new marketing channels and tactics.
As mentioned earlier, the Average Revenue Per User (ARPU) is nothing but total revenue arising from the active users of a SaaS business divided by the total number of customers giving rise to such revenue.
The following components form a part of the Average Revenue Per User of a SaaS business.
- Monthly Recurring Revenue (MRR)
MRR measures how much revenue a business generates from the subscription payments that subscribers or customers pay each month. It is a growth metric that enables SaaS or subscription-based companies to forecast their expected revenue for a given month.
- Account Upgrades
Account upgrades form a part of MRR and are sometimes called Expansion MRR. These are the recurring revenues a SaaS business generates due to additional sales to its existing customers in a given month. A metric performance measures revenue growth from existing customer upgrades or added services. In other words, account upgrades are the difference between the value of the old and upgraded plans.
- Account Downgrades
Account Downgrades are also part of MRR and are sometimes called Contraction MRR. It represents the decrease in the monthly recurring revenues of a SaaS business. The decline in MRR happens when the existing customers renounce or reduce the scope of their current subscription or service in a given month. Thus, Account Downgrades are a performance metric that measures revenue change from existing customers downgrading or applying discounts. It is nothing but the difference between the value of the old and downgraded plans.
- Churned MRR
Churned MRR is also called Canceled MRR. It refers to the monthly recurring revenues lost due to the existing customers giving up on their product or service subscription. It may include non-renewals, cancelation of customer subscriptions, etc. Thus, Canceled MRR is a performance metric that measures the change between MRR lost due to downgrades, and MRR added from expansion revenue. This is important in understanding the areas where a business can improve despite having an MRR.
- Total Paying Customers
Total Paying Customers refers to all customers who have paid for the SaaS service within the month and have active accounts. If a SaaS business has certain “free users” accounts, they should not form a part of the ARPU calculation. This is because such accounts are not generating revenues for the SaaS business.
Thus ARPU formula is:
Average Revenue Per User (ARPU) = Total MRR/Total Number of Active Customers
Average Revenue Per User (ARPU) = (Beginning MRR + Expansion MRR – Contraction MRR – Churned MRR)/Total Number of Active Customers
How To Calculate ARPU For A SaaS Business?
Let’s consider an example to understand the ARPU calculation of a SaaS business. Suppose ‘Zootin’ is a cloud-based customer relationship management (CRM) software that helps businesses generate and track leads. It wants to calculate the ARPU for December 2021. The following are the key revenue metrics of ‘Zootin’ for December 2021.
|Key Revenue Metrics of Zootin for December 2021|
|Total Active Customers||20|
|Calculation of ARPU|
|ARPU Formula||Total MRR/Total Active Users|
|Total MRR||Beginning MRR + Expansion MRR – Contraction MRR – Churned MRR|
|Total Active Users||20|
As we can see, the Average Revenue Per User of ‘Zootin’ for December 2021 is $43. This is the sum of the total MRR divided by the total active customers of ‘Zootin’ for December.
Using the formulas above, the Total MRR for ‘Zootin’ for December 2021 is $5number of 50 ($500 + $200 – $100 – $50). The total active customers for December 2021 were 20. As a result, the ARPU for December 2021 was $28 ($550/20).
How Do You Interpret ARPU For A SaaS Business?
The past ARPU trend of a SaaS business enables it to take key strategic decisions. Such decisions may include increasing the sales of high-paying SaaS products and reducing or ceasing the sales generating lower revenues. Also, it helps a business to know its growth potential and make projections that help in enhancing customer retention.
Thus, changes in ARPU also bring about changes in other key SaaS metrics. These include Customer Lifetime Value (LTV), MRR, profitability, and efficiency.
1. Monthly Recurring Revenue (MRR)
The ARPU of a SaaS business has a direct impact on its MRR. The monthly recurring revenues of a business increase when its individual customers contribute more revenue each month. This may result from increased upsells or account upgrades and new customers subscribing to the SaaS products monthly.
2. Customer Lifetime Value (LTV)
Customer Lifetime Value (LTV) is the total dollar amount a SaaS business will likely receive from an individual customer over the life of their account with the SaaS product. A SaaS metric measures how well a SaaS business monetizes its products (MRR) with how well it retains its customers (MRR Churn).
Thus, an increase in MRR or a decrease in MRR churn can help a business enhance its LTV. This showcases that increasing ARPU also increases the LTV of a business.
3. Product Pricing
ARPU also indicates whether a SaaS business is charging the correct price for its products. For instance, a declining ARPU indicates that the business is not attracting a good price from a few of its customer segments. In other words, it means that the customers are deriving more value out of the SaaS product as compared to the product pricing. As a result, the business should charge more price for the enhanced value it is providing to the customers via its Product.
4. Sales Efficiency
A SaaS business’s ARPU also reflects its sales team’s efficiency. As the sales and marketing teams become adept in their sales and marketing pitches, the ARPU of a business improves.
Increasing ARPU indicates that the SaaS business has relevant customers who want to invest in the value proposition that its Product is offering. Such insights help the sales and marketing teams of the SaaS business to have efficient systems in place.
Furthermore, insights into the ARPU of different product segments may enable executives to determine the trends in cross-selling and up-selling.
How To Optimize ARPU For A SaaS Business?
As mentioned earlier, the ARPU of a SaaS business helps the business understand the trends regarding the products and the pricing plans.
Such insights enable a business to make key strategic decisions like improving product pricing, enhancing sales of popular products or plans, ceasing non-performing products or plans, etc.
Thus, optimizing the ARPU is extremely important for a SaaS business. The following is how a SaaS business can optimize its ARPU.
1. Optimizing Product
It is extremely important for a business to determine the growth potential of its SaaS product on a continuous basis. The executives must determine strategies to enhance the Product’s growth potential. Such strategies may include expanding geographically, adding new features, diversifying product segments, or providing new services.
Note that each opportunity that has the potential of adding value to the existing SaaS product is a way through which a business can increase its ARPU.
For instance, Salesforce is a SaaS-based company that initially developed a CRM. Then, it came up with its Customer Success Platform to tie up sales, service, marketing, analytics, community, and mobile apps. Customers loyal to Salesforce help the company add to their business by sticking to Salesforce and the SaaS services it offers. This helps the business in enhancing its ARPU numbers.
2. Improving Pricing
The simplest way to enhance ARPU numbers for a SaaS business is to increase the Pricing of its Product. However, such a strategic initiative must be taken after taking into consideration a host of factors including the needs of the customers.
It is important for a SaaS business to intimate the customers beforehand about the price increase. Further, it must also explain to customers the value addition they will get in return for the price increase.
It is important for a SaaS business to understand that a strategic step such as an increase in the price of the Product may have dire consequences. For instance, customers may switch to alternative products.
One way to overcome such a consequence is to go for a variable pricing model. Such a model helps a SaaS business offer different features at different prices. For instance, they can develop basic, standard, and premium plans offering different pricing features. Such a scalable pricing model helps a SaaS business to increase its ARPU as well as keep customer needs into consideration.
3. Account Upgrades
Another way via which a SaaS business can optimize its ARPU is to offer account upgrades, add-ons and cross-sells. This way each customer would subscribe to a plan as per their need. For instance, a customer of a CRM SaaS product may prefer taking a basic plan and purchasing a customer support add-on for the initial installation and maintenance.
Another customer might prefer buying the premium package or an enterprise-level plan as he runs a big team.
Customers would keep renewing their subscriptions or purchasing add-ons depending upon the level of trust they place in the SaaS product. Once they have trust in the Product, they will not look for alternatives and stay loyal to the Product.
4. Bundled Features
Many SaaS businesses prefer giving customers product features and add-ons in bundles. They have separate plans depending on the size of the teams or customer requirements.
For instance, a solopreneur may buy a standard license for cloud-based accounting software. Since he is the only one running the show, he may update expenses, incomes, and other accounting transactions in the software on his own.
On the other hand, a medium-sized business having a team of executives may require an enterprise-level package. That’s because such a package has the option to add multiple users who can use the cloud-based accounting application at the same time.
This is an effective way of improving the ARPU of a SaaS business. That’s because it serves customers with product features per their needs and requirements.
5. Minimize Customer Churn rate
Churn rate refers to the customers who abandperiodaaS application in a given period of time. A high churn rate would mean declining ARPU for the SaaS business.
A SaaS business must always aim to reduce its Churn Rate. It should try to retain customers for a long time by enhancing product features, optimizing Pricing, enhancing customer support, and overall experience.
Note that loyal customers would keep on renewing their subscriptions. And this would result in increasing the ARPU of the SaaS business.