This post is by Joel York from Chaotic Flow by Joel York
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Since publishing the original SaaS metics blog series and subsequent SaaS Metrics Guide to SaaS Financial Performance, I’ve received numerous inquiries on various details and hidden gotchas in SaaS metrics implementation. This new series of SaaS Metrics FAQs explores some of these finer SaaS metrics points in a simple Q&A format. In this second post, I examine SaaS MRR churn, a SaaS metric that extends from SaaS customer churn which was covered in the first installment.
SaaS Metrics FAQ #4 | What is MRR Churn?
SaaS MRR churn measures the erosion of SaaS monthly recurring revenue (MRR). Mathematically, the SaaS MRR churn rate is an extension of the SaaS customer churn rate calculated by substituting monthly recurring revenue in place of the number of customers. For example, if your SaaS business has 100 customers representing an MRR base of $1M at the beginning of the year, and 5 customers cancel a total of $100K in MRR during the year, then your annual MRR churn rate is 10%, while your annual customer churn rate is only 5%. The general formula for for SaaS MRR churn can be stated as the amount of MRR cancelled (ΔMRR) per time interval (Δt) divided by the total MRR at the beginning of the interval (MRRtotal).
|SaaS MRR Churn Rate||=||ΔMRRcancelled contracts|
|Δt x MRRtotal|
In the formula above, the Δ is a common math symbol that means change or interval.
SaaS Metrics FAQ #5 | Why Measure MRR Churn?
The simple answer to this question is money. SaaS customer churn rate is important, particularly if you run a B2C SaaS business where revenue is generated by monetizing users through advertising or such. However, B2B SaaS companies generate revenue from direct subscription sales. SaaS customer churn is an interesting operations metric, but SaaS MRR churn is a critical financial metric. SaaS CFO’s always prefer MRR metrics.
The slightly more complex answer is that MRR metrics tell you if SaaS customer churn is leaning more toward larger customers or smaller customers. IN addition MRR metrics highlight two very important SaaS revenue drivers that customer metrics do not: upgrades and downgrades. In the example above, the MRR churn rate was double the customer churn rate, indicating that larger customers are churning. This quality of the SaaS MRR churn rate becomes more apparent when we expand the above formula to show off its individual components.
MRRtotal = MRR1 + MRR2 + … + MRRN-1 + MRRN
ΔMRRcancelled contracts = MRRcancellation 1 + MRRcancellation 2 + … + MRRcancellation M
In the expanded formula above, MRRN is the MRR value of customer number N and MRRcancellation M is the MRR value of cancelled customer M. For example, if there are 100 customers with $10,000 MRR subscriptions and 10 customers with $100,000 subscriptions, then total MRR can be calculated using the above formula as follows.
MRRtotal = $2M = 100 x $10,000 + 10 x $100,000
If 5 $10,000 customers cancel and 1 $100,000 customer cancels, then MRR churn is $150,000 = 5 x $10,000 + $100,000. The MRR churn rate is 7.5% = $150,000 / $2M, whereas the customer churn rate would be 5.5% = 6 / 110. MRR churn is higher, because 1 $100,000 customer is worth more than 5 $10,000 customers. To this way of thinking, SaaS MRR churn can be viewed as recurring revenue weighted customer churn.
SaaS Metrics FAQ #6 | How Do I Analyze SaaS MRR Churn?
You can conduct all the same analyses on SaaS MRR churn that you do on SaaS customer churn from simple annual MRR churn rate calculations to complicated MRR churn cohort analysis. The main difference is in the interpretation of the results as recurring revenue weighted versions of the originals. Most importantly, MRR metrics provide the ability to separate the impact of downgrades and upgrades on changes to MRR from the impact of customer churn and growth, respectively.
SaaS MRR churn and growth analysis allows you to separate
the MRR impact of customer churn and new customer growth
from the MRR impact of downgrades and upgrades, repectively.
(A shout out to the Meltwater finance team for turning me on to
this nice MRR churn visual. Thanks Rik, Till and Ludwig!!)
SaaS Metrics FAQ #7 | How Do I Calculate the MRR Churn Rate in Practice?
SaaS MRR churn rate is calculated by substituting MRR for the number of customers uniformly in all your SaaS customer churn rate formulas. For this reason, the SaaS MRR churn rate is subject to all the same measurement problems of the SaaS customer churn rate arising from low churn rates, high churn rates, variable contract lengths, and so forth. If you have any of these issues, you should refer to the previous post in this series which provides a number of SaaS churn calculation tips to mitigate them. If you decide to go measure MRR churn using only contracts up for renewal (Tip #3), then be sure to use the MRR weighted average contract renewal period.
|Monthly MRR Churn Rate||=||ΔMRRcontracts cancelled in month|
|ΔtMRR weighted average renewal period x MRRcontracts up for renewal|
In the formula above, the denominator only counts MRR from contracts up for renewal in the month and the numerator counts MRR of contracts up for renewal in the month that cancel. This gives the MRR churn slice of the waterfall diagram above, however, that still leaves upgrades and downgrades.
SaaS Metrics FAQ #8 | How Do I Calculate the MRR Upgrades and Downgrades in Practice?
It is important to separate upgrades and downgrades from churn, because they each represent distinctively different economic situations. Churn implies a severing of the business relationship, so recovering a churned customer will generally imply a new cost of acquisition. Upgrades and downgrades do not generally entail future acquisition costs, however, they do imply very different sales strategies: upselling vs. recovery respectively. Upgrades and downgrades are calculated as follows.
ΔMRRupgrades = ΔMRRupgrade 1 + ΔMRRupgrade 2 + … + ΔMRRupgrade U
ΔMRRdowngrades = ΔMRRdowngrade 1 + ΔMRRdowngrade 2 + … + ΔMRRdowngrade D
In the formulas above ΔMRRupgrade U and ΔMRRdowngrade D represent the net upgrade and downgrade MRR of customer U and D respectively. For example, if a $100,000 customer downgrades to $90,000 then ΔMRRdowngrade = $10,000.
It’s also worth noting that there is zero difference between SaaS MRR churn and SaaS ARR churn, because all the formulas are percentages (monthly recurring revenue churn vs. annual recurring revenue churn, not monthly churn vs. annual churn). To convert any of the SaaS MRR churn formulas above so SaaS ARR, you simply multiply both the numerator and denominator by 12, cancelling the conversion out of the calculation. I could search and replace ARR for MRR throughout this entire blog post and it would still be 100% correct.