June 11, 2019 | Authored by: Kevin Cancilla
9 Essential Subscription Business Metrics
The subscription business model has become the new normal. Companies of all types — from disruptive startups to traditional businesses — have adopted subscriptions for the promise of open-ended recurring revenue. But how can those subscription businesses measure performance? The old metrics for financial reporting that worked before might not have the same usefulness. Here are the top metrics every subscription business needs to track.
1. Monthly recurring revenue (MRR)
Perhaps the most essential metric for subscription businesses is MRR: a depiction of the dependable revenue the company can bank on month to month.
The equation is relatively simple: Take the number of customers and multiply them by the monthly rate they pay. If you have an annual plan, divide the price by 12 to normalize revenue to the month — or two if billed biannually, and so on. Say you offer a media quarterly subscription plan at $39, which breaks down to $13 a month. If you have 120,000 readers: 120,000 x ($39/3) = $1,560,000 in MRR.
A related metric is net new MRR, which is pared down to revenue from new sales. Upsells and cross-sells are included, but only the difference in what was paid most recently. So, let's assume 22,000 of the 120,000 customers in this quarter are new, which equals $286,000 a month. Let's also assume 5,000 upgraded to a premium tier priced at $54 a quarter. The $15 difference multiplied by the number of upgrades and divided by three months equals $5, or $25,000 in upgrades normalized by month in the quarter. Taken together, net new MRR would total $311,000.
MRR offers the most real-time insight into financial performance. It is the most accurate near-term barometer of company health and an essential data point for operational decision-making. MRR is also the basis for other financial performance metrics like customer lifetime value (CLV).
2. Annual recurring revenue (ARR)
ARR is similar to MRR, but serves different operational needs. ARR stretches the revenue scope to produce a long-term outlook for macro forecasting or annual reporting purposes.
To calculate ARR, multiply the monthly rate by 12, and then that value by the number of customers to annualize revenue. A startup that sells a health and beauty kit at $15 per month with 475 customers would use this equation: 7,500 x ($15x12), which results in $1,350,000 in annual revenue for that product line.
If you already have an annual plan, be sure to deduct any free months that are included as part of a sign-up bonus. This is why ARR is valuable: because it can contextualize a well-performing month as inflated by freemiums and reveal the true trajectory of sales over a broader timeline.
ARR is also highly watched by investors who consider it a more reliable indicator of business health. Many subscription companies initially operate at a loss, and prospective investors will want transparent and assuring projections for revenue growth.
3. Average revenue per user (ARPU)
Disparate service tiers (i.e., different plans for $9.99, $19.99 and $29.99) can complicate MRR analysis. That same health and beauty company may also offer premium boxes, or more economical options that are delivered less frequently. Because of this, it may be difficult to visualize what the average customer spends.
APRU will eliminate any skew and provide the needed transparency. To calculate ARPU, simply divide the MRR number previously calculated by the total number of customers.
ARPU is one of the most useful metrics. ARPU may vary based on demographics, regions and other variables, such as sales channel, that give you insights into the performance of different segments of your business and customer base. Often businesses will set ARPU-based business targets to drive marketing and sales campaigns, repackaging of products and bundles, or enrichment and localization of offers – all aimed at increasing ARPU.
4. Customer lifetime value (CLV)
Arguably the most important metrics for subscription businesses is customer lifetime value, which indicates the total revenue a single customer is expected to generate over their lifetime utilizing the service. This revenue must exceed the cost of acquiring the customer – which is often recovered only after several payments have been made – and the cost of delivering the service.
The equation for CLV is a multipart one. You will need separate values for cost per acquisition (see below), as well as APRU.
Once these factors have been assembled, calculating CLV becomes essentially an algebraic matter, deducting the cost expectancies from the projected revenue normalized across the customer lifetime. For instance, take the average monthly revenue of a customer. Let's say $21.50. Annualize it to $258 and multiply it by the average lifetime of the customer, five years. Roughly, a customer would generate $1,290 over their lifetime. Any customer who stays that long will be profitable, so the ones who are around a year or less are the ones to focus on. Let's say a customer cancels after seven months. To that point, they would have generated $150.50 in MRR, which might only be pushing up against breakeven after factoring in average acquisition costs and overhead. On the other hand, a customer who stays for a year and a half generates $387, making retention or churn risks a clear priority.
CLV is essential for decision-making. For instance, if CLV is observed to be stagnant or receding, it could point to deeper-seated issues such as a low renewal rate, increased churn and other symptoms which may suggest the need for a greater investment in marketing. In the long term, CLV can be used by leaders to frame progress toward profitability, or gauge performance relative to expectations.
5. Customer acquisition cost (CAC)
The key to subscription business success is extremely simple – acquire and retain more customers. Growth is dependent on customer acquisition outpacing churn, and profitability is on the other side of the threshold if customer acquisition costs (CAC) are under control.
CAC is easily calculated by tallying up the costs directed at acquisition-focused sales and marketing and dividing that by total new customers for a given time period. The CAC metric indicates how well-optimized acquisition budget and processes are and ensures the right balance between spending on acquisition and retention. CAC should be broken down across channels. For instance, average costs per customer acquired through social versus email may show that all the money being put toward social ad creative and targeting is not creating the "bang for buck" desired.
6. Churn rate
Churn is the bane of every subscription company's existence. Visibility of the extent and causes of churn will empower businesses to control or mitigate it.
The formula is relatively simple: take the cancellations you have in a given period and divide it by total customers during the same time, and then multiply by 100. If 7,000 of your customers churned during a month out of a total 150,000 users, your churn rate would be 4.6%. Many companies will have proprietary tweaks to the calculation, perhaps factoring in the actual days a churned customer was active before leaving.
There's an acceptable level of churn for every subscription business — generally between two and four percent — but the higher the churn rate, the lower almost every other value metric will fall. Many factors cause churn. You need to be able to isolate them and address them individually. It could be your service is not so easy to use, or inferior to your competitors. Perhaps you are addressing the wrong audience. Perhaps you are not doing a good job of communicating the value of the service to your users. Perhaps your users are dropping due to failed payment transactions (passive churn).
Understanding and addressing the causes of churn is essential and can often be the most cost-efficient way to improve your business's heath.
7. Growth efficiency/magic number
Often used in a marketing context, growth efficiency is essentially a measure of growth in recurring revenue per $1 spent in marketing or reinvestment. Begin by figuring the difference in new recurring revenue between quarters, divide that by total marketing and sales expenditures for the first time period, round to the nearest tenth, and there you have the magic number.
Figure the net new MRR discussed in No. 1 for consecutive quarters and find the difference. Let's say Q3 saw a boost over Q2 in new sign-ups to the tune of $345,000. Then, total your customer acquisition costs in Q2, which come in at $285,000. That's a magic number of about 1.2 — which is pretty good.
Growth efficiency is a quality metric that expresses in a very simple manner exactly how efficient you are at generating growth, i.e., the relationship between marketing/sales spend and growth. Anything under one would indicate potential disconnect between sales efforts and real new revenue, while anything above one signifies charged growth.
It can be useful to mock up different scenarios using different growth rates to establish an optimal range, and then continually track the magic number to ensure you're operating in a cost-effective zone. It's a metric seemingly tailor-made for investor presentations as well, given that it's easily understood and can have an impact on an audience.
8. Lead velocity rate (LVR)
Lead velocity rate indicates your effectiveness at attracting new customers. Track LVR to help ensure that you are constantly nurturing a pipeline of new leads. Conversely, seeing LVR dip month over month would be a bright red flag for any decision-maker that perhaps the sales or marketing team is lagging, or there's a deeper disconnect between what the product is and how it's being marketed.
To calculate LVR, take the difference in qualified leads you have between months, divide that figure by the number of qualified leads in the last quarter and multiply by 100. In action, this would look a bit like this: Your qualified leads dipped from December to January, perhaps as a result of the holidays, from 1,000 to 885. That's a difference of -115 — that number divided by the previous month's 1,000 and multiplied by 100 will be a negative 11.5%.
When calculated over a rolling timeframe, LVR can help contextualize marketing effort success, or help identify areas of weakness in the pipeline, like seasonality or big drop-offs after a limited-time discount ends. Having a continuous supply of leads to nurture and convert is essential to subscription-fueled growth.
9. Subscriber return on investment
For this metric, you'll need to calculate CLV and CAC. Simply divide the lifetime value by the average acquisition cost. This provides a snapshot of return on investment (ROI) — a much-scrutinized expression of sustainable growth and profitability, or problems ahead conversely. To determine subscriber ROI, let's take the previous calculated CLV of $1,290. Let's assume a CAC of $215. CLV divided by CAC then equals a ratio of around 6:1. While that means customers are largely profitable, the ratio is on the high side, which indicates you could be spending too little and missing out on business. A 1:1 ratio or less, on the other hand, would signal you're spending too much. The sweet spot is between 2:1 and 4:1, or around $350 in acquisition costs.
Having a high CLV can be something to tout, but if acquisition costs take a large chunk out of that return, growth or financial stability might not be all it's chalked up to be. While not a be-all, end-all metric, subscriber ROI can offer a clean, easily digestible metric that examines fundamental operations to a subscription-based business.
Which metrics should subscription businesses track?
For all subscription businesses, detailed and continuous measurement of operational performance is critical to building and executing a strategy that will drive growth and success, determine where to invest, when to invest, and where to cut back. Core metrics like MRR, CAC, ARPU, CLV and churn rate must be tracked. The choice of which additional metrics to follow is up to each individual business. The more accurate your data, the more sophisticated you can become in identifying the metrics that best serve your business and enable you to make informed strategic decisions that drive your business forward in the right direction.
If you're interested in learning more about how you can make better sense and gain more value from your data, contact Vindicia today.
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