Drilling Down Into MRR

For subscription based companies, monthly recurring revenue (MRR) is the best way to predict operational income over any given period. Essentially, MRR equals the amount of subscription revenue from customers over a given month. Some companies also refer to this metric as average recurring revenue (ARR).

For making long term strategic plans, it can be the most important metric to watch. The biggest benefit of MRR is its help in determining where to devote resources to cut down on churn. The biggest drawback is that GAAP doesn’t recognize MRR as a reportable metric.

MRR is a calculated, predictive measure, not recognized revenue. That’s one of the reasons why there is so much variation for what MRR means for different companies. GAAP attempts to take conservative methods of computing actual recognized revenue every day between the start and end date of a subscription period. Because it deals with real numbers, there is an extreme amount of variation. For managers trying to see trends in the data, trying to use recognized revenue only tends to complicate matters.

Smoothing Uncertainty

MRR evens out the uncertainty by establishing a constant revenue number to clarify where the company is heading. MRR can indicate what a company should be able to expect based on projected existing customers, sales, upgrades and churn.

Consider the following:

• A customer upgrades in the middle of a month, which could vastly change revenue for that day but only moderately affect MRR.
• Another customer drops two services but retains the base program, eliminating revenue streams and offsetting the above upgrade.
• A third customer pays their bill two weeks late, resulting in lower than expected revenues one day and higher than expected revenues the next.

The preferred GAAP revenue reporting method number displays wild fluctuations when a single constant, modified monthly would give a more accurate picture of income. Companies that operate on month-to-month billing have a great deal more uncertainty, but also a shorter sales cycle. MRR typically does not include variable fees, but for month-to-month subscription services, it often has to include estimates on these numbers. SaaS Optics offers some suggestions on calculating MRR for term subscriptions vs. month-to-month models.

Fixing Churn

One of the most valuable lessons to draw from MRR is in tracking down churn. Cutting down on churn is essential to the growth that underpins the success of a subscription model. MRR churn can be calculated by plugging MRR in place of customers in the standard churn formula. In other words, MRR churn equals the change in contracts over the MRR for any given month.

Here’s a good example: Company X has 200 customers and $2 million in MRR at the beginning of the month. During the period, 10 customers cancel for a total loss of $200,000. MRR churn rate will be 10 percent but the customer rate is only 5 percent, indicating that larger customers are churning. Further analysis can discover the percentage of upgrades or downgrades per month and suggest ways to address customer trends before they spiral out of control.

The point is that MRR cancels out the noise of minor variations to indicate the health of the company at a high level. It is not a financial or accounting number, but one that should be used for correcting strategy and enhancing customer experience. To reduce churn and maintain a steady growth rate, pay close attention to upgrades and downgrades, as well as the type of customer that is having the greatest effect on MRR.

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