Metrics to forecast business success of a product
1. Monthly recurring revenue (MRR)
These metrics measure a product’s total revenue in one month.
What are the different components of MRR?
MRR metric can be broken down to help you understand how your business is performing in terms of acquisition, retention, and scaling.
New MRR: This is the revenue your business makes from all the new customers gained during a month. This can be directly attributed to all your new customer acquisition strategies and help mark out the channels that contribute to revenue.
Upgrade MRR: This is the additional MRR from all customers who have upgraded to a higher pricing plan from a lower-priced plan, or purchased a recurring add-on. Upgrade MRR gives you a fair representation of how well your product scales with the growth of your customers.
Expansion MRR: Often confused with Upgrade MRR, Expansion MRR also takes into account MRR contribution from reactivation of a previously canceled subscription and free-to-paid conversions. Especially useful for subscription businesses that use a freemium model, contrasting Expansion MRR with Upgrade MRR gives a deeper level of understanding of how well you are able to convert free customers to paid customers, and how often canceled subscribers return to you.
Contraction MRR: This metric reports the MRR lost due to cancellations, downgrades to lower price plans, removal of recurring add-ons, or even because of availing discounts. It is useful for understanding how well your business is able to retain the MRR from existing subscribers, indirectly indicating the capability of your product/service to scale with your customers’ needs.
Churn MRR or Cancellation MRR: A component in the calculation of Contraction MRR, Churn MRR or Cancellation MRR takes into account the MRR lost due to canceled or churned subscriptions. Churn is useful in understanding how well your product stays relevant to your customers’ needs. During the early stages of a subscription business, a high or a rising churn MRR or cancellation MRR may indicate poor product-market fit, while a similar trend during later stages may point towards a recent marketing campaign that brought in customers with the wrong promise.
Downgrade MRR: This is the other component that drives Contraction MRR. Downgrade MRR is the sum total of all reductions in MRR from existing customers, excluding those from cancellations.
Reactivation MRR: Additional MRR from customers who had previously churned or canceled. Reactivation MRR is a component of expansion MRR. It is important for these customers to have contributed $0 to the MRR in the previous month (does not include users in free trials).
Why MRR is important for your business?
If your business revolves around subscriptions, this should be a fair representation of the money your customers will be bringing in. It depicts the health of a business, something an investor will look at before he or she invests in the business. That makes MRR the one number metric you should strive to be growing every month.
2. Average revenue per user (ARPU)
Average revenue per user (ARPU) allows you to count the revenue generated per user monthly or annually. You need these metrics to define the future service revenue, in case you’re going to change the pricing plan or roll out a promotion.
There are two types of ARPU: per new account and per existing account. ARPU per new account refers to metrics based on new accounts appearing after the subscription plan or product price was changed. ARPU per existing account involves the data from accounts established before the price change. This is the ARPU formula:
Monthly recurring revenue / total number of accounts = ARPU
Use ARPU to compare yourself to competitors, consider different acquisition channels, or segment which tier of customers brings more value.
How to use MRR and ARPU. It’s an effective KPI to use to monitor a company’s current health and it’s especially valuable in SaaS businesses working on a subscription basis. Since you don’t need to worry about one-off sales after acquiring a recurring customer, MRR is easily calculated and predictable.
3. Customer Lifetime Value (CLTV or LTV)
CLTV is the total worth to a business of a customer over the whole period of their relationship. It’s an important metric as it costs less to keep existing customers than it does to acquire new ones, so increasing the value of your existing customers is a great way to drive growth.
If the CLTV of an average coffee shop customer is $1,000 and it costs more than $1,000 to acquire a new customer (advertising, marketing, offers, etc.) the coffee chain could be losing money unless it pares back its acquisition costs.
Knowing the CLTV helps businesses develop strategies to acquire new customers and retain existing ones while maintaining profit margins.
Average Revenue Per User (ARPU) * Average customer lifetime = CLTV
How to use CLTV
It is useful metric used by marketing managers especially at a time of acquiring a customer. Ideally, lifetime value should be greater than the cost of acquiring a customer. Some also call it a break-even point.
The basic formula for calculating CLTV is the following (1):
(Average Order Value) x (Number of Repeat Sales) x (Average Retention Time)
For example, let’s say you run a Health Club where customers pay Rs 1000 per month and the average time that a person remains a customer in your club is 3 years. Then the lifetime value of each customer is (according to the formula above):
Rs 1,000 per month x 12 months x 3 years = Rs 36,000. This means each customer is worth a lifetime value of Rs 36,000.
Once we calculate CLTV we know how much the company can spend on paid advertising such as Facebook ads, YouTube ads, Google Adwords etc. in order to acquire a new customer.
4. Customer Acquisition Cost (CAC)
This metric covers all the costs spent on attracting customers: marketing spendings, sales team work, advertising. Sometimes these costs include salaries of marketing and sales professionals. Usually, customer acquisition cost involves setting a specific period of time and total revenue. There are several formulas to calculate CAC, but the simplest one is:
Sales & marketing spendings for a period of time / total # of customers generated for a period of time = CAC
How to use CAC. Use CLTV and CAC together to identify whether customers bring you less profit than what you spend on them, and whether it’s time to reconsider pricing and product marketing strategy to attract more users.
Importance of Customer Acquisition Cost
CAC is a key business metric that many businesses and investors look at. In fact, many companies end up failing due to not fully understanding their customer acquisition cost.
1. Improving return on investment
Understanding the cost to acquire new customers is crucial to analyzing marketing return on investment. For example, consider a company that uses several channels to acquire customers:
By using CAC, a company is able to determine the most cost-effective way to acquire customers. In the table above, we can see that Social Media provides the lowest acquisition cost while Social Events cost the most. A company presented with this data may consider using social media marketing more to generate more customers.
2. Improving profitability and profit margin
Understanding its CAC provides a business with the ability to fully analyze the value per customer and improve its profit margins. For example, assume that the value of each customer to a business is $60.
Relating it to the example above, which channel would you choose to use? A business that does not understand CAC would adversely affect profitability by choosing to use Social Events as a channel. The channels Social Media and Posters would improve profitability for the company as the CAC is lower than the value per customer.