How to Calculate SaaS Growth?

calculation
08May, 2019
Reading Time: 7 minutes

Running a SaaS web-based software business is no joke. It may seem like all work is automated and the only thing that one has to do is check the bank account at the end of the month or the year.

Maybe you’re barely starting and getting ready to growth hack the heck out of your startup, hire a full-stack marketer, content strategist, social media marketer, paid media, the fastest way to get to 1000 subscribers, race to venture funds, or bootstrapping down to the penny is a thing before your burn rate (breathe).

Sounds like a strategy? Well, a lot of effort goes into building a SaaS company, and you might miss a few opportunities if you don’t know where to look or monitor how the money is coming in and where the money is going.

Don’t worry, you’ll understand what metrics you need to follow for your startup to succeed. But if you don’t know how to calculate and measure your growth, you’d be bound to struggle sooner or later.

Here is how to calculate SaaS growth.

Why do we want to measure our SaaS Growth?

The strategy is to be detailed as possible and how the money is coming in.

The metrics include the following;

  1. Monthly Recurring Revenue (MRR)
  2. Annual Recurring Revenue (ARR)
  3. Customer Churn
  4. Revenue Churn
  5. Lifetime Value
  6. Growth Ceiling

Monthly Recurring Revenue

This revenue primarily comes from your client’s subscription fee. MRR becomes the most appealing aspect of this business model. The most prominent problem is the retention of the subscribers. But even before coming up with the question of how to retain the subscribers in your business, there is the hurdle of how to calculate MRR. 

How to Calculate MRR?

When calculating MRR, there are two ways to go about it depending on the particular data that you want.

a) Customer by Customer

This option is a simple method of calculating MRR whereby you take into account the sum of the amounts paid by all the subscribers to your business. When using this method to calculate MRR, you will need to factor in the different subscription plans as well.

If, for example, you have customer group X that enrolls to a $50/month package and another customer group Y which is on a $100/month package. You have calculated each package separately and then add all of them together. So, assuming group X has five members, and group Y has three members, your MRR will be:

($50 x 5) + ($100 x 3) = MRR
= (250) + (300)= 550
Total MRR= $550

b) Average Revenue Per Account

This formula is even a more straightforward way of coming up with the MRR for your business. What this method will require however is that you have a general idea of what is the average amount paid as subscription fee by your subscribers. The average amount paid is what is referred to as the ARPU (Average Revenue Per Account) in this case. Multiply this number by the number of clients that you have in your business.

MRR= ARPA x Total No. Of Subscribers

Therefore, if your business has five clients who pay and an average monthly subscription fee of $100, your MRR will be:

($100×5) = $500

With these two methods of calculating MRR, you can now have a clear picture of how much revenue is coming into your business on a monthly basis. The next step that follows is calculating MRR growth.

How to Calculate MRR Growth?

Every business owner out there aims to grow their profits. For a subscription business, the MRR which you calculate monthly is what you intend to build up. So how do you know whether there has been any significant growth in your MRR?

Unlike other businesses whereby an increase in the number of clients is the main point of focus, in subscription businesses it is different. Getting new subscribers do not necessarily indicate that the business is fairing well. For your MRR, these three concepts are the most important.

1. New MRR

This term refers to the revenue that is now expected to come due to new subscriptions. If, for example, this new month your business has got six new subscribers; 3 of them subscribe to the $50 package, and the other three subscribe to the $100 package. Your new MRR will be:

($50×3)+($100×3)= New MRR
($150)+($300)= $450

2. Expansion MRR

Expansion MRR is gained from the existing customer base when the customers either upgrade their subscriptions or if they purchase additional packages. For example, say we have four clients that had paid for the $50 bundle now upgrading to the $100 bundle. On the other hand, two clients that have subscribed to the $100 bundle decide to buy an additional package that you have availed for $25; your MRR will be:

($100×4) +($25×2)=Expansion MRR

($400)+($50)= $4503.

3. Churn MRR

In any business, there is the upside and the downside, the same applies to a subscription business as well. In a given month, you may have encountered a situation whereby some of your subscribers canceled their subscription or downgraded.
These two actions are bound to affect your MRR negatively. For example, you may have one client canceling their $50 package and three others on the $100 package downgrading to the $50 package.
Your MRR will be affected as follows:
($50×1)+($50×3)= Churn MRR
($50)+($150)= $200
Your MRR will now be minus $200 in the month that follows.Your net MRR will now factor all these into one and will is calculated as follows:
Net MRR= New MRR+Expansion MRR-Churn MRR
In this case;
($450)+($450)-($200)=
$900-$200= $700

The Growth Ceiling

The growth ceiling refers to a point in time where the number of new customers is equal to the number of churned customers. When this happens in this business model, the growth rate of the business effectively stalls to nil.

The growth ceiling is essential in a SaaS business model since it helps shape the direction of the business and the steps to be taken to avoid any challenges that come up before the growth ceiling stage occurs. Many startups experience rapid growth in their early stages, but the growth ceiling stage poses a problem for them that demands innovation and critical thinking. 

The growth ceiling is an acronym for the maximum number of customers that a SaaS business can acquire. This can also be related to the revenue the business makes and is, in this case, the highest recurring revenue that a business running on the SaaS model can rake in.

How to Open your growth ceiling?

The growth ceiling, though, a representation that business has grown, is also quite undesirable. You do not want to find out that your business cannot make any more money or cannot sustain a larger client base than it does already.

So it is crucial to come up with ways that help your SaaS business opens up its growth ceiling. Before you can devise a way to open up your growth ceiling, knowing how to calculate your growth ceiling is the first step.

So how do you estimate the growth ceiling?

We have described the growth ceiling as the maximum number of customers or the highest recurring revenue level that your subscription business can achieve, all these with specific churn rate in play. Using this basis, we can then come up with the breakdown on how to calculate the growth ceiling.

i) The maximum number of customers

The maximum number of customers that your business can have is arrived at by dividing the number of new customers by the percentage of your churn rate.

Max customers= Customer acquisition rate/%churn rate

ii) Highest recurring revenue

To calculate the highest recurring revenue that your business can achieve, you will multiply the maximum number of customers and the average income each of their accounts contributes.

Max MRR= Max no. Of customers x ARPA

An example:

Say company A gets ten new customers a month with a monthly churn rate of 10% and the ARPA is $50.

a) The growth ceiling for company A will be;
10/ 0.10= 100 customers

b) The highest recurring revenue will be;
100x$50
=$5,000

With the growth ceiling now clearly understood, the next step is coming up with ways to open up the growth ceiling for your subscription business.

The following are some of the most effective means of opening up your growth ceiling.

1. Increasing your LTV

Increasing your lifetime value means that you can capitalize on the expansion MRR and are also able to have a better retention rate. This LTV option is a strategy that works from the inside out and proves useful for any business that focuses on it.

2. Viral campaigns:

Coming up with the right strategy that can help you market your business in some viral means helps to build up the customer acquisition rate. This influx of customers helps to offset the growth ceiling as more clients subscribe to your service. 

3. Work on your churn rate:

For your business to have a better chance of opening up its growth ceiling, it is necessary that you work on the churn rate. You do not stand a chance of opening up the growth ceiling if your churn rate is higher than the industry range of between 4 and 6%. The common SaaS businesses have a churn rate or between 2 and 3%.

Zero Cash Date

This formula is a metric that you will not hear so very often in the SaaS world. The Zero Cash Date (ZCD) is the most likely date at the current spend of your SaaS business that you will run out of cash. For non-experts, this may seem like a pessimistic view of things, but looking at it soberly as a business owner, it helps determine how long your subscription business can run. Calculating your ZCD accurately and making it open to your team members helps each team member work towards achieving the business goals despite the imminent threat of the growth ceiling. 

Cost of Goods Sold

COGs is the total cost of packaging and delivering a service to the end-user in a SaaS business. In the subscription business, it can be hard coming up with the right figure for this when compared to a physical business.

The following are the basis of COGs for any subscription business: 

a) Third-party licensing fees.
b) Credit card and other payment processing fees.
c) Web hosting fees.
d) Customer onboarding fees and,
e) Support team costs.

COGs are drafted on a monthly basis, and thus you can calculate them against the MRR of a business. 

Burn Rate

Closely related to the ZCD that we discussed above is the burn rate. This metric is the rate at which a start-up utilizes its initial capital. You should also come up with the burn rate on a monthly basis. The burn rate needs to be maintained at a healthy level that helps to ensure the business runs effectively and experiences minimal resource wastage. Failure to tame the burn rate of any start-up will result in it folding sooner than expected. For a SaaS business, this becomes even more critical considering that COGs are not easily discernible. 

All these are critical metrics that come into play when one thinks of how to calculate SaaS growth. Focus on MRR, and all other metrics that come into play are the recipe for a successful subscription business.