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Net revenue retention (NRR) is a key metric that SaaS companies use to better understand their growth. As a stand-alone metric, it gives you insight into the growth potential in your existing customer base. When you plot the trend in NRR over several quarters, you can more clearly see the overall direction your business is heading in and how quickly.
However, while calculating NRR for a specific cohort is pretty straightforward, tracking it across all your cohorts over time can prove difficult. In this article, we’ll show you the difficulties you’re likely to encounter when tracking this important metric and how to do it right. But first, let’s run through a quick refresher on what NRR is and what it tells you, and why you need to track it. (Note: If you want to take a deeper dive on this topic, check out our Strategic Finance Wiki article on NRR).
What NRR is and why you need to track it
NRR is the percentage of recurring revenue a SaaS company retains from its existing customers over a specified time period. It doesn’t include any revenue from new customers acquired over that same period, only the customers the company had at the beginning of the period.
Tracking NRR gives you insight into your customer retention performance (renewals) and expansion performance from cross-sells and upsells. An NRR above 100% indicates your business is growing.
The ability of NRR to tell you about both of these important aspects of your business, (keeping your customers and increasing their spend with you) makes NRR a good indicator of its sustainability and scalability.
How do you track NRR?
Tracking NRR is more difficult than it may seem at first glance. Calculating and plotting NRR for a given cohort is easy enough. But, when you’re talking about doing that for several different cohorts, month over month to arrive at a single annual value, it becomes much more complex. We’ll walk through it here. But, first, let’s take a look at the NRR formula:
You can calculate the current ARR for the formula above as follows:
Step 1. Define your cohort.
You can define your cohorts using any time period that makes sense for your business based on your sales velocity and deal volumes (e.g. monthly or quarterly). A cohort consists of all the new customers you acquired during the period you’ve defined.
The example we’ll use here is a SaaS company founded in January 2020 with two monthly subscription levels, a “Pro” level at $1,500 and an “Enterprise” level at $3,000. Let’s assume that we’re now at the end of 2022. Normally, you would track NRR for all customers, but for simplicity, our example will track NRR for just the 15 new customers we acquired in our first year grouped into quarterly cohorts as shown below. Note that if you’d like to see an expanded view of how the values in this example were derived, download our Simplified Customer Master Sheet.
Step 2. Record the trailing 12-month (TTM) ARR for each cohort to your table.
The TTM ARR is the total ARR one year prior to the period you’re calculating your NRR for.
In this example, our TTM ARR is from the first full year after acquiring our customers. So, for each of our cohorts shown in the table below, the ARR in each quarter of 2021 reflects what we have earned from each cohort in that same quarter of 2020, one year prior.
Step 3. Record the current ARR for each cohort
The current ARR reflects what the cohorts are paying today, which takes into account the performance of each cohort over the past year. Recall that for this example, we’re now at the end of 2022. So, the values for each quarter in the table below include any Expansion ARR added during 2021 and any ARR lost to churn or downgrades.
Step 4. Calculate the NRR for each cohort.
To calculate the NRR for each cohort, use the NRR formula above dividing the Current ARR from Step 3 by the TTM ARR from Step 2 for each period.
Step 5. Calculate the overall NRR and plot your results.
To calculate the overall NRR for all cohorts combined, simply sum up the ARRs for each quarter and apply the NRR formula. Once you have these values, you can plot them on an X-Y graph to see your NRR trend as shown in the figure below.
Some caution on how not to calculate NRR
When calculating NRR, you may be tempted to simply divide the current ARR of your existing customers today by the TTM ARR for your existing customers from the same period 12 months prior. This is fundamentally flawed because not all of the customers you have today were customers 12 months ago. Some of them became customers at different times during the past year and have not yet had a full 12 months yet. This means that if any of them churn or downgrade their subscriptions in the future, your NRR won’t capture that. Thus, calculating NRR in this way makes it look higher than it really is.
NRR must be based on cohorts of customers to provide an accurate picture of how well your business is performing in terms of retaining customers and increasing their spend with you. Further, you should always go back 12 months when calculating NRR because it is based on ARR, annual recurring revenue. If you don’t go back one full year for each cohort you’re tracking, you won’t fully capture the expansion ARR and churn ARR from that cohort that could affect your NRR.
Interpreting your NRR results
NRR by definition is a lagging indicator, which means that by the time you measure it for a given cohort, it might be too late to implement any changes to impact the ARR from that cohort.
For example, let’s say you have 100 customers in Q1 of 2022 and in Q1 of 2022, they were paying a total of $1,000. Fast forward to Q1 of 2023. You calculate the NRR again and find that you’re only generating $950 from this cohort now, or 95% of what they were paying you before. So, you know that your revenue from this cohort has decreased. While this is concerning, it’s already happened, and there’s nothing you can do at this point to gain back that lost revenue.
However, this example also illustrates how tracking NRR can reveal actionable insights that you can use in your planning going forward. In this case, you know you’re losing customers due to some combination of churn and downgrades. Now, if you can figure out why that’s happening, you can take steps to address the problem so it doesn’t continue in future quarters.
This is just a single cohort example. Tracking your NRR becomes a lot more powerful when you do it for the entire customer base and determine your overall NRR. The insights you’ll gain will help you plan and budget more effectively by using your gross revenue retention (GRR) and NRR metrics to calculate the upper bound for churn ARR and expansion ARR targets you need to hit in the next fiscal year.
A caveat regarding the predictive power of NRR
There are some scenarios in which NRR can lose its predictive power. This can happen if you’ve had a significant change in your relative success in selling into different markets in the most recent 12-month period, which isn’t reflected in the current NRR value.
For example, let’s say you serve two market segments, small and mid-sized businesses (SMB) and mid-market (MM). Compared to SMB customers, the deal sizes and expansion rates for MM customers are typically higher while churn is lower. In most quarters, you can count on your sales team to close one MM deal for every two deals they close with SMBs. But if in the past 12 months that ratio skewed more towards SMBs, say to one MM deal for every five SMB deals, your NRR will be much lower than it was before..
Broadly speaking, NRR works best for planning and budgeting in future quarters if your business is in a relatively steady state in which there aren’t any significant changes that might impact your revenue. But because it’s measured over a longer, 12-month time frame, it can lose its predictive power in some situations.
To illustrate this, we can look at our previous example within the context of the current economic climate. SaaS buyers today are delaying software purchases or at least thinking twice before they commit, which translates into lower deal sizes, lower expansion revenue, and a higher possibility of churn. So, even if your market segment mix (SMB to MM ratio) doesn't change significantly, all of those factors will still affect NRR. However, you wouldn’t see the real impact until 12 months later.
These examples show why it’s always a good idea to interpret your NRR results in conjunction with other less lagging indicators:
- Monthly revenue churn rate – Evaluating your NRR alongside your churn, a key component of NRR, can give you a clearer picture of renewal and retention in your business.
- Customer Lifetime Value (LTV) & Customer Lifetime – LTV tells you the value of your customers to your business, and the Customer lifetime in months tells you how long your customers are sticking around. A change in either of these values can help you better understand what's happening with your customer base and can help illuminate what you’re seeing in your NRR.
- SaaS quick ratio –This metric tells you how many dollars you’re earning for every dollar lost to churn, so it helps you understand how churn is affecting your NRR. Note that while the SaaS quick ratio includes your New logo ARR, which isn’t included in the NRR calculation, it still gives you an idea of the overall growth efficiency in your business and where you may need to focus more of your efforts (e.g. on retention, adoption and expansion, or new customer growth).
Drivetrain simplifies NRR tracking
If you’re thinking about setting up this kind of tracking in a spreadsheet based on the example we’re provided here, keep in mind that this is a very simplified example. Tracking your NRR (or any SaaS metrics for that matter) in a spreadsheet isn’t ideal. While it’s possible to track month-over-month NRR for several cohorts in this way, doing so would require so many spreadsheets that it would be almost unmanageable, and almost as soon as you finished, it would be time to start all over for the next month. Even tracking your NRR quarterly with spreadsheets is a behemoth task, not to mention extremely tedious and error-prone.
This is where a purpose-built financial planning and analysis (FP&A) platform like Drivetrain really shines. In addition to automating data aggregation from all your source systems, Drivetrain gives you the power to easily calculate your NRR and other financial and SaaS metrics in real time and use them to build the models you need to understand your business at a deeper level.
Calculating and tracking NRR could easily become a full time job. That’s time that cannot be used for the kind of forward-looking analysis needed to understand what NRR is telling you.
With Drivetrain, you can spend more of your time on the financial modeling necessary to surface actionable, data-driven insights to drive your business forward, monitoring its progress along the way, and proactive adjustments when needed to stay on target. Book a demo today to see how easy it can be to plan, manage, track and grow your business with Drivetrain!
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