The SaaS industry is plagued with acronyms and business gobbledygook.
If you're not careful, you'll find yourself in a state of information paralysis: overwhelmed with the amount of stuff you need to keep track of and learn to do your job well.
To spare you unnecessary pain and suffering, this article is an attempt to unravel the mess around one simple metric every SaaS business should know: Annual Recurring Revenue.
ARR is one of the most vital metrics because it helps you predict the future:
a) how much money you will make, and b) when exactly your business will become profitable (if it ever does).
Today, we'll show you exactly what ARR is, why it matters, and (more importantly), how to grow it.
Let's start with the basics.
What is ARR?
ARR stands for Annual Recurring Revenue. It is the total amount of money your business will make per year if you maintain the current level of customers.
It's an estimation metric that shows a normalized value of a business' gross revenue over a period of 1 year.
In other words, it's your current top line or monthly recurring revenue ( MRR ) multiplied by 12, minus lost revenue.
For instance, let's say you have 100 customers who are paying you $100/month. Your ARR is $120,000 (100 customers x 100/month x 12 months).
Why is ARR One of the Most Important SaaS Metrics?
So far, so good. But why is ARR so important to your business?
Well, because it's much more than just an accounting trick to calculate the amount of money you'll make.
ARR makes your business predictable and makes you a strategist. It will allow you to:
a) forecast customer behavior, and b) optimize your product's pricing for growth.
Let's discuss both points in more detail.
1. ARR is a Forecast of Your Future Revenue
It's pretty much like the weather.
You're not 100% sure if it will rain, and you can't say precisely when. But you know it'll rain in a week or two. You can even tell how much water you need to prepare for.
In the same way, your ARR is a forecast of how much money you will be making in the future.
For instance, if your ARR is $100,000 and you know that you have a 5% monthly churn rate, then next month's ARR will be $95,000.
In short, ARR tells you how fast your revenue is growing or shrinking.
This makes it a very powerful tool because it will allow you to discover some interesting patterns and trends.
If your ARR is going down, it means one of two things:
- Your churn rate is increasing (i.e., customers are canceling their subscriptions more often).
- Your average revenue per user ( ARPU ) is going down (i.e., customers aren't spending as much money on your product).
If your churn rate is increasing, then you'll need to spend more time on customer retention activities. If your ARPU is going down, then you'll need to spend more time on pricing experiments.
The bottom line is: ARR tells you exactly how your revenue is doing. It's a great tool for monitoring and measuring the overall health of your business.
2. Optimize Your Product's Pricing For Growth
A critical part of growing a SaaS business is experimenting with the price point.
And this is exactly where ARR comes in handy.
You see, your current ARR is the result of your past pricing experiments. So when you experiment with pricing, you'll have a built in benchmark to measure your experiments against.
This information can give you some great insights and help you discover:
- The maximum price customers are willing to pay for your product (and the highest possible ARPU)
- The lowest possible churn rate your business can have at this price point
In other words, optimizing your price for growth means finding the sweet spot where you have a low churn rate and a high ARPU.
Every time you experiment with pricing, make sure to compare the results against your current ARR. This will help you measure your experiments and determine which ones will move the needle.
ARR Benchmarks For SaaS Organizations
Benchmarks play a crucial role in growth because they set the grounds for comparison.
If you own a SaaS company, your ARR benchmarks will vary depending on your industry and maturity level.
However, there are some industry-wide benchmarks that are pretty solid.
A relatively recent study revealed that only 2% of companies reported shrinking revenue YoY, and roughly 9 out of 10 brands reported annual revenue growth greater than 10%.
Here’s a more thorough explanation of these numbers:
- SaaS companies with $2 million in annual revenue should be growing at 90% YoY to be in the top 25% of its peers.
- SaaS companies with $10 million in annual revenue should be growing at 55% YoY to be in the top 25%.
- SaaS companies with more than $10 million in annual revenue should be growing at 20% YoY to avoid being in the bottom 25% of its peers.
Of course, these numbers aren't carved in stone and your mileage may vary.
But they give you a good idea of the type of growth you need to be seeing at different stages of your business.
Regardless of the size and maturity level of your SaaS company, it's vital that you measure your ARR performance against industry benchmarks.
This will not only help you remain grounded and realistic, but it will also help you spot potential signs of trouble early on.
Effective Strategies For ARR Growth
Now that you ‘ve got the basics of ARR, let’s explore a few strategies to grow it.
In short, there are just four ways to improve your ARR:
- Increasing your ACV
- Reducing your CPAs
- Reducing churn
- Acquiring more customers
Let’s explore each of these strategies in more depth.
1. Increase Your ACV (Average Contract Value)
This is a fancy way of saying “charge more for your product.”
When you increase your ACV, you can do it in two ways:
- Increase your prices (thereby increasing the amount of revenue per new customer)
- Increase the total contract value of your existing customers
The first method is the simplest, but it may also be the hardest.
That's because when you try to raise your prices, it usually means that you need to introduce a pricing tier and help your customers understand the value of each tier.
Pricing tiers are critical for your SaaS business, but they can also be a double-edged sword.
There's no such thing as a one-size-fits-all pricing strategy.
Each of your customers has different needs and will value your product differently.
This means you'll need to experiment with different pricing strategies and tiers to find the optimal mix.
The alternative is to increase the amount your existing customers pay without changing your pricing structure.
This is a lot harder to do, but it can be invaluable if you get it right.
A few strategies to do it might include:
- Upsells and cross-sells: Offering your existing customers additional products or services after they sign up might help you increase your ACV.
- Increase the average contract length: Getting customers to commit to longer contracts can increase the amount they pay every month (or year).
- Increase the number of users on a single contract: In software, it's more common to have a larger number of employees using a single account. By increasing the number of users per contract, you can increase your ACV.
2. Increase Retention
Churn is one of the biggest enemies to your SaaS business.
It eats up crucial resources and eats into your margins.
Fortunately, there's a few key things you can do to prevent churn and increase retention.
Let's explore a few of them:
a) Increase ACL (Average Contract Length)
There's a high correlation between average contract length and churn rates.
Where the average contract length is less than a year, the churn rate is 16.7%. By increasing this length to two years or more, that almost halves to 8.5%.
In other words, the longer the contract length, the lower your churn rate.
As we covered earlier, you can increase your contract length by offering discounts for longer term contracts, upselling and cross-selling to existing customers, or increasing the number of users per account.
b) Loyalty programs
Some SaaS businesses use loyalty programs to great effect.
These can take many forms, but most involve some reward for the customer to keep them coming back for more. For instance, you could offer discounts for renewing contracts, or you could offer special bonuses.
The exact strategy is up to you, but don't be afraid to experiment with different loyalty programs to see what works best for your business.
c) Personalized communication
Another proven strategy is to use personalized communication with customers.
When customers feel like you care about their needs, they're more likely to stick around.
And it's not just us saying that.
A few tactics to try in your personalized communication might include:
- Send a questionnaire when customers first sign up: Getting their feedback on the product and their needs could help you create better products in the future.
- Send a survey periodically, particularly after key milestones: Whether they've just opened an account, got their first invoice paid, or renewed for another term, sending a survey at that time could be the impetus they need to stick around.
- Send personalized emails on their birthdays or special events: Send this along with a gift card or coupon to give them a reward for being a loyal customer.
These are just a few ideas to get you started, but personalizing your communication should prove especially valuable.
3. Reduce Your CPA (Cost per Acquisition)
Once you've got your marketing engine humming, it's time to make it even more efficient.
Some tactics can help you reduce your CPA and improve the efficiency of your marketing engine:
a) Optimize for mobile traffic
Mobile traffic is the future, and it's important to make sure your landing pages are optimized for mobile.
Many people start their shopping journeys on their mobile devices, so you should too.
If your landing pages aren't optimized for mobile, prospects could get frustrated and leave before converting. What's more, Google will punish you for having subpar mobile sites by pushing you further down the search results.
b) Personalize your messaging
We talked a little about personalization in the previous section, but this tactic deserves its own.
Personalized messaging can have a huge impact on your CPA.
For instance, personalization can reduce CPAs by up to 50%, according to Adweek.
Besides, email marketing personalization can increase conversions by up to 760%.
In other words, people seem to love personalized offers.
By investing some time and resources into fine-tuning your messaging, you can enjoy the benefits of lower CPAs and increased conversions.
c) Tap into multi-device targeting
Thanks to the proliferation of mobile devices, people are using multiple screens at once.
This doesn't just mean people are using their desktop and laptop at the same time.
People switch devices throughout the day to access content, often starting with their smartphone before moving on to their laptop.
So you need to make sure your messaging resonates with people across all these devices.
One way to do this is by leveraging multi-device targeting.
This basically gives you the opportunity to serve your message across all devices, so people get the same brand experience no matter when or where they access your message.
This might sound simple, but it can provide a big boost to your marketing.
4. Acquire New Customers
Now that you've smoothed out your engine and optimized it for growth, it's time to find more fuel.
This means acquiring new customers.
But not just any customers. You should look for the right ones.
About 20% of your customers produce 80% of your sales.
In other words, there is a power law at play.
As you grow, it's vital to find the 20% of your customers who are responsible for most of your ARR. Then, think of ways to replicate these profiles across other customer segments.
A simple way to do this is to look at your customers and find out what they have in common.
If they all work at a certain company, for example, this might be a good place to start.
Once you've got a pool of similar customers, make it a priority to reach out and develop relationships with them.
Think of all the things your core group has in common. Their industry, company size, business model – you should be able to find a few commonalities between them.
Then use this information to target other customers with similar profiles.
The point is to get in front of more prospective customers who are likely to do business with you.
By using this approach, you can get more out of your current clients while accelerating future revenue.
ARR is one of those metrics that can be easy to overlook and difficult to grow.
Fortunately, there are some simple strategies you can use to get the results you're looking for.
By implementing the information outlined in this guide, you should be able to experience significant growth in your ARR.
And, if you're looking for additional resources, take a look at this guide to SaaS metrics.