Let’s jump right in.
You’ve seen 348 diagrams of how to calculate GRR and NRR
But how do operators actually convert raw contract data into everyone’s favorite SaaS metrics?
Don’t worry…
Today we’re diving into 3 super important metrics (Renewal Rates, GRR, and NRR), the differences with other common metrics and common pitfalls.
Download the free worksheet to follow along and test out your skills 👇
This is the second part of my series on building an ARR Book. If you didn’t check out Part 1: ☁ How to Build an ARR Book (Part 1)
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Renewal Rates
Renewal rates aren’t as widely discussed externally as its cousin GRR as it’s largely an internal operating metric. The metric measures how much ARR is renewed vs. contracts ending and is commonly tracked by management and GTM teams.
Renewal Rate = Renewed ARR / ARR up for Renewal in period
ARR up for Renewal is simply the value of contracts that are ending, and therefore must be renewed in any given period.
While its highly related to a company’s GRR, GRR is a balance metric while up for renewal is a transaction metric. Your GRR will reflect the cumulative renewed balance over time as measured by the Renewal metric.
An important distinction is that ARR must be renewed BEFORE the contract ends. So the Renewed ARR (and the flip slide, Churned ARR), is a generally captured a period before Lost ARR is reflected in your ARR bridge and therefore the GRR calculation.
You will also be able to track which months will require more renewal effort (typically at the end of quarters and fiscal year) and what products/segments are coming up for renewal which much impact your overall churn.
Gross Revenue Retention (GRR)
Gross retention is how much ARR is retained (excluding upsells and lands) from the starting balancing 12 months ago
GRR = Retained ARR from logos 12 months ago / ARR 12 months ago
As discussed above, it reflects the cumulative churn from the up for renewal contracts over the past 12 months which is why the 2 metrics are important to consider and analyze together.
The other important difference GRR accounts for is different length contracts. If a company only sells 1 year contract, that means 100% of their ARR must be renewed every year. Not only does this leave more opportunities for customers to churn, it also strains the company on an operational level as most contracts require a touch point from the GTM team as some varying level to renew the contract.
If a SaaS company expands their average contract to 2 years, that means only half of their ARR is up for renewal every year. As an example, an 80% renewal rate would then be reflected by a 90% GRR.
Net Revenue Retention (NRR)
Net Revenue Retention is generally considered the holy grail of SaaS metrics as it reflects how much incremental revenue you’re able to drive from current customers.
NRR = Total ARR / ARR from logos 12 months ago
GTM teams are frequently divided between “hunters” and “farmers”. Hunters go out and find new logos while “farmers” try to expand current customers.
Landing new customers tend to have longer sales cycles and require more resources to close (from BDRs, SE, legal, and other support). Overall this makes new logos generally more expensive relative to incremental ARR contribution than expansion ARR.
In theory, once you land a customer, expansion should be easier as the relationship and trust has already been built (again, “in theory is pulling a lot of weight here). This leads to shorter sales cycles and fewer other internal resources needed to close a contract. In expansion deals, the primary expense is enabling customers to increase usage, add new seats, or purchase incremental modules.
All else equal, a higher NRR should enable higher long-term margins especially as growth slows and new logos become a smaller % of total ARR growth.
Comparing vs. Gross retention and Net Retention rates
Anyone close to SaaS metrics knows there are millions of ways to calculate these metrics, with each company using their own internal spin on each of the metrics.
When you think about the number of inputs going into each of these calculations, you can quickly picture the number of assumptions that must go into each stage.
As such, there are many other commonly used terms that are sometimes used to reflect the above metrics, derivatives of such or shortcuts to represent similar trends.
The most common of these is using the ARR book / Leaky Bucket to calculate in-period expansion and churn and gross these up to an annual metric. ICONIQ uses a similar methodology in their SaaS Glossary ARR Funnel template.
While keeping track of these metrics may be helpful it’s important to remember they hide a lot of underlying information that a full ARR book would uncover.
As a note, top VCs and growth equity investors generally require a full ARR book as part of their normal due diligence precisely for this reason.
Reminder: Real Life is MESSY
Its easy to build excel examples to show how to calculate these metrics in hypothetical situations, but as discussed above, real life if always messier.
I could write a full post on the intricacies of ARR books and contract data but to quickly highlight a few complexities our simple example doesn’t cover:
MRR vs. ARR. Most metrics force monthly contracts into annual metrics such as GRR and NRR. I generally speak more to annual contracts and metrics as my experience is in the b2b space.
Large contract complexity. When companies offer many products or pricing tiers to large customers, there’s frequently movement between these products, with different timing, and varying discounting across products. Its important to member all these metrics are cohorted on a logo basis to net out any of these impacts.
Active ARR vs. Contracted ARR. Again there are many differed terms for the same thing, but Contracted ARR may reflect all contracts signed, even those that have not started yet, while active ARR is only contracts which have started and are actively contributing to revenue.
Discounts/Ramp deals. There’s always operational reasons (i.e. a massive customer wants to pay you a lot of money) to discount your products or provide varying levels of service throughout the contract. When possible, your ARR should seek to represent your revenue recognition in the period as closely as possible.
And make sure to check out my other SaaS 101 posts:
With Blessings of Strong NRR,
Thomas
Any questions? Respond to this email or drop them in the comments 👇
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🚨 Workshop starts TOMORROW! (reply to this email with any questions)