By Alex Wittenberg, airCFO Director of Financial Advisory
At airCFO, we help startup founders like you track the metrics that matter most to support your startup’s financial growth. These mission-critical metrics are used in a variety of ways, from managing your business more effectively to communicating KPIs to your board and other stakeholders.
One of the ways we add value is by sharing the insights of other market leaders to give a deep dive view of why these metrics matter. To that aim, in this article we highlight net revenue retention: what it is, why it matters, and how to measure it. And we’ve weaved in insights from both the operator and investor perspectives:
- Patrick Coughlin, CEO of the startup TruStar, an Intelligence Management platform that transforms and automates data for security operations
- Arun Penmetsa, Partner at Storm Ventures, an early-stage venture capital fund focused on building enterprise leaders
What Is Net Revenue Retention?
Net Revenue Retention (NRR) measures the overall change in recurring revenue for a cohort of customers from one period to the next.
NRR is extremely useful as an indicator of how sticky a startup’s product really is to its customers. It also acts as a measure of the customer success team’s retention / upsell / cross-sell efforts. It is widely used to measure KPIs in a Software as a Service (Saas) business to capture cases such as:
- Customers buying new products from your company
- Customer churn
- Customer expansion or contraction based on usage
A strong NRR demonstrates that a company is able to successfully renew customers and deliver a strong value proposition to them in subsequent years of the relationship. A company whose business model depends on strong NRR is said to have a “land-and-expand” go-to-market strategy. Many of today’s most successful SaaS businesses use this approach.
And when your NRR is above 100%, it means the business is healthy and able to grow even if it does not acquire more customers.
From the startup perspective, Patrick says “NRR is a really valuable North Star for operators as it can serve as a proxy for how sticky your product is. Using NRR, you can shift your team’s focus to accounts that will expand over time versus those that will not grow with you over the long term.”
Arun observed that most of the value captured from a customer doesn’t come in the first year, but in the years that follow as the customer relationship deepens, making both gross and net retention valuable metrics to track.
When evaluating an investment opportunity, Arun looks for a business model that might lead a customer to pay more next year compared to this year: new features on the roadmap, network effects, usage-based pricing, etc. It’s also important for a customer to have predictability behind their revenue retention; a well-functioning business rarely sees a surprise churn.
Arun notes, “Whether it is through adding new seats, features or product lines, you want your net retention to be over 100%. There is some dependency on your sector and whether your customer profile is small business or enterprise, but generally being above the 130% mark for net revenue retention is very impressive. If you look at some of the best public companies, they have net retention of 130% to 150%, and so the compounding value of their customer contracts can get pretty dramatic over the years.”
How to Calculate Net Revenue Retention
Now that you know what NRR is, let’s talk about how to calculate it.
NRR is calculated by dividing the recurring revenue from renewal customers at the end of a period (incorporating expansion/contraction/churn) by the recurring revenue those customers represented at the beginning of that period.
Let’s look at an example:
- In a given quarter, a startup has $100K of annual recurring revenue (ARR) expiring across four customers @ $25K apiece.
- Two customers renew at their original $25K price point, one expands their usage of the product and signs a $75K deal in year 2 (a $50K increase over their original contract), and the last customer churns
- At the end of the quarter, the customers who previously represented $100K of ARR now represent $125K ($100K + $50K upsell – $25K churn)
- The company’s NRR for this cohort of customers is 125% ($125K/$100K)
When You Should Start Measuring NRR
A startup can start using NRR from day one as a lagging indicator of how much value certain customer segments are deriving from their product.
Patrick noted, “The challenge with NRR in the early stages is that there are a lot of reasons why an account can grow. You need to be having a very honest conversation with yourself about what metric sits upstream of revenue retention and how programmatic and repeatable that driver is. We found that our company’s true ‘North Star’ metric is the number of integrations that a given customer plugs into our system – we discovered this to be our most important metric by looking at which customers were most likely to renew with us and expand their services in future years”.
Once a startup has discovered a programmatic retention and expansion playbook, they can then begin tracking NRR to understand how well that playbook is functioning.
Another way to think about it is to begin tracking NRR when a company’s customer profile begins to look consistent over time.
Arun cautions against tracking NRR before this point, saying that “If you start tracking NRR too early, before you know which customer profile you’re selling to, you might base product decisions on customers who you don’t even want to keep around in the long-term.”
Net Revenue Retention Benchmarks for SaaS
At a bare minimum, a company should aim for a Net Revenue Retention number of over 100%, meaning that an average customer’s year 2 revenue is greater than their year 1 revenue.
Companies with higher Annual Contract Values (ACV) should have higher NRRs. For Enterprise SaaS, 125% is considered a good Net Retention Rate benchmark.
The highest performing public SaaS companies along this metric are shown here:
Source: Clouded Judgment (Substack)
Strategies to Improve Net Revenue Retention
When assessing performance, a founder needs to dig below the surface-level NRR metric to analyze the drivers in NRR movement.
It’s critical to understand the factors that motivated each customer to expand, contract or churn: for example, was the decision caused by macroeconomic factors (cyclicality / seasonality), the internal dynamics at the company, or an issue with your product?
As a VC, Arun advises that “Companies should pair NRR, the quantitative view of performance, with a set of qualitative views. Customer success should measure data points outside of revenue – like NPS – and get a sense of the reviews for your product/business from external sources, or by running customer advisory/case studies. Also, be sure that you’re segmenting your analysis of NRR by cohort, either chronologically or by customer persona.”
And from the founder side, Patrick said that, “You can be intimidated by the wild swings in NRR when a whole customer churns early in the business life, but as a startup you have to understand that you will churn customers.”
Your customer success team needs to diligently seek out and aggregate feedback from customers to help the company focus on strategies for improving NRR.
Need help? Let’s talk.
Now that you know what net revenue retention is, why it matters, and how to measure it, it’s time to get to work.
Need some help with your NRR? Schedule a discovery call and let’s see if we can help.
Author Note: Alex Wittenberg leads airCFO’s Financial Advisory team and serves as fractional CFO to 6 high-growth startups, primarily in the B2B SaaS space. He has a background in management consulting, startup finance and as founder of a social enterprise startup called CoffeeQ