How Net Revenue Retention Can Make or Break Your SaaS Business

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Net rev­enue reten­tion (also known as the net reten­tion rate or NRR) is a com­mon­ly used met­ric in SaaS com­pa­nies to mea­sure a com­bi­na­tion of cus­tomer reten­tion and upsel­l/cross-sell effec­tive­ness with exist­ing accounts.

The net reten­tion rate is expressed on a per­cent­age scale rel­a­tive to rev­enue. It is defined as fol­lows:

Net Retention Rate = Revenue from Accounts in Cohort at Start of Period / Revenue from Accounts in Cohort at End of Period

While many hear the term “net rev­enue reten­tion” and know investors ask about it, there are quite sig­nif­i­cant math impli­ca­tions to NRR that most peo­ple mas­sive­ly under-appre­ci­ate.

Let’s start with the basics and then build up to the insight­ful.

First, gross rev­enue reten­tion refers to your abil­i­ty to keep exist­ing cus­tomers with­out them can­cel­ing their sub­scrip­tions. It is a cohort-based met­ric. As such, you don’t include all of the cus­tomers in your SaaS busi­ness. Instead, you only include those cus­tomers who were active­ly pay­ing you at the start of the peri­od, and you com­pare the rev­enues from that spe­cif­ic cohort of accounts at the start of the peri­od ver­sus the end of the peri­od.

If you have 100 exist­ing cus­tomers on the first of the month pay­ing you $1 each, and 100% of those cus­tomers are still there on the last day of the month pay­ing you $1/month, then your gross rev­enue reten­tion is 100%. (Or the same idea stat­ed in oth­er ter­mi­nol­o­gy: your gross rev­enue churn rate is 0%.)

Note: Gross Rev­enue Reten­tion % + Gross Churn Rate % = 100%

Gross rev­enue reten­tion specif­i­cal­ly excludes upsells in the month. It only counts what exist­ing cus­tomers were con­tract­ed for on the first of the month and whether they are still there at the end of the month.

It is also a cohort-based met­ric. As such, you don’t include all of the cus­tomers in your SaaS busi­ness. Instead, you only include those cus­tomers who were active­ly pay­ing you at the start of the peri­od, and you com­pare the rev­enues from that spe­cif­ic cohort of accounts at the start of the peri­od ver­sus the end of the peri­od.

To clar­i­fy, let’s walk through an exam­ple.

In a giv­en year, on Jan­u­ary 31, you have 100 accounts that gen­er­ate $1,000 each for that month. Your month­ly recur­ring rev­enue for Jan­u­ary would be $100,000 (100 accounts x $1,000 per account). Now, let’s fast for­ward to Decem­ber 31 of the same year. Your rev­enue for Decem­ber = # of active accounts (that exist­ed in Jan­u­ary of that same year) x $ rev­enue per account.

To demon­strate, here are some exam­ples of net reten­tion rates under a vari­ety of sce­nar­ios.

First, assume that $100,000 month­ly recur­ring rev­enue from Jan­u­ary is the same across all sce­nar­ios below.

Cohort = Accounts that were active­ly pay­ing sub­scrip­tion fees in Jan­u­ary

# Active Accounts in Cohort Still Pay­ing in Dec$ Rev­enue per Account in DecDec Rev­enue Across All Accounts in Cohort
(# Accounts x $ per Account)		Annu­al Net Reten­tion Rate
(Com­pared to Jan)
Sce­nario 1100$1,000$100,000100%
Sce­nario 280$1,000$80,00080%
Sce­nario 3100$900$90,00090%
Sce­nario 4100$1,500$150,000150%
Sce­nario 590$1,300$117,000117%

Why Does Net Retention Rate Matter in SaaS?

As you can see, the net reten­tion rate is impor­tant because it’s a lead­ing indi­ca­tor of the rev­enue and prof­it growth poten­tial of the busi­ness.

When a busi­ness gains rev­enue through a sub­scrip­tion-based mod­el or repeat pur­chas­es, it is high­ly sus­cep­ti­ble to churn. Often, cus­tomers sub­scribe or make a pur­chase, and for some rea­son, they churn out. Thus, you stop receiv­ing pay­ments from them. This is rep­re­sent­ed by a net rev­enue reten­tion rate below 100%. In that case, rev­enues will auto­mat­i­cal­ly decrease over time.

Ide­al­ly, your busi­ness would have a net reten­tion rate above 100%. In these cas­es, the high rate shows that you’re keep­ing cus­tomers and they’re also increas­ing their spend­ing each month. If that’s the case, you could the­o­ret­i­cal­ly increase your rev­enue for­ev­er, even if you don’t acquire new cus­tomers. 

As a result, SaaS busi­ness­es with net reten­tion rates over 100% will typ­i­cal­ly receive very high val­u­a­tions.

In this next exam­ple, let’s say you have 100 exist­ing cus­tomers on the first of the month pay­ing you $1 each. At the end of the month, all 100 cus­tomers are still there. They’ve all main­tained their exist­ing con­tract, thus the gross rev­enue reten­tion is 100%.

How­ev­er, let’s say 10% of your cus­tomers were upsold into a high­er plan. They now pay $2 a month instead of $1. So from this group of cus­tomers, you start­ed the month at $100/month. Going into next month, they are now all con­tract­ed to pay an aggre­gate of $110 ($100 base + $10 in upsells).

In this sce­nario, your net rev­enue reten­tion is 110% (and your net rev­enue churn rate is actu­al­ly a neg­a­tive 10%).

Remem­ber: Net Rev­enue Reten­tion % + Net Rev­enue Churn % = 100%

110% NRR + (-10%) Net Rev­enue Churn = 100%

To help you find your net rev­enue, Click Here to Down­load my Net Rev­enue Tem­plate.

Okay, now that we have that out of the way, let’s get to the more inter­est­ing stuff.

Oth­er than the fact that you get to keep more rev­enue, what is the big deal about net rev­enue churn any­way?

Gen­er­al­ly, the high­er the net rev­enue reten­tion, the bet­ter. But, there’s an enor­mous inflec­tion point when NRR exceeds 100%.

This is enor­mous­ly impor­tant to grasp, espe­cial­ly if you have a SaaS busi­ness that is at or able to get to NRR over 100%.

To under­stand why this is such a huge deal, we have to step back for a moment to look at the math of recur­ring rev­enue busi­ness­es.

Net Revenue Retention < 100% Creates Recurring Revenue Ceilings

Recur­ring rev­enue busi­ness­es are great. You get 90%+ of your rev­enue every month on the first day of the month.

How­ev­er, there’s a prob­lem with recur­ring rev­enue busi­ness­es at scale. Even­tu­al­ly, the busi­ness gets so big that the churn dol­lars get enor­mous.

At this math­e­mat­i­cal ceil­ing on the busi­ness, your month­ly new book­ings dol­lars = month­ly churn dol­lars.

 

Net Revenue Retention Less Than 100%

This is because, in most recur­ring rev­enue busi­ness­es, there is some rev­enue loss each year. If there is any rev­enue loss, that means that with­out new book­ings, the rev­enue base shrinks over time.

Net Revenue Retention > 100% Massively Impacts ARR

How­ev­er, when net rev­enue reten­tion is over 100%, there is no loss. Every ini­tial sale not only retains but expands as well.

When you do the math, there is no rev­enue ceil­ing on the busi­ness.

Net Revenue Retention Over 100%

This means that if you can sus­tain net rev­enue reten­tion over 100% and you have any new book­ings each month, your busi­ness will the­o­ret­i­cal­ly and math­e­mat­i­cal­ly become a bil­lion-dol­lar ARR busi­ness… even­tu­al­ly (even if it takes 100 years).

The the­o­ret­i­cal math­e­mat­i­cal max­i­mum rev­enue at matu­ri­ty for a SaaS busi­ness with NRR over 100% is…. wait for it… infi­nite.

Here’s why this mat­ters.

When com­pa­ny val­u­a­tions are deter­mined, they are deter­mined in one of two ways (and often both ways). The first is to look at what com­pa­ra­ble com­pa­nies are sell­ing for. The oth­er is to build a mod­el fore­cast­ing the company’s life­time rev­enues and net income.

Intu­itive­ly, it makes sense that a busi­ness whose cur­rent tra­jec­to­ry nev­er hits a ceil­ing is worth more than a com­pa­ny whose cur­rent math­e­mat­i­cal tra­jec­to­ry tops out at $10 mil­lion ARR. They have wild­ly dif­fer­ent eco­nom­ic val­ues and thus wild­ly dif­fer­ent com­pa­ny val­u­a­tions too.

Annual Recurring Revenue

Con­cep­tu­al­ly, NRR over 100% is extreme­ly excit­ing. But to real­ly grasp why investors val­ue this met­ric (espe­cial­ly when com­bined with over 100% annu­al growth in new ACV and high mar­gins), you have to do the math.

To illus­trate the impact of net reten­tion rates, let’s look at a few exam­ples.

For com­par­i­son, let’s look at two busi­ness­es that each start with $10 mil­lion ARR (annu­al recur­ring rev­enue). Also, assume that nei­ther busi­ness has gained new cus­tomers.

Busi­ness 1 has a 60% net rev­enue rate, while Busi­ness 2 has a 140% net rev­enue rate.

Of course, we can already tell that Busi­ness 2 is going to see more rev­enue growth, but let’s look at the full impact of that dif­fer­ence in rate.

At the end of five years, the rev­enue of Busi­ness 1 has dropped to just over $1 mil­lion. Alter­na­tive­ly, the rev­enue of Busi­ness 2 is approach­ing $40 mil­lion.

SaaS Net Revenue Retention Comparison - 5 Years

After ten years, the rev­enue of Busi­ness 1 con­tin­ues to decrease to about $100 thou­sand, while Busi­ness 2 has passed the $200 mil­lion rev­enue mark.

SaaS Net Revenue Retention Comparison - 10 Years

Con­tin­u­ing the trend of the pre­vi­ous charts, after 15 years, Busi­ness 1 is down to a few thou­sand dol­lars. In com­par­i­son, Busi­ness 2 sur­pass­es the $1 bil­lion mark.

Again, Busi­ness 2 has over $1 bil­lion in rev­enue even though it has not acquired a new cus­tomer in 15 years.

Line chart comparing SaaS net revenue retention at 60% vs 140% over a 15-year period, showing exponential revenue growth with higher retention

Giv­en these charts, it’s easy to see why busi­ness­es with high net rev­enue rates con­sis­tent­ly gain the atten­tion of investors. With a net reten­tion rate of over 100%, your rev­enue can’t decrease, even with­out new cus­tomers.

In recur­ring rev­enue busi­ness­es, ARR is extreme­ly sen­si­tive to net rev­enue reten­tion.

If you look at things from a val­u­a­tion stand­point, the val­u­a­tion for Busi­ness 2 is going to be a much big­ger num­ber than the same mul­ti­ple applied to Busi­ness 1.

But wait… there’s more! 🙂

There’s a third-order impli­ca­tion to net rev­enue reten­tion, which has to do with the ratio of life­time val­ue to cus­tomer acqui­si­tion cost (LTV/CAC).

How Does NRR Impact LTV/CAC

To put it sim­ply, the high­er the LTV, the more you can spend to acquire new cus­tomers. Com­pa­nies with a high­er NRR and strong sales process­es can out­spend com­peti­tors, and that’s an enor­mous advan­tage.

Let’s go back a bit. 

The LTV/CAC ratio helps eval­u­ate a go-to-mar­ket team’s abil­i­ty to cost-effec­tive­ly acquire cus­tomers. Typ­i­cal­ly, an LTV/CAC ratio of 3.0 or high­er is good.

Here’s the plot twist.

You can only real­ly cal­cu­late the life­time val­ue of a cus­tomer when they leave. What hap­pens if cus­tomers nev­er leave and, in fact, stay and spend more?

In the­o­ry, the LTV is infi­nite or can’t yet be deter­mined.

So, what’s the impli­ca­tion for this?

Many com­pa­nies try to get their cus­tomer acqui­si­tion cost down. This is total­ly wrong think­ing. (Okay, it’s not “wrong” per se, but it is lim­it­ed.)

Instead, you want to get your LTV up so high that you can tap lead-gen­er­a­tion sources and cus­tomer-acqui­si­tion chan­nels that your com­peti­tors can­not eco­nom­i­cal­ly afford to pur­sue.

In every mar­ket, there are low-cost lead-gen­er­a­tion chan­nels and high-cost ones.

If your LTV is high enough, you can afford to acquire new cus­tomers through all chan­nels, includ­ing the more expen­sive ones.

All of your com­peti­tors with low­er LTV can only afford to com­pete in the low-cost lead-gen­er­a­tion and the sales chan­nels.

Let me give you some sim­ple exam­ples.

For many SaaS com­pa­nies, refer­rals from exist­ing cus­tomers are the low­est-cost way to acquire new cus­tomers… because there’s vir­tu­al­ly no cost.

If your com­peti­tor has a very low cus­tomer-life­time val­ue, then they real­ly can’t afford high­er-cost cus­tomer-acqui­si­tion chan­nels like paid ads, spon­sor­ships, con­tent mar­ket­ing, out­bound tele­mar­ket­ing, or live events.

If you have a very high LTV (fueled in large part by high net rev­enue reten­tion), then you can go acquire new cus­tomers via paid ads, spon­sor­ships, con­tent mar­ket­ing, out­bound tele­mar­ket­ing, and live events… while they can’t.

Even­tu­al­ly, a com­pa­ny that can com­pete on all fronts gen­er­ates enough crit­i­cal mass to become the de fac­to stan­dard in that mar­ket. You become the “safe choice” because every­one else is already using you. This then starts a vir­tu­ous cycle upward. Life­time val­ue goes up, while cus­tomer acqui­si­tion costs go down. When the LTV/CAC ratio goes up, you can afford to spend more to acquire even more cus­tomers.

Key per­for­mance met­rics like net rev­enue reten­tion are not just num­bers you’re sup­posed to man­age just because investors and debt lenders care about them. Met­rics like NRR have rela­tion­ships with oth­er key met­rics that, in turn, have enor­mous impli­ca­tions for win­ning in the mar­ket­place. To be an effec­tive SaaS CEO, you must under­stand these rela­tion­ships and the impli­ca­tions they have on the out­come of your busi­ness.

This is the strate­gic part of being a CEO. It’s play­ing “chess” and see­ing five moves ahead when every­one else can only see one move ahead.

NRR dri­ves an advan­taged LTV/CAC ratio… a supe­ri­or LTV/CAC ratio exploit­ed prop­er­ly gives you access to cor­ners of the mar­ket that your com­peti­tors can’t reach. In oth­er words, when you have an LTV/CAC advan­tage, your TAM (total address­able mar­ket) is sig­nif­i­cant­ly big­ger than your competitor’s.

If your com­peti­tor can only con­tact those prospects that their exist­ing cus­tomers know while you can afford to con­tact the entire mar­ket, you will win.

Additional Resources

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Vic­tor Cheng
Author of Extreme Rev­enue Growth, Exec­u­tive coach, inde­pen­dent board mem­ber, and investor in SaaS com­pa­nies.
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