ARR (Annual Recurring Revenue)

Definition

Annual Recurring Revenue (ARR) is a metric used by SaaS and subscription-based businesses to measure the predictable and recurring revenue normalized for a single year. It represents the value of the contracted recurring revenue components of term subscriptions normalized for a single 12-month period.

Key Components/Applications

1. Subscription Revenue: Regular payments from customers for ongoing service
2. Expansion Revenue: Increased revenue from existing customers (e.g., upgrades)
3. Contraction Revenue: Decreased revenue from existing customers (e.g., downgrades)
4. Churned Revenue: Lost revenue from cancelled subscriptions
5. New ARR: Revenue from new customers added in the period

Importance in SaaS

For SaaS businesses, ARR is crucial because it:

1. Provides a clear picture of the company's financial health and growth
2. Helps in forecasting future revenue and cash flow
3. Is a key metric for valuation, especially for investors and potential acquirers
4. Allows for easy comparison with other SaaS companies
5. Helps in setting sales targets and evaluating performance
6. Indicates the stability and predictability of the business model

Best Practices

1. Consistently define what constitutes recurring revenue
2. Exclude one-time fees and non-recurring charges from ARR calculations
3. Regularly track and report on ARR, including its components (new, expansion, churn)
4. Use ARR in conjunction with other metrics like churn rate and CAC
5. Analyze ARR trends over time to identify growth patterns and issues
6. Break down ARR by customer segments or product lines for deeper insights
7. Ensure accurate and timely recording of subscription changes

Common Pitfalls/Challenges

1. Including non-recurring revenue in ARR calculations
2. Failing to account for discounts or promotional pricing
3. Not properly tracking or attributing expansion and contraction revenue
4. Overemphasizing ARR at the expense of other important metrics
5. Difficulty in accurately forecasting ARR due to complex pricing models
6. Misalignment between cash collections and recognized revenue

Tools

1. ProfitWell: Revenue recognition and subscription analytics
2. ChartMogul: Subscription analytics and revenue recognition
3. Baremetrics: Subscription analytics and insights platform
4. Recurly: Subscription management and billing platform
5. Zuora: Subscription order-to-revenue platform

Real-World Examples

1. Salesforce: Reported $21.25 billion in ARR for fiscal year 2021
2. Slack: Had $630 million ARR before being acquired by Salesforce
3. Zoom: Reported $2.65 billion in ARR for fiscal year 2021
4. Dropbox: Surpassed $2 billion in ARR in Q4 2020

Related Terms

• MRR (Monthly Recurring Revenue)
• Churn Rate
• LTV (Lifetime Value)
• CAC (Customer Acquisition Cost)
• Net Revenue Retention
• SaaS Magic Number

Further Reading

1. SaaS Metrics 2.0 – A Guide to Measuring and Improving What Matters