What is Monthly Recurring Revenue (MRR) And How Do You Calculate It?

What is MRR?

Monthly recurring revenue is a company’s expected monthly income from customers. It is mostly associated with the software-as-a-service (SaaS) industry, which offers services to customers on a subscription basis. Think about your telecom service provider, streaming platform, or software application provider.

The MRR assumes great importance in the backdrop of the dominance of SaaS. In Singapore alone, SaaS companies accounted for 58% of the public cloud market share in 2020.

As a performance metric, monthly recurring revenue is crucial to track as changes in MRR directly reflect changes in a company’s growth momentum.

MRR vs ARR

While discussing the meaning of MRR, it is important to differentiate it from annual recurring revenue (ARR). Annual recurring revenue is the income a company expects to generate from annual subscriptions. As the title suggests, it is calculated annually. One can say that MRR provides a micro view of a company’s growth over a short period while ARR gives a macro view and is more suited for a longer period.

The importance of MRR for your business

While monthly recurring revenue is not required for financial reporting, it is an important metric to track as it has more than a few benefits for business:

Monitoring performance

Monthly recurring revenue is an easy, decisive indicator of company performance. First of all, tracking MRR gives you visibility over your monthly cash inflow, in turn letting you know whether you have enough funds to cover your monthly expenses. A month is also a fairly reasonable period to measure growth and assess if a business is on a healthy growth trajectory or sputtering and slowing down.

Financial forecasting

Given that predictability and consistency are factors in monthly recurring revenue, tracking MRR can help you make informed financial forecasts backed by data. With a careful analysis of your monthly revenue data, you can predict, with a degree of certainty, projected sales or revenue for the following month/months. What’s more, you can use this information to plan your business strategy for the short and long terms, including those all-important investment decisions.

Budgeting

Now that you know how much revenue is coming in every month, compare this information with your monthly expenses and you’ll know exactly how much you have left over to re-invest in your business. Knowing how to budget and stick to budgets is a must if you are a small business or start-up with space to grow but limited resources. Realistic and well-planned budgets contribute to reliable decision-making.

Knowing customer behaviour

There’s another advantage to knowing what is your MRR, and that is the valuable insights you gain into customer behaviour. Knowing how likely a customer is to renew their subscription or cancel it altogether gives you room to plan accordingly – by making improvements to your products and services, offering discounts, throwing in attractive add-ons, upgrading your after-sales service, and so on. Your data-backed efforts will reward you with a healthy subscriber base and handsome profit margins.

Types of MRR

There are six types of MRR and each provides a unique insight into customer behaviour, revenue flow, and business growth:

New MRR

Revenue generated by new customers who sign up for a product or service.

Expansion MRR

Revenue from existing customers who have expanded their subscriptions with upgrades and/or add-ons.

Churn MRR

Revenue lost as a result of customers cancelling their subscriptions. Churn MRR is arguably the most important metric to keep tabs on as it helps you understand why and how customers fall off. And while churn is an integral part of the SaaS business, it is still highly undesirable. A high churn rate not only indicates loss of revenue but additional expenses, too, as it costs much more to sign up a new customer than to convince an existing one to renew.

Contraction MRR

Loss of revenue from customers downgrading their subscriptions (changing to a cheaper plan) or removing features.

Reactivation MRR

Revenue regained from customers who had ended their subscriptions but have since returned.

Net New MRR

Net new MRR is an aggregate of four MRRs. To calculate it, you add new MRR (new customers) and expansion MRR (customer upgrades). Then, from the total, you subtract churn MRR (cancellations) and contraction MRR (downgrades). Net new MRR serves as a measure of the increase or decrease in your recurring revenue for a specific month compared to the previous month.

How to calculate MRR

There are two ways to calculate MRR:

By revenue per customer

This MRR formula requires you to calculate the monthly recurring revenue for each customer and then add up the revenue for all your customers. For example, let’s say you have five customers with varying MRRs – two of them are on an SGD 10-per-month plan while the remaining three pay SGD 30 per month. Therefore, your MRR equals SGD 10 + SGD 10 + SGD 30 + SGD 30 + SGD 30 = SGD 110. If you have a large data set on account of a large customer base, using this MRR formula can be time-consuming and prone to errors. Then using the next MRR formula makes more sense.

‍By average revenue per unit (ARPU)

To calculate MRR using this method, you first need to calculate the monthly average revenue per user (ARPU). The formula is ARPU = Total revenue / Average number of monthly users. Now, you can calculate the MRR using this formula:

MRR = ARPU x Total number of customers

MRR example

Let’s calculate the MRR of a SaaS company from January 2023 to April 2023. Assuming that the company starts with 2,000 active subscribers in January and witnesses a churn rate of 3% and acquisition rate of 5% for the entire four-month period, the number of active users for each month is:

January: 2,000 - 60 + 100 = 2,040

February: 2,040 - 61 + 102 = 2,081

March: 2,081 - 62 + 104 = 2,123

April: 2,123 - 64 + 106 = 2,165

Now. assuming that the monthly ARPU is SGD 250, the MRR for the four months would be:

MRR for January: 2,040 x SGD 250 = SGD 510,000

MRR for February: 2,081 x SGD 250 = SGD 520,250

MRR for March: 2,123 x SGD 250 = SGD 530,750

MRR for April: 2,165 x SGD 250 = SGD 541,250

Mistakes to avoid when calculating MRR

While the MRR formula is straightforward enough, these wrong practices can still skew your calculation: 

Including quarterly and annual revenue at full value

Not all subscription revenue is monthly. Some customers choose to pay weekly, quarterly, semi-annually, and annually too. Including these non-monthly payments into your MRR formula will give you inaccurate results. What you need to do is change these payments into monthly instalments. For example, if a customer is on an annual SGD 1,200 telecom plan, simply divide that number by 12 and the SGD 100 figure you get is what you use for your MRR calculation.

Including non-recurring revenue

One-time set-up fees, professional services fees, and consulting charges are examples of non-recurring revenue. Including such non-subscription fees will inflate your company’s MRR and give you a false picture of its financial health.

Including trials

It is common practice to offer potential customers a free trial in the hope of converting them into paying customers. But not every free trial ends in a subscription and including their value in your calculation will inflate your New MRR and Churn MRR, leading to skewed results.

Leaving out discounts

If you have given a customer a discount on their subscription, this must be factored in. Not including discounts will erroneously inflate your MRR.

Excluding late and transaction fees

Payment delays are common in the subscription business, and accounting for delinquent charges on late-paying customers is a must for accurate MRR recording. But there is a practical problem here. Late fees are usually not included in MRR calculations at the end of the month because the payment has not come through. What experts advise is for companies to create a separate category for delinquent fees, so that these can be monitored as well. Similarly, remember to include transaction fees in your MRR calculations if they are of a recurring nature.

Neglecting MRR categories

Each MRR type gives a unique perspective into a business’ growth. If you ignore the various categories and choose to work with only a top-level MRR figure, you might be missing out on a major problem area – such as a high rate of cancellations that is masked by a short period of high growth.

How to analyse MRR

At first glance, monthly recurring revenue looks like a simple, one-dimensional figure. But it can provide nuanced and defined insights into your business if used correctly. A well-thought-out MRR analysis can help you:

• Identify trends that can help you acquire and retain more customers
• Assess the effectiveness of individual pricing tiers and your company’s sales approach as a whole
• Use the insights to identify areas for improvement and plan strategy.

How to increase MRR

Offer a great product

This is the easiest way to avoid churn and retain customers who might be thinking of ending their contracts with your company. Focus on quality (of products and services) rather than quantity (of customers) and back it up with prompt customer service and smooth lines of communication. What’s more, a great product allows you to increase your prices without putting off customers.

Get your pricing right

Product pricing can be a tool to improve MRR. Instead of taking a one-size-fits-all approach, most SaaS companies prefer to offer customised products and services. That’s because each customer has different requirements. One way of customising is offering different pricing tiers – basic, standard, and premium – that target varied sections of customers. Then there’s usage-based pricing, which allows your subscribers to be billed only for what they use. To choose the right pricing strategy, all you need to do is analyse your company’s MRR data, which is rich in useful information and insights into customer requirements and behaviour.

Upsell/cross-sell

Upselling involves persuading customers to upgrade to a more expensive product/plan while cross-selling entails offering related products and services that complement the original purchase. For example, upselling is when your streaming service platform convinces you to move from a single-user plan to a family plan at a higher cost. Meanwhile, a company makes a cross-sell when it bundles a training class with a software subscription for an additional fee. Upselling and cross-selling are effective techniques to employ when your existing customer base is willing to spend a little more on your products.

No freebies and ‘unlimited’ plans

Free plans are an easy and effective marketing tool companies use to get more customers. However, offering too many free plans does nothing for your revenue and might even give the impression that your products are of little value. Another limitation of free plans is that they offer only the most basic features, so users don’t get to know the full extent of your offerings. Instead of free plans, offering limited-period free trials can have the same effect from a marketing perspective while also improving your monthly recurring revenue. Similarly, offering ‘unlimited’ plans is equal to putting the brakes on your income flow. A smarter move would probably be to price a product according to the value it provides.

Limitations of MRR

Despite its undeniable usefulness, monthly recurring revenue is not a magic bullet. In fact, there are several limitations to using MRR: 

Lack of precision

Measuring your company’s financial health solely on the basis of its MRR can be misleading. Let’s assume that your last sale was six months ago, when you sold an annual contract payable in monthly instalments. For the last six years, you have been receiving these monthly instalments, which gives a false impression of revenue and growth. For a more accurate reading of company finances, it would be wise to use several other metrics in addition to MRR. These include customer churn and customer lifetime value (which measures the total revenue earned from an average customer over their entire relationship with your company).

One-dimensional approach to revenue

A company’s revenue can vary. Take, for instance, a company that sells SaaS subscriptions in addition to products that account as one-time sales. In such a scenario, using MRR to inform decisions on resource allocation might lead to disagreements and disputes between the two arms of the business. Another shortcoming in using MRR is that many companies tend to treat all revenue as the same. However, the cost of acquiring a new customer is much more than retaining an existing customer or re-acquiring a former user. Failing to treat these revenue types as separate categories will lead to an inaccurate MRR reading.

Timing complications

A company’s recurring expenses have different timelines. However, when computing the MRR for a particular month, you might include subscription payments that are four weeks apart. One way to avoid this problem is to make daily revenue reports, but this might not be a practical solution.

Cashflow concerns

Attracting customers is a top priority for most businesses, but it comes at a cost. As we mentioned, it is more expensive to get a new customer than to persuade an existing one to renew their plan. In the MRR business model, you might sell an annual contract but the revenue is spread across months. This might mislead to spend money you don’t yet have to expand the business, resulting in a negative cashflow and debt situation. This is the reason why precision and attention to detail are crucial when calculating and analysing MRR data.

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