SaaS ARR (Annual recurring revenue) Guide: Running a Health Check on Your SaaS Business
If you explore hundreds of SaaS company websites, you will see that the majority of them have a toggle switch on their pricing page – monthly billing or annual billing? That’s particularly designed to facilitate the decision process for the potential buyers – some want to pay in advance and save money, some avoid a long-term agreement and choose to pay when they will need the software.
When both the monthly and annual billing systems are available on your website, you feel the need to calculate your revenue from both separately. So in this guide, we will talk about the annual billing system, how to calculate your ARR and how to convince your existing customers to switch from monthly to annual (and discover is it worth?). Let’s get started.
What does SaaS ARR stand for?
ARR is the abbreviation for Annual Recurring Revenue. It’s typical for subscription businesses, especially SaaS and is a metric that shows the monetary value of a single subscription normalized for a single year. One-time fees (for example, training or consultation) are not included in ARR.
How to calculate your SaaS ARR?
ARR SaaS metric = (#number of customers)*annual subscription fee of the 1st pricing plan + (#number of customers)*annual subscription fee of the 2nd pricing plan + (#number of customers)*annual subscription fee of the 3rd pricing plan (and the list continues depending on the number of your pricing plans).
When you start to calculate ARR, you should know what’s included in that metric and what’s not. Like mentioned above, you should exclude one-time fees during your SaaS ARR calculation but include
- Your new customers who subscribe to an annual plan
- Your existing customers who upgrade from monthly to annual billing
When your annual subscribers stop using your services or go from annual to monthly, this affects your ARR in a negative way.
Let’s look at examples.
If one customer subscribes to your annual plan for 2 years and pays $5.000 to you upfront,our ARR is $2.500 in this ca
If one customer subscribes to your annual plan for 2 years and pays $5000 with monthly payments ($208), your ARR is again $2.500.
If a customer subscribes to your monthly plan, pays $100 monthly and uses your services for a year, your ARR is 0 because this should be calculated separately as MRR (Monthly Recurring Revenue).
If a customer subscribes to a 1-year plan and pays $500 upfront or with monthly payments, your ARR is $500.
Doesn’t matter if a subscriber pays the annual fee in advance or on a monthly basis. If an annual or multi-year plan has been chosen, you include them in your SaaS ARR calculation.
Why annual billing will make you feel happier?
In our article Annual vs Monthly Subscription for SaaS Businesses: Weighing the Pros and Cons, we cover the topic in-depth and also talk about how the transactional model is different from the subscription. We will summarize the main pluses in the bullet points below:
1. You will not feel confused or be up against the wall when the next customer churns – with the annual plan they agree to stay around for a year. Your churn rate is one of the few metrics (+ CAC) you never would like to increase.
2. When your customers subscribe to an annual plan but make the payment monthly, you can expect X amount of dollars to be paid on a regular basis. You know how much you can afford to spend monthly on A, B, and C, including hiring new team members or investing in marketing.
3. When your customers subscribe to an annual plan and make the payment in advance, you already have the cash in your pocket (actually, in your credit card) and again can plan how you are going to invest those dollars.
You will usually come up with an opinion that when you offer a discount for annual billing, you lose dollars and when customers pay you monthly, it’s the actual price. True because when one gives you $50 and 12 times it’s a higher amount than if another one gives you 20% less – $480 at once. But look from another angle.
First, you can price your software decently (not just expensive), so that $120 annually doesn’t affect the future of your business.
Secondly, cases when the customers stay with you for as long as a year and don’t choose a more economic annual billing – is not impossible but happens rarel
Thirdly, your churned customers cost you more dollars than $120 that you could “sacrifice” to acquire and retain them. Believe that’s always true.
Take care of Annual Recurring Revenue as a metric… Why should you do that?
ARR in SaaS shows the overall stability of your business in the long-term, opposite to the MRR (Monthly Recurring Revenue) that is less predictable. Find out the main reasons below:
1. You monitor your SaaS business trends
Like in the case of monthly revenue, you have the opportunity to check your SaaS company’s overall health and reveal how your recurring revenue changes, did you perform better this year or the previous.
2. You can plan your investments/expenses
When you charge monthly, you don’t know whether 1 or 10 customers will churn or 20 new customers will be acquired. Similar situations of uncertainty make you come in more conservative and modest decisions in your spendings. With your exact ARR data, you can be more confident about your investments in your team, software or service as your money will come back little by little (or maybe already came back with customers’ upfront payment).
3. Investors want you to know it
If there is only one metric your potential investors care about, the answer is ARR because it reflects how stable and profitable your SaaS company is. If you are new in the market and your only subscription option is monthly, you probably don’t have a metric other than MRR. But ARR is what investors will use to evaluate how powerful your SaaS is.
How to optimize your ARR?
If your customers choose your annual plans more frequently than monthly plans, you already have a an occasion to celebrate. But high ARR is a sign for even bigger success. Let’s learn together which ways will lead to more desirable ARR.
#1 Decreasing CAC – As we mentioned, ARR is your gross revenue and you should reduce CAC so your net annual profit makes a satisfying amount for you.
#2 Making a minimum discount – No one says the more discount you offer for your annual plans, the richer you will become. And no one says 20% annual is the industry discount norm you should follow. Even 10% may be a good motivation for your users.
#3 Following a strong upselling strategy – Once done wrong, a customer’s first reaction can be that you are a greedy salesperson and care only about grabbing more money. Your upselling offer should be relevant to the situation and directed to users who are likely to accept your idea.
Want your customers to switch from monthly to annual billing? Here are 6 ways to succeed
If you want to know the truth, it shouldn’t be your one and only goal. You probably have customers who don’t upgrade their plans because they can’t afford a large payment upfront, need your software for short-term projects or they always look for alternatives and don’t want to tie their hands.
And finally, when we look from your viewpoint, monthly payments save you from making discounts, attract customers with less resistance and facilitate the job for your sales team. But if for A or B reason monthly billing causes you more headache than happiness, then keep on reading to discover: How to make that subtle monthly to annual shift happen.
1. Don’t hurry to convince
If a customer just signed up for your monthly plan and is yet getting acquainted with your company, don’t push your annual plan immediately. Let them “warm up”, explore your software, experience the benefits and make sure they made the right decision. If you keep in touch with your customers via email you can send your offer at least after 1-2 months of their subscription.
2. Incentivize your customers
When you want someone to do what you want them to do, you should tell them – what they will receive in return. What’s in for them? In the SaaS industry, two common ways of awakening motivation are to offer a discount at around 20% or 1 more month for free (both are “discounts”, only approaches are different).
3. Make the upgrade process easy
When you visit pricing pages of popular SaaS websites, you will see something like “Upgrade anytime”, i.e. a customer doesn’t have to contact the support team or wait until the end of the month to change the billing model or your “Switch to annual” offer is not available for a limited time. Maybe your customer is not ready for the change now but can consider it after overcoming some minor challenges.
4. Let them pay monthly
Your customers choose an annual plan but pay monthly. What’s the best part? You have regular, not one-time revenue flow and your customer will not complain that he can’t afford big payment upfront. Ok, now you know – your customer will not churn tomorrow and your customer knows – he will not pay extra money like monthly subscribers mostly do.
5. List the benefits clearly
As we mentioned above, creating incentives is key but how about expressing them in a comprehensible and enticing way? Mention about the special discount they will receive (and will save dollars!), tell them how exhaustive it is for the financial department to deal with invoices, let them know how the long-term usage helps reach more tangible results.
6. Bring examples
What do your previous customers tell about the long-term usage of your software? Did annual subscription make their business life easier or how did it improve their online performance? Not that you don’t just “praise” your software’s features like in general but showcase why one should be committed to it for at least a year. Use testimonials and case studies focusing on why months are not enough.
How to talk to your customers on monthly to annual shift? Follow this email example
An email message is one of the best ways to talk about business partnerships – not so informal like social media and not so formal, like a phone call. Your email should contain many or all the points mentioned in our 6-point list. Without further ado, let’s see how a high-performing email template will look like.
You’ve been using our software for more than [number] months and we’d like to thank you for choosing our services.
Do you enjoy our [e.g. email marketing automation] software? Have you already experienced tangible improvements in your overall marketing performance?
Well, acknowledging how essential consistency is in your email marketing efforts, we want you to have a look at our annual billing option. You may ask “What should I gain if I choose annual billing over monthly?”. Find the answers below:
- You will save 15% [e.g. $200] per year.
- Activities like lead nurturing, sending updates to subscribers, asking your customers for feedback require constant email flow – you will be doing all of this throughout the year.
- And the best part: You have the opportunity to pay again on a monthly basis (no big upfront payments!)
Monthly to annual change is available for any time. Feel free to contact us should you have any further questions.
If you’d like to use this email, that’s totally fine. Just note that you should apply the necessary changes according to your software and business. Our aim is to emphasize the key points of email structure – how to start, how to continue, how to finish, what tone of voice to use.
We don’t claim ARR is better than MRR or you should consider having only annual plans. Moreover, we encourage you to offer both options so you are able to target small businesses too who not always can afford long-term commitment.
Which billing system do your customers choose the most?