Source: Competitive Pricing Strategy Competitive pricing is one of the most popular pricing strategies. But does it work for SaaS businesses? This article will examine the advantages and disadvantages and provide an overview of competitor-based pricing. When you’re just starting to acquire your first few customers, there might not be enough data to understand the pricing fit of your customer base. Therefore, you can use data from competitors who have been in the market for a while to aid your pricing strategy as you test the waters for yourself. 73% of subscription leaders reported in the 2024 State of Subscriptions and Revenue Growth that they plan to increase prices. How to implement a competitive pricing strategy Implementing a competitive pricing strategy involves a few key steps. Here's an overview to get you started: Research your competitors: Look at direct competitors, who sell something very similar to your product, and indirect competitors, who might meet the same customer needs but in a different way. Analyze your competitor's pricing: Collect data about how much your competitors are charging. Don’t just look at the numbers; try to understand the features and benefits they’re offering at those prices and the perceived value they offer. Decide your pricing position: Based on your analysis, decide where your product or service fits. If your product has more features or better quality, you might price it higher. If you’re new and trying to enter the market, you might set a lower price to attract customers. Monitor the market: Markets change, new competitors emerge, and customer preferences shift. Regularly review your pricing strategy and adjust as needed to stay competitive. This way, your pricing reflects the market landscape and supports your business goals and product value. What are some common competitive pricing strategy mistakes to avoid? When implementing a competitive pricing strategy, businesses often make several common mistakes that can impact their success. Lack of comprehensive market research: One major mistake is not conducting thorough market research. Businesses might base their prices solely on the most visible competitors or outdated information, missing out on broader market dynamics and newer competitors. It’s crucial to continuously gather and analyze data from direct competitors and indirect ones to get a comprehensive understanding of the competitive landscape. Ignoring value proposition: Another common error is pricing solely based on competitors without considering their own product’s value proposition. If you price a product without understanding why it’s valuable to customers, you risk underpricing, which erodes profits, or overpricing, which deters potential buyers. It’s important to know what differentiates your product and to price accordingly. Not being flexible: Pricing isn’t a set-it-and-forget-it element. Markets evolve, new competitors emerge, and customer preferences change. A common mistake is not revisiting your pricing strategy regularly. You need to be agile and ready to adjust your pricing to stay competitive and relevant in the market. By avoiding these common competitive pricing pitfalls, you can better leverage competitive pricing strategies to your advantage and ensure you attract and retain customers without compromising on profitability. How often should a business reassess its competitive pricing strategy? You should reassess your competitive pricing strategy regularly. Market conditions can change rapidly—new competitors may enter the market, existing competitors might adjust their pricing, or customer preferences could shift. By reviewing your pricing strategy frequently, you can ensure that your business remains competitive and adapts to any significant market dynamics. Furthermore, more frequent reassessments may be necessary during rapid growth, product launches, or significant external changes like economic shifts or regulatory changes. Staying proactive with these reviews helps you capitalize on opportunities to refine your pricing for better market alignment and profitability. How is competitor-based pricing calculated? To arrive at a reasonable pricing decision that maximizes profit margins, group your competitors according to relevance in ascending order and see where your product and brand fit in the range between them. With a competitive pricing strategy, you have two different types of competitors you need to be aware of while grouping them: Direct competitors: Direct competitors offer similar products or services and compete for the same market share. Indirect competitors: Indirect competitors offer products or services that will overlap with yours and partly solve the problems in a completely different way. They may be products with one or two similar features to yours and don’t compete for the same market share. How does competitive pricing strategy impact market positioning? After finding your product’s fit in the market and accounting for internal expenses such as production costs, you must now understand competitive pricing and analyze how to price the product. There are three methods you can use to price your product after doing a thorough analysis of your competitors. Pricing above the competition: Offering products or services priced superior to your competitors. It is usually done when you feel your products or services are a notch above your competitors. Pricing on the same level: Also known as price matching. You price your product similar to that of your competitors. But here, your primary focus should be on the added value your product offers, even though your product and its features are the same as your competitors. Pricing below the competition: Pricing below competitors should not be a strategy unless your product has limited features. It can be effective to offer a competitive price to attract customers, increase sales, and promote brand value. How does a competitive pricing analysis help a business? Competitive pricing analysis helps you by providing crucial insights into the pricing landscape of your market. By understanding what competitors charge and the value they offer, you can strategically position your pricing to attract more customers, maximize profits, or enter new markets. It allows you to identify pricing opportunities and threats, align your pricing strategy with market expectations, and remain competitive without sacrificing profit margins. Advantages of competitor-based pricing Simplicity - A competitor-based pricing model is straightforward to implement as it requires basic research and insight into who your competitors are and what they’re doing with products and prices. It takes only a few hours to arrive at a decision for the same. Low risk - Since your competitors are well-known players in the market and have been around for some time, the chances are slim that your pricing strategy might need to be corrected if you base it on theirs. Used with other pricing strategies - A company can calculate its pricing based on a value-based or cost-plus pricing model. But, before arriving at a final price solely based on the above two models, you can compare yourself with the competition and adjust your pricing to be on par with your competitors. By combining two models or using a hybrid, you’ll be aware of the market and have a sound strategy to stay ahead of the competition while covering your costs. Disadvantages of competitor-based pricing Unsustainable strategy in the long term - A competitive pricing strategy can be sustained during the initial stages of market entry. Still, as you progress, you may not be able to use it long-term. Your competitors might be improvising based on the market pricing data or might change pricing entirely with a change in marketing strategy to focus on a different market segment. This is a model attributed to short-term goals, and you could tank your profits in the long run if you follow the same strategy because as you scale, you need to evolve your pricing strategy based on your product and not on what someone else has to offer. You will soon need to adjust your pricing strategy based on consumer demands and market insights. Don’t have access to the details and reasoning for the pricing - When you’re implementing a competitive-based pricing model, you’ll be missing out on the details your competitors might have, and if they go wrong, you go wrong, as well. Your future profits and revenue might be hit by relying on someone else’s strategy. One amongst the herd - Since it’s a strategy implemented solely based on your co-market players, you will not be seen as different and will be a part of a broader herd offering the same products and services at the same price. This will not help your brand stand out, and you will not be able to explain why your product is priced this way to your customers. What is an example of competitive based pricing? Software as a Service (SaaS) is no different, in this domain price war of competitive based pricing have been causing loss. And here are few more examples demonstrating this approach: Project Management Tools : A new SaaS company attempting to get into the project management space might cross-sell with competitors such as Asana, Trello or Monday. com. Example: If the platforms charge anywhere between $10 to $20 per user per month, the new company could price their service at $15/per user for a happy medium offering, yet have differentiating features or services. CRM Software: For example, there tends to be a sort pricing war in the CRM Software space – HubSpot vs Salesforce I am looking at you. A new entrant could simply look at pricing slightly above-average in this case; if HubSpot offers a baseline plan for $50, and Salesforce charges $75, they might come in at $60 to cover potential pilots from customers tempted by the high end. Email Marketing Services: Mailchimp and Constant Contact, which are the two most significant players in Email Marketing Services, also tinker with their pricing tiers such that one adjusts its offerings based on what is being offered by the other one. If, say, Mailchimp introduces a new feature at or around X price level, then Constant Contact may up their game in turn (either by adjusting their own pricing or implementing something similar as justification for what they charge). Video Conferencing Tools: Zoom and Microsoft Teams are incredibly competitive when it comes to pricing of video conferencing tools. Zoom has a free tier with limited features, and its pro version is available for $14.99; if users choosing between the two end up sharing an evenly priced market, Microsoft Teams could potentially throw in some competition here or there with pricing of their own if many users are willing to switch without too much persuasion. Accounting Software: QuickBooks and FreshBooks, both companies price their accounting software based on what the other offers. For example, if QuickBooks accounts $25 monthly for the most basic plan, FreshBooks might violate a similar subscription at $20 per month as a lower-cost alternative. The examples above illustrate the way SaaS companies leverage competitive-based pricing to position themselves well in the market so as to stick out from competitors, while at the same time know all about how their other rivals approach pricing. Is competitive pricing analysis right for SaaS? For many SaaS businesses , competitor-based pricing may not be the right pricing model . It can be combined with another pricing model but not solely used as a stand-alone pricing method. Also, while it is the sole purpose of the strategy itself, the most significant setback is that your pricing is based on your competitors' pricing method, so the price doesn’t equate to the value you’re providing for your customers. It doesn’t do justice to your product offerings and the value of your product will likely get diminished with the crowd. If you aren't perceived for your value as a product, your customer might not think twice about choosing your competitor's product for a similar price. In addition, you will have no price intelligence as to why a particular set of features is bundled together and offered for that specific price. Competition-based pricing can be likened to plagiarism if used in isolation, offering only short-term market sustainability. Saas Pricing Masterclass: Ace your SaaS pricing strategy with the lessons in this 25-minute masterclass . Final thoughts on competitive pricing strategy The examples above illustrate the way SaaS companies leverage competitive-based pricing to position themselves well in the market so as to stick out from competitors, while at the same time know all about how their other rivals approach pricing. The need of the hour for any business focusing on keeping a fierce hold in ever-changing sectors is to adopt a competitive pricing strategy without sacrificing on margin. Though a mainstream tactic in B2C circles, particularly in E-Commerce, competitive pricing should be optometric rather than prescriptive — at least for B2B SaaS companies. Of course, you have to keep in mind the product value and functionality for having competitive and real-value reflecting pricing practices. The short term market competitiveness can be sustained and is pretty good in limiting additional injury but also acquiring substantial added value over time by competing pricing effectively with other pricing models . By regularly re-evaluating your pricing policy and adjusting to shifting markets or competitive dynamics, you can reliably anticipate customer behaviors and empathetic concerns, setting a new bar for sustainable success. For a deeper dive, and to have our experts tailor your pricing strategy to the unique requirements of your business get in touch. Book your complimentary pricing consultation here for personalized advice and insights to navigate pricing complexities and drive your business forward. Source: Recurring Revenue Model Today, the role played by recurring revenue models like subscription services and membership programs is very important in business strategies. In such models customers pay at regular intervals, be it monthly or annually to have continued usage of products or services. This not only provides funds continuously but also cultivates strong lifelong customer relationships. Found in the software, media and telecommunication industries among others, recurring revenue models are highly regarded because they are predictable and encourage customer retention, as well as lower product prices. They assist in maintaining stable cash flows that ensure the stability and growth of the enterprise. Read More: Power up your revenue strategy with Chargebee's insights! What is the recurring revenue business model? The recurring revenue business model is a business strategy where customers pay for access to a product or service repeatedly at regular intervals, such as monthly, quarterly, or annually. This model is popular in various industries, including software, media, and telecommunications, as it provides predictable income, enhances customer retention, and makes products and services more affordable for customers. What are the different types of recurring revenue models? 1. Subscription model The Subscription Model is a type of recurring revenue model in which customers pay a fixed fee to access a product or service at regular intervals, such as monthly ( monthly recurring revenue ( mrr )) or annually ( annual recurring revenue ( arr )). Slack is an example of a subscription-based business model. Pros: Provides a predictable and consistent income stream for the business Encourages customer loyalty through continuous access to the product or service Allows businesses to offer different subscription levels and pricing tiers to cater to different customer needs and budgets Cons: May require significant investment in marketing and sales to acquire new customers If the product or service does not meet customer needs, customers may cancel their subscription, leading to a loss of revenue Who it works for: The Subscription Model works well for businesses that provide ongoing access to digital content or services, such as: Software companies offering software applications Streaming services providing on-demand movies and TV shows Music services offering music streaming Fitness and wellness services providing access to classes or programs This model is particularly suitable for businesses that can provide regular updates and improvements to their offering to maintain customer satisfaction and prevent churn 2. Usage-based billing Customers are billed for their usage on a regular schedule. A good example of this kind of recurring revenue model is Zapier. Pros: Saves the customer money when there’s irregular usage. It’s good value for low to mid-volume users. Cons: Unpredictable revenue for the business because of customer usage fluctuations, as well as unpredictable and surprising costs for customers. It may not provide good value for the higher volume customers. Who it works for: Usage based models work best for businesses that can easily track usage whether it’s the number of emails/messages/invoices sent, APIs used, or triggers activated. 3. User-based billing: Teams or organizations pay for the number of people using the product every month or year. A good example here is Atlassian, that charges $7 a month per user for teams with more than 10 people. Oftentimes with this structure, the same capabilites are provided to all users regardless of usage or volume. Pros: More predictable revenue and scales well for large/enterprise teams. There’s no need to track usage. Cons: This system may serve as a barrier for economical teams who will limit number of seats to control costs. Also, it doesn’t always align with product value, in which case you’ll be leaving money on the table. For instance, a customer may end up paying for users who aren’t active. Slack addresses this issue by adding prorated credits for users who have become inactive in a billing cycle, and only charging for active use. Who it works for: User-based billing works optimally for team collaboration or customer service tools. 4. Tiered billing: This pricing structure is built in ‘tiers’. Each tier is constructed for a specific buyer persona and is capped off in price. Once a user hits a functionality ceiling on a particular tier, they are upgraded to the next tier offering more functionality and usage. A popular example is Hubspot with its Basic, Pro & Enterprise tiers. Pros: It allows you to appeal to a wide range of users and their specific needs, so there’s something for everyone. It also helps businesses understand where customers see the most value. Cons: ‘Something for everyone’ is not always a good bet, because it has the potential to become sprawling and complicated very quickly. There is also the possibility of the tiers not including a certain user-type’s needs. Who it works for: It’s most commonly used by businesses offering sales or marketing products. 5. Hybrid Billing: This model takes a mixed approach, choosing aspects of two or more revenue business models. Eg: Both Zapier and Atlassian have hybrid pricing, where hitting specific usage levels or number of users will require you to upgrade to the next tiered plan. Pros: It’s a flexible way to structure pricing and it allows businesses to overcome the disadvantages of a single model by bringing more nuanced pricing that’s better aligned with value. It also allows for more customizable plans and features. Cons: It may bring in more complexity, so businesses need to take additional effort to keep their hybrid models simple enough for everyone to grasp. When users can’t understant the process or if it is overly complicated, it discourages use. Who it works for: SaaS businesses where the value customers get from the product/service doesn’t clearly fit into any one model. 6. Freemium: Freemium offers a lifetime free plan with a premium upgrade to convert free customers into paying customers. Evernote, Dropbox, Buffer all offer a freemium model . Pros: Low barrier to entry. It’s relatively easier and quicker to acquire a sizeable customer base. It is a great way to spread brand awareness and get users acquainted with the product. Cons: If businesses don’t think it through, they could easily run at a loss servicing new customers and find themselves unable to give paying customers the time and attention they need. It could also attract the wrong kind of customers who see the most value in the ‘free’ part of your freemium model and don’t feel the need to upgrade. Who it works for: It works well for businesses where the cost of servicing new customers on a free plan is low and the potential to convert them into paying customers within a certain period of time is reasonably high. This of course requires a sound business model but can be great way to quickly grow. 7. License Model The License Model is a type of recurring revenue model where customers pay a recurring fee to use a product or service. This model is commonly used by software companies, where customers pay an annual fee to use the software, often with updates and support included. Microsoft, Adob, Spotify & Netflix offer license model Pros: Provides a predictable income stream for the business Fosters long-term relationships with customers Encourages customer loyalty as they feel they are getting good value for their money Cons: Customers may feel locked into the agreement and may not be able to easily switch to a different product or service The business must continually update and improve the product to maintain customer satisfaction and prevent churn Who it works for: The License Model works well for software companies and other businesses that provide ongoing access to a product or service. It is particularly suitable for businesses that can provide regular updates and improvements to their offering to maintain customer experience and prevent customer churn. 8. Retainer Model The Retainer Model is a type of recurring revenue model where a client pays a fixed fee to an agency or consultant for ongoing services over a set period. This model provides a predictable income stream for the service provider and encourages long-term relationships with clients. Law firms like Baker McKenzie, DLA Piper, and Clifford Chance use the retainer model to provide ongoing legal services to clients Pros: Predictable income stream: The retainer model provides a consistent and predictable income stream for the service provider. Long-term relationships: The model fosters long-term relationships with clients, as they are committed to working together over a set period. Cons: Transparency can be an issue: It can be difficult to track where time and money are being spent, and clients may not have full control over how their resources are utilized. Who it works for: The Retainer Model is suitable for businesses that provide ongoing advisory services, such as consultants, attorneys, and coaches, who can benefit from the stability and predictability of the model What are the benefits of recurring revenue model? 1. Makes budgeting and planning easier The biggest benefit of having recurring revenue is that it's more steady and predictable than one-time revenue generating models. This makes it easier to plan your business around it. Additionally, the recurring revenue model reduces the risk of fluctuations in sales and helps businesses focus on providing ongoing value to their customers, rather than constantly acquiring new ones. This makes monthly and quarterly planning easier, accurate, and more effective 2. Improves Customer Retention  Recurring revenue model helps businesses improve customer retention by creating a long-term commitment for customers and providing ongoing value.  With a recurring payment, customers are less likely to cancel their subscriptions because they don't want to lose access to their favorite products or services. The consistent and reliable service provided through the recurring revenue model builds trust, leading to increased customer satisfaction and reduced churn. 3. Helps You Offset High Customer Acquisition Cost The recurring revenue model can also help offset high customer acquisition costs by reducing the need for constant acquisition and instead focusing on retaining existing customers. With a predictable stream of revenue, businesses can focus on providing ongoing value to their customers, building stronger relationships, and increasing customer loyalty. What are the Challenges With Recurring Revenue Model ? Difficult To Implement With A Bespoke Product Or Service The recurring revenue model is difficult to implement with a bespoke product or service. You need to standardize your offering to be able to create a monthly or usage-based pricing structure. Your customers will become accustomed to paying for the same thing month after month, so you mustn't deviate from that price point. The most common way to do this is through subscriptions. When creating your subscription model , it's important to make sure that you're getting the most value out of each customer and that there are no hidden costs involved with the recurring revenue model. For example, if you're selling software as a service (SaaS), make sure that every customer has access to all features and functionality at no additional cost. If you're selling products or services as part of an ongoing contract, make sure that there is an upfront cost associated with each purchase (that doesn't change over time). Makes It Tricky To Expand To A New Offering The primary challenge with a recurring revenue model is that once you standardize it, it becomes tricky to expand to a new offering since it may or may not fit into your existing wheelhouse.  Adding a new product or service to the existing offering could mean adding new pricing tiers, or increasing the price on the existing plans. Both these strategies can tend to impact the overall conversion rate on your offering. Providing Value Consistently Is A Must You need to make sure that your customers are happy and continue to use your products or services. To do this, you need to be able to provide them with value at every step of their journey, from the initial contact with your company until they have completed a transaction. Another challenge is that if you don't keep up with demand, your customers will not renew their subscriptions. This can result in losing a lot of money and also losing the trust of your current customers who may decide to leave for another company if they don't see any improvement in service quality or customer support. To avoid this situation, you must offer great customer support so that your customers feel comfortable when making purchases from you again in the future. Building a Recurring Revenue Model Based on Value The end game of finding the right recurring revenue model is to figure out how to facilitate a fair exchange of value between a business and its customers. Many businesses unknowingly charge lower than they can and end up hurting profits. The other side of the spectrum is charging too much for something, which will lead to obvious results. Customers will use the product for a few months and when the price and value don’t match, they churn and find other solutions in the competitive SaaS market. The best path to knowing if a fair exchange is happening, is to identify and align your recurring revenue model with a value metric. It will enable you to price your offerings optimally for you and your customers, resulting in a win-win for both in terms of growth. Harnessing the Strategic Power of Recurring Revenue Models with Chargebee When you incorporate a steady income model into your business, it not only helps stabilize the business but also creates long-lasting relationships with customers through continuous value offerings using subscriptions or memberships. This method increases the reliability of your financials and instils loyalty by continuously fulfilling customers’ expectations. However, implementing this strategy is not always easy. To be successful, one must understand pricing strategies , maintain customers, and constantly provide benefits. Achieving success also requires listening to others' opinions, keeping an open mind, and ensuring that everything is customer-oriented. How Chargebee Can Help To bring about a huge change in the management of recurring revenue models, you can consider adopting Chargebee into your processes. Here is how Chargebee’s expertise can enhance your company: Additional Reads There’s no school that teaches businesses how and what to price their products and why. But as the trend of approaching revenue models more strategically grows, so does the volume of quality information on the subject. Browse through some of these resources and articles to learn more: Here is an exhaustive teardown of how three well-known SaaS players test, learn, repeat, and ace their pricing games. How to Experiment with SaaS Pricing Strategies – Teardowns of Shopify, Zendesk, and StatusPage Pricing is the center of your business, and here’s a list of things that you need to make sure you’ve checked off before you launch a pricing change. A 6-Point Checklist to Foolproof your SaaS Pricing Experiments Dear SaaS Peers, Scale Value, Not Usage. (It’s Not as Simple as You Think) Source: LTV-CAC Ratio LTV: CAC ratio benchmarks Understanding the LTV/CAC ratio is crucial for businesses, especially in the SaaS industry, as it measures the relationship between the customer lifetime value (LTV) and the cost of acquiring that customer (CAC).  A 1:1 ratio indicates that you are spending as much on customer acquisition as customers are spending, leading to a lack of profitability. Improving your customer acquisition strategy is essential to achieve a more favorable balance and increase profitability. The LTV-CAC Ratio is a good indicator of how valuable your company is––a ratio of 3:1 indicates your customer's value is three times more than the cost of acquisition. The LTV-CAC ratios help you determine how much you should be spending on acquiring customers. If this ratio is low, you're pretty much-burning money in the long run because if you are spending more to acquire your customers than their expected return on revenue throughout the customer’s lifetime, eventually you will run out of resources to acquire any more customers. INDUSTRY LTV CAC LTV: CAC RATIO Business Consulting $2,622 $656 4:1 eCommerce $252 $84 3:1 Entertainment $823 $329 2.5:1 SaaS (B2C) $2,306 $166 2.5:1 SaaS (B2B) $664 $273 4:1 Customer Acquisition Cost vs. Lifetime Value Customer Acquisition Cost ( CAC ) and Lifetime Value (LTV) are important metrics for a subscription business to understand the underlying unit economics and inform marketing efforts.  Now, before we get into the ratio as a whole, let's break down the components. Customer Acquisition Cost Customer Acquisition Cost (CAC) is the total cost of gaining a new customer, including marketing and sales expenses. It is a crucial metric for businesses to understand their return on investment (ROI) for customer acquisition efforts. The CAC Payback Period is a metric that measures the time it takes for a company to earn back the money invested in acquiring customers, or in other words, the break-even point. CAC is calculated as the total cost of acquiring customers, divided by the total customers acquired over a given period. The 'cost' is your total spend on sales and marketing costs. CAC calculation For example, if you spend $300 acquiring new customers in Q1 and acquire 200 customers, then your CAC is $1.5. Lifetime Value Customer Lifetime Value (LTV) is a metric that predicts the net profit a customer will generate over the entire span of their relationship with a business. It evaluates the potential value of a customer to a business, informing strategic decision-making by helping businesses identify and prioritize their most valuable customers. A low LTV can indicate that a business is not maximizing the potential value of its customers, or that customer retention (retention rate) is low. Lifetime value (LTV) is the average revenue a single customer will generate throughout their lifetime as a customer of the business. And to calculate the Lifetime Value metric, you must first calculate the Average Revenue Per User (ARPU) and your Churn Rate . LTV Formula Or, you could calculate it as LTV = ARPU * Gross Margin * Average Duration of Customer Contracts We have a very detailed blog that tells you how to calculate lifetime value that comes with a ready-to-use template too! Calculating CAC-LTV Ratio Once you've found the CAC and LTV metrics individually, you can now calculate the LTV-CAC ratio. To do that, you simply divide the lifetime value by the customer acquisition cost. How to Calculate the LTV to CAC Ratio : What is a good CAC: LTV Ratio? Ideally, the LTV/CAC ratio should be 3:1, which means you should make 3x of what you would spend on acquiring a customer. If your LTV/CAC is less than 3, it's your business sending out a smoke signal! This should be taken as an indicator to try to reduce your marketing expenses so you can sustain effective acquisition efforts in the long term. CLV and CAC: Which is more important? Both CLV (Customer Lifetime Value) and CAC (Customer Acquisition Cost) are important metrics for businesses, with an inverse relationship between them. A higher CAC typically leads to a lower CLV, and vice versa. Balancing these two metrics is crucial for business profitability and growth. CLV helps businesses evaluate and plan their strategies to benefit from bringing a customer to the business, while CAC measures the cost incurred to acquire a new customer. Both metrics are essential for businesses to evaluate and understand, as they provide distinct yet related stories about the effectiveness of business strategies. To optimize the CLV: CAC ratio, businesses can focus on strategies that increase customer lifetime value without increasing customer acquisition costs. These strategies include identifying an ideal customer profile, optimizing pricing strategies , reducing customer churn rate, upselling, cross-selling, and charging, and moving towards subscriptions and memberships. The ideal CLV: CAC ratio for businesses is generally considered to be 3:1, indicating that for every dollar spent on acquiring a customer, a business should generate three dollars in customer lifetime revenue. However, this ratio can vary depending on the industry and business model. How does the CAC-LTV Ratio help? What type of customers to acquire An enterprise customer can have a high CAC, but they'll also have a higher LTV since they tend to churn less. It makes sense to look at these enterprise customers, yet the LTV-CAC can help you uncover valuable revenue. For example, in the case of HubSpot, they had two personas: Owner Ollie and Marketer Mary. The former was the owner of a small business and did their marketing, while the latter worked for a slightly bigger company and was in charge of marketing. At first, they concentrated their efforts on Marketer Mary, which had an LTV of $11,125. But later, they found that selling to Owner Ollie through a channel partner produced an even better LTV of $11,404. How much to spend on acquiring customers As a subscription or SaaS business , you'll be spending significant fund on acquiring customers through sales and marketing. But how much do you spend? Knowing the ideal LTV/CAC ratio and working it backwards can inform how much you need to spend if you know LTV. For example, if the LTV of a customer you want is $30,000 and you're looking to hit an LTV/CAC ratio of 3:1, then you'll need to spend approximately $10,000 on an acquisition. Raising investments If your customers are worth three times the value of the acquisition, then investors are all ears. But the point here is not to parade this metric around, it’s to show the investors that "this company has a broad product-market fit and its strong LTV-CAC today is likely sustainable at similar levels over time." How to optimize the LTV-CAC Ratio? Before you can optimize your spend, make sure you've calculated the CAC accurately. If everything is in place, here are a few pointers to help you out. Focus on the right channels The channels that bring in the most customers aren't always necessarily the ones that work. If those customers churn out quickly, there's no point in allocating many funds to these groups and crying over spent costs, which is why you should invest in channels that facilitate inbound marketing . Since 81% of consumers conduct online research before buying, having a targeted and informed approach will attract leads who are more likely to be interested in your solutions over a long period of time. It gives you good quality customers while having less costs. Experiment with pricing If you have a freemium business model , try experimenting with your pricing to figure out the factors that could convert more paying customers. It could be an increased pricing tier, a feature-based pricing model, seat-based pricing, etc. The more quickly you can convert freemium users to a paid plan, the lower your CAC would be. But don't compromise customer happiness, because soon you will have no customers to keep or new ones to attain. Reduce sales complexity An arduous sales process or a longer sales cycle will lead to a higher CAC. Keeping your prospects engaged with an effective hand-holding process and proper onboarding is critical in retaining those in the sales process. Ensure you invest in setting up a tight funnel and make each step easily navigable. Customer retention is key. If you want to be a profitable business, you have to cut your cost of revenue and as a digital business, the majority of this will come from CAC. At the same time, you need quality customers who love your business and stick with you for long periods of time, enabling high lifetime value and a chance at expansion revenue . In Conclusion A SaaS business (or subscription business) is no doubt a customer-centric business. You need to acquire customers at low costs and keep them happy for an extended period of time. The LTV-CAC Ratio serves as a guardrail for maintaining these conditions. So keep peeking over at these KPIs as a pulse check––it's also one of the critical SaaS metrics investors use for the valuation of companies. Source: Average Revenue Per User Average Revenue Per User vs. Average Revenue Per Unit Average Revenue Per User (ARPU) and Average Revenue Per Unit (ARPU) are metrics used to measure revenue generated per user or unit within a specific time period. ARPU is commonly used in subscription-based and SaaS companies, while ARPU is used in businesses that sell physical products. Both metrics help you assess your financial performance, identify trends, and make informed decisions about pricing strategies , customer segments, and revenue generation. ARPU is calculated by dividing total revenue by the number of users or customers, while ARPU is calculated by dividing total revenue by the number of units sold. Both metrics are important for businesses to track and analyze for growth and financial health. Why understanding ARPU is important Understanding ARPU (Average Revenue Per User) is crucial as it reveals the mean revenue potential and profitability of your customer base. ARPU is calculated by dividing the total income generated in a specific period by the number of active users or customers, resulting in an average figure that represents the profit generated per user. ARPU offers valuable insights into the revenue potential and profitability of your company's customer base, enabling you to identify segments of users or customers that generate higher profits and focus your efforts on attracting and retaining high-value customers. It also allows you to assess the success of pricing strategies, product offerings, and marketing campaigns. For eCommerce, ARPU is considered a more significant metric than conversion rate because it takes into account how much each customer spends, not just whether they convert. This provides a more detailed understanding of revenue potential. By concentrating on ARPU, you can pinpoint high-impact audience segments to personalize marketing and sales efforts, driving targeted and efficient growth to maximize your marketing and sales budget and get the best return on investment.  Tracking ARPU over time enables businesses to monitor their performance metrics' healthiness while identifying areas for improvement like increasing average order value or reducing subscriber churn. By establishing ARPU benchmarks and goals, companies can strive to maximize their revenues and customer retention strategies for long-term success and sustainability. shorten this content What is Average Revenue Per User (ARPU) in SaaS? Average Revenue Per User (ARPU) is a crucial metric for SaaS companies, representing the revenue generated on average from each user. It’s calculated by dividing the total revenue generated by the number of users. ARPU is a valuable indicator of a SaaS company's financial performance, helping to evaluate marketing, sales, and customer retention strategies. The formula for calculating ARPU in SaaS is: ARPU in SaaS = Total Revenue / Total Number of Users It can be used to make informed business decisions about pricing, targeting marketing campaigns, and developing new features. ARPU can also be used to benchmark your company's performance against industry averages and communicate financial performance to stakeholders. ARPU is a key metric for SaaS companies to understand and track for sustainable growth and profitability. How to Calculate ARPU ARPU is your total monthly recurring revenue (MRR) or Committed MRR (CMRR) divided by the total number of active users/subscriptions. ARPU Formula ARPU (monthly) = Total MRR / Total Active Subscriptions (Users) The Calculation of ARPU can include the following metrics: Upgrade MRR : Revenue obtained only from subscriptions that have upgraded from a lower to a higher plan. Downgrade MRR : Revenue lost due to subscriptions moving to lower plans. Churned MRR: MRR lost due to customers canceling their subscriptions or reducing the number of features used (in the case of usage-based pricing) It is important to note that your ARPU should not include free/ freemium users as they do not add to your revenue. However, if you want to include free users in your ARPU calculation, it’s better to have a separate metric ARPPU (Average Revenue Per Paid User) that only calculates the revenue per paid subscription. What is Considered a good ARPU? A good ARPU (Average Revenue Per User) varies by industry and company goals. Generally, a higher ARPU indicates successful monetization of the user base, often resulting from effective marketing campaigns or high-value product offerings. A declining or low ARPU can be alarming, signaling customer dissatisfaction, suboptimal pricing models , or the need to reassess marketing strategies.  To set ARPU benchmarks and goals, you can use historical data, review trends, and segment ARPU by customer demographics, product types, or geographic locations. ARPU can be used to forecast profit, measure the value of each customer, and make informed decisions on pricing strategies and subscription trends. The Difference between ARPU and LTV  ARPU (Average Revenue Per User) and LTV (Customer Lifetime Value) are essential metrics used to measure the performance of a business. While ARPU measures the average revenue generated from each customer in a specific time period, LTV estimates the total revenue generated from a customer over their entire lifetime.  LTV formula LTV = (Lifetime spend - lifetime variable costs) / # of customers acquired How does ARPU relate to Customer Churn? ARPU (Average Revenue Per User) is closely related to customer churn in businesses, particularly in the SaaS industry. High ARPU customers are valuable as they contribute significantly to Monthly Recurring Revenue ( MRR ) and are correlated with lower user churn rates. Customers with higher ARPU are less likely to churn compared to those with lower ARPU. This relationship is crucial because reducing churn is essential for sustaining and growing a customer base. Lower churn rates mean more customers stay longer, leading to higher Lifetime Value (LTV) and more opportunities for businesses to monetize these customers through cross-selling and upselling strategies. The Average Revenue Per User (ARPU) is a key metric used to measure the financial performance of a business. It is calculated by dividing total revenue by the number of users. Monitoring ARPU can help you assess your pricing strategies and profitability. Ultimately, understanding the connection between ARPU and customer churn is vital to keep a close eye on customer retention and churn and enable you to increase revenue. Must read: Check About Our Short Course on Fundamentals of Churn Importance of ARPU in Business The importance of ARPU (Average Revenue Per User) in business is multifaceted and significant, particularly for companies in the telecommunications (telecom) and media industries. Below are six key aspects of ARPU's importance: Revenue forecasting: ARPU serves as a fundamental component in financial models for revenue forecasting, aiding in the development of robust financial plans based on customer retention, revenue assumptions, and customer acquisition. Identifying revenue opportunities: ARPU analysis facilitates the creation of a solid marketing and pricing strategy for upgrades and add-ons, uncovering trends in downgrades and upgrades and enabling you to prioritize features for upselling to customers in specific pricing plans. Revenue generation insights: ARPU offers valuable insights into revenue generation and customer behavior, helping you to determine the profitability of different customer segments, identify opportunities for upselling and cross-selling, and make informed decisions about pricing strategies. Tracking business health: ARPU allows you to monitor the health of your business strategies, analyze the performance of different products, sales channels, or geographical regions, and forecast revenue. Product segmentation: ARPU enables you to keep track of business per different segments such as users, products, sales channels, or even geographical regions, making it easier to identify the most sellable products or the most profitable stores. Conclusion: Harnessing ARPU for SaaS Success Average Revenue Per User (ARPU) is more than just a financial metric—it’s a strategic view of your business that gives you invaluable insights. By understanding and applying ARPU, you can gain deeper insights into customer behavior, optimize pricing strategies, and drive efficient revenue growth. Whether you’re refining your pricing model, exploring new market segments, or adding customer value through upsells and add-ons, ARPU provides a clear path to increased profitability. Ready to take your SaaS business to the next level? Start by analyzing your ARPU to identify opportunities for improvement, and consider experimenting with pricing and service offerings to maximize your revenue per user. Let ARPU guide your business decisions and pave the way for sustainable growth.  Reach out to our team for expert advice or delve into our resources for more actionable strategies. Let’s unlock your business’s potential together! Source: Monthly Recurring Revenue Why is MRR important for subscription businesses? For companies operating on a subscription model , Monthly Recurring Revenue (MRR) is more than a simple financial metric; it's a cornerstone of your strategic and operational planning. MRR is a reliable barometer of the company's financial health, offering a steady measure of the income generated from your customer base each month. This consistency is crucial for making informed forecasts about revenue trends, enabling you to identify whether your revenue is on an upward trajectory or facing declines. MRR isn't just significant for internal assessments and strategy adjustments; it's also an important factor that potential investors and acquirers scrutinize closely. It demonstrates the predictability and stability of revenue, key attributes that can influence investment decisions. A solid grasp of your MRR can significantly improve your business’s appeal to external stakeholders by highlighting its sustained financial viability and growth potential. Here are four primary reasons why MRR is important for your business: Predictability: MRR provides a reliable way to forecast future cash flows and budgets, as it allows you to predict the amount of revenue you can expect to receive monthly. This predictability is essential for financial planning and managing expenses efficiently. Scalability: MRR enables you to scale your operations more effectively, providing a steady and predictable cash flow. This allows you to invest in growth opportunities with minimal risk, such as marketing and product development. Customer relationships: MRR helps you build long-term relationships with your customers, providing a recurring revenue stream tied to the ongoing value that customers receive from the product or service. This enables you to focus on customer retention and develop deeper relationships with your customers. Growth metrics: MRR is essential for measuring the growth and success of a business. It provides insights into revenue trends, customer acquisition and retention, and the basic health of the company. By tracking MRR, you can identify areas for improvement and make informed decisions about your product roadmap, sales, and marketing efforts. In a macroeconomic climate that rewards efficient growth, having a firm grasp of your MRR is table stakes. Ten different types of MRR Various monthly recurring revenue models provide flexibility to align revenue generation strategies with customer needs and consumption habits. This approach ensures a more predictable revenue stream and nurtures enduring customer relationships to increase subscriber retention and minimize churn. Here are ten types of monthly recurring revenue models: New MRR : This is your business's revenue from all the new customers gained during a month. New MRR can be directly attributed to all your new customer acquisition strategies and helps provide attribution to the channels contributing revenue. Additionally, when New MRR is compared to the Customer Acquisition Cost ( CAC ), it can provide insights into the efficiency and profitability of acquiring new subscribers. Upgrade MRR : This is the additional MRR from all customers who have upgraded to a higher-pricing plan from a lower-priced plan or purchased a recurring add-on. Upgrade MRR accurately represents how well your product scales with the growth of your customers. Expansion MRR : Often confused with Upgrade MRR, Expansion MRR also considers MRR contribution from reactivation of a previously canceled subscription and free-to-paid conversions. Especially useful for subscription businesses that use a freemium model, contrasting Expansion MRR with Upgrade MRR gives a deeper level of understanding of how well you’re able to convert free customers to paid customers and how often canceled subscribers return. Contraction MRR : Contraction MRR tracks the Monthly Recurring Revenue (MRR) lost through cancellations, downgrades to lower-tier plans, removal of recurring add-ons, or discounts. It provides insights into your business's ability to retain MRR from current subscribers, reflecting your product/service's scalability to meet customer demands effectively. Churn MRR, also known as Cancellation MRR, is a key element when calculating Contraction MRR. It reflects the monthly recurring revenue lost due to churned or canceled subscriptions. Analyzing churn helps gauge how effectively your product meets customers' needs. In the initial phases of a subscription-based business, a high or increasing churn MRR or cancellation MRR may suggest a misalignment between your product and market demand. In later stages, a similar trend might signal the impact of a recent marketing campaign that attracted customers with inaccurate expectations. Downgrade MRR Downgrade Monthly Recurring Revenue (MRR) comprises all MRR reductions from current customers, except for cancellations, contributing to Contraction MRR. Reactivation MRR : Reactivation Monthly Recurring Revenue (MRR) refers to the extra revenue generated from customers who had previously churned or canceled their subscriptions. It is a key element of expansion MRR. Notably, these customers should not have contributed any revenue to the MRR in the previous month (excluding users in free trials). Net new MRR : This is the net amount of MRR gained or lost, calculated by adding new MRR, expansion MRR, and churn MRR together. Average revenue per account (ARPA): This is the average revenue generated per customer, calculated by taking the average of how much all customers are paying and dividing it by the total number of customers. How to calculate MRR ? Calculate MRR by considering all active and non-renewing subscriptions, excluding those in free trials from the calculation. The MRR formula  MRR = Sum(Monthly Recurring Charge of all paying customers) If you know your ARPU ( Average Revenue Per User ), you can multiply it by the number of paying customers to find your MRR. MRR = ARPU * Number of paid customers For example, if you have 100 customers paying an average of $50 per month, your MRR would be $5,000. Remember, MRR can be influenced by three factors: new MRR, expansion MRR, and churn MRR. New MRR is the additional revenue new customers contribute to the top line. Expansion MRR is the additional MRR that results from cross-sells or upsells to existing customers. Churn MRR represents revenue lost from customers who cancel or downgrade subscriptions. For a precise view of your business growth, compute net new MRR by summing new MRR, expansion MRR, and churn MRR. This metric indicates the MRR gained or lost by your company. Common mistakes when calculating MMR It’s crucial to avoid common mistakes and ensure accurate data inputs when calculating your Monthly Recurring Revenue (MRR) because it directly impacts your financial insights and decision-making processes. Common mistakes when calculating Monthly Recurring Revenue (MRR) include: Incorrectly accounting for non-monthly billing intervals: Failing to adjust for non-monthly billing intervals can lead to inaccurate MRR calculations. Including non-recurring revenue: Including one-time payments or non-recurring revenue sources in MRR calculations can skew MRR accuracy. Treating MRR as ARR ( Annual Recurring Revenue ): Confusing MRR with ARR can lead to errors in forecasting and financial reporting, as these metrics serve different purposes and timeframes. Adding non-recurring costs: When adding non-recurring costs, MRR must comprise only the recurring revenue from customers, excluding any one-time expenses. This distinction helps ensure clarity when tracking revenue. Ignoring discounts: Failing to account for discounts given to customers can distort the actual MRR contribution from each customer, leading to inaccurate calculations and an overinflated CLTV . What is a good MRR rate?  A good MRR rate varies depending on the stage and growth of your business. A recent survey found that the average growth rate across 424 SaaS companies listed was 52%. Does this mean your subscription business has to grow by 52% to have a “good” MRR? For early-stage startups, a good annual churn rate is between 10%-15% for the first year, while for established businesses, a good SaaS churn rate is under 1% for monthly churn and between 5%-7% for annual churn. To increase MRR, you can focus on strategies such as upselling and cross-selling , reducing churn, and implementing effective marketing strategies. These strategies can help you improve your MRR by increasing revenue from existing customers, reducing revenue loss from churn, and acquiring new customers. When calculating MRR, remember to consider different types of MRR, such as New MRR, Expansion MRR, and Churn MRR, to get a more accurate picture of revenue growth and trends. By tracking different types of MRR, you can identify areas for improvement and make data-driven decisions to increase revenue. In addition to MRR, you can also use metrics such as the SaaS quick ratio to measure revenue growth and churn. The SaaS quick ratio is calculated by dividing New MRR and Expansion MRR by Downgrade MRR and Churn MRR. A good SaaS quick ratio is considered to be above 4.0.  This metric can help you determine if your revenue growth is supported by effective churn management and customer retention strategies. Overall, a good MRR rate depends on the stage and growth of a SaaS business, and increasing MRR requires a combination of strategies to increase revenue, reduce customer churn , and acquire new customers. By tracking different types of MRR and using metrics such as the SaaS quick ratio , you can make data-driven decisions to increase revenue and grow your business. How to increase MRR for your business Using the strategies outlined below, you can increase MRR for your business and improve overall financial performance. Upsell to your client base: Encourage existing customers to upgrade or switch to more comprehensive plans. This strategy can generate additional revenue without the need to acquire new customers and ensure your subscribers get the most value from their subscriptions. Increase prices: Regularly review your pricing models and make adjustments as needed. This could involve increasing prices due to rising material or labor costs, aligning with higher market prices, or reshaping your pricing strategy to highlight specific subscription tiers, products, or services. 73% of subscription professionals are planning to increase prices in 2024, according to the Subscription and Revenue Growth report . Free trials: Offer free trials to potential customers, allowing them to test your product or service before committing to a paid subscription. This strategy can increase customer acquisition and provide you with a base of customers to upgrade to a paid plan. Keep MRR churn to a minimum: Implement effective dunning and proactive cancellation management to minimize churn and maintain a healthy MRR. This includes communicating with customers to collect past-due balances before canceling their accounts and offering flexible billing and subscription options to accommodate their evolving needs. Run promotions: Offer promotions or discounts to attract new customers or encourage existing ones to upgrade their subscriptions. This strategy can help increase MRR and improve customer retention. Provide a yearly subscription payment plan option: Offer a discounted rate for customers who pay annually, which can help increase revenue and improve customer loyalty. Create landing pages: Develop custom landing pages for different customer segments or marketing campaigns to improve conversion rates and increase MRR. Overdeliver and provide an exceptional customer experience: Focus on providing excellent customer service and support to encourage customer loyalty and reduce churn. This strategy can help increase MRR and improve customer retention over time. Track performance with detailed reporting: Use detailed reporting and analytics to monitor MRR growth and identify areas for improvement. This strategy can help you make informed pricing, marketing, and customer retention decisions. Expand upmarket: Consider expanding your business by targeting larger enterprises or offering more comprehensive solutions. This strategy can help increase MRR and improve customer loyalty. Get rid of the word free: Avoid using the word "free" in your marketing and pricing strategies, as it can attract customers who are less likely to convert to paid subscriptions. Instead, focus on offering value and benefits that justify the cost of your product or service. Conclusion Monthly Recurring Revenue (MRR) is a crucial metric, especially if you offer subscription-based services. It tells you how much money you can count on making every month. By calculating your MRR, you can predict future earnings and plan your growth strategies more effectively. Ready to supercharge your monthly recurring revenue (MRR) engine? Take the first step towards maximizing your monthly revenue by requesting a demo of Chargebee , the leading Revenue Growth Management (RGM) platform tailored for subscription-based businesses.  Our main objective is to help you increase your revenue through various solutions, including efficiently managing subscriptions and recurring billing , optimizing pricing and payments, accurately recognizing revenue, streamlining collections, and improving customer retention. Chargebee provides over 6,500 businesses with the tools to calculate their subscription revenue easily, allowing them to work more efficiently. Source: Usage-based Billing As consumers, we already encounter usage-based billing in various aspects of our lives, such as electricity charges and Uber rides. In essence, the process works as follows: You use a product or a service The provider employs a metering system to monitor your sage You pay for the usage each billing cycle. Understanding Usage-Based Pricing in SaaS Traditionally, businesses adopt the usage-based billing model when they can clearly measure how much of a product or service a customer uses.  However, in SaaS billing , usage-based pricing often encompasses additional dimensions. It’s not just the rate of customer consumption that is important; the value linked to the product, known as the value metric , also plays a crucial role. A primary differentiator of usage-based billing is its use of a basic unit to measure usage that is not time or user/seat-based. In contrast to seat-based models, where customers pay upfront for additional licenses, usage-based billing offers two main options: a postpaid model, where customers are charged based on actual consumption after the fact, and a prepaid model, where customers make a prepayment that entitles them to a certain amount of usage, with the option to top up if they exceed their initial limits. Adoption of Usage-Based Billing Usage-based pricing, which was originally used by companies like AWS for their infrastructure services, is now widely used across all types of software companies. Application SaaS: These companies offer software applications with pricing based on the usage of specific features or volume of interactions, such as Zendesk's customer interactions, HubSpot's marketing contacts, and Dropbox's storage. Middleware SaaS: These companies provide services that integrate or connect other applications. Pricing is typically based on the volume of transactions, automated tasks, or communication services, such as Stripe's transaction fees, Zapier's task automation, and Twilio's messaging and call rates. Infrastructure SaaS: These companies offer foundational cloud services with pricing based on the resources used, such as Snowflake's data processing, AWS's computing and data transfer, and Google Cloud Storage's data storage and access. AI companies: These companies offer AI-driven solutions with pricing based on usage; foundational AI providers like OpenAI charge for access to their language models, while application-based AI providers like DeepL and Jasper charge for specific functionalities like translation or content generation. Benefits of Usage-Based Billing These core reasons have mainly driven the rise in popularity of usage-based billing: Lower barrier of entry: From a customer’s point of view, a subscription company offering a flexible, pay-as-you-go model is much more attractive and economical than a rigid subscription fee that doesn’t consider product consumption. Aligns pricing strategy with value: Since usage-based pricing is fundamentally driven by consumption, it ensures customers pay for what they value and use. This is especially important in times of economic uncertainty and rising inflation rates where customers exhibit prudent spending.   Better cost and margin structure: As companies automate more tasks through AI and other technologies, the need for human users (or licenses) to complete tasks is reducing. Hence, seat pricing fails to capture and monetize the true value of automation, undercharging customers and eroding your profit margins. Usage-based pricing offers a powerful alternative in this aspect as it aligns pricing with your value metrics. Challenges of Usage-Based Billing While it offers greater flexibility and better margins, there are some challenges with adopting a purely usage-based pricing model: Unpredictable revenue: With usage-based billing, your revenue is tightly linked to the real-time consumption of your product, making Monthly Recurring Revenue (MRR) predictions challenging. Fluctuations in usage or seasonal variations can lead to significant revenue swings. While peak usage boosts revenue, it can also lead to unpredictable costs for your customers, potentially causing sticker shock and complicating budget planning. Pricing model compatibility: Usage-based pricing isn't universally suitable for all subscription models. For SaaS platforms with numerous features, identifying a single or few metrics to base pricing on can be difficult. Additionally, this model may not align with long-term revenue growth objectives. For example, a platform like Netflix charging based on the amount of content watched could be attractive to customers but may not be a viable monetization strategy for the company. Hybrid pricing models—a combination of usage and subscription fees—offer a better alternative. They combine the predictability of the recurring revenue model with the flexibility of consumption-based pricing. Explore why hybrid pricing strategies find increasing relevance in SaaS .   Implementing Usage-Based Billing: Key Considerations To successfully implement usage-based billing (UBB), consider the following steps: Analyze feature usage: Examine feature usage patterns closely to identify your core revenue drivers. Focus on value metrics that reflect the value your platform delivers. Align these metrics with your revenue goals and ensure they support growth as usage increases. Determine pricing structure: Decide how to price your value metrics—whether per unit, tiered , volume-based , or stairstep. Your choice will affect profit margins and customer perception of your pricing model. Choose the right billing system: Select a metered billing system that accurately tracks and converts user consumption into invoices. Ensure the system can scale with your business, whether you opt for a subscription, usage-based, or hybrid model. Automate billing: Streamline your billing process by automating the transfer of usage data to your billing platform, enhancing efficiency and accuracy. Focus on these essential areas to develop a successful Usage-based billing (UBB) strategy. Want to get the most out of your pricing model? Check out our in-depth guide on Hybrid and Usage-Based Billing for Subscriptions . Chargebee’s metered billing solution simplifies the process by automating billing workflows, which reduces manual effort and minimizes errors. It aggregates usage data to ensure accurate billing so you can rely on precise charges. The platform also supports easy experimentation with different pricing and packaging options without extensive developer involvement, making finding the best monetization model for your business easier. Additional Resources The great middling: Hybrid pricing model and its growing SaaS relevance Your guide to the consumption-based pricing model How YouSign implemented a usage + seat-based pricing model Source: Consolidated Invoicing Why does Consolidated Invoicing exist? Many a time, there will be multiple subscriptions from a single customer. This could be subscriptions to multiple products of yours or subscriptions for different teams from a single customer. And raising a separate invoice for every single purchase is redundant and often spammy. Consolidated invoicing combines all these individual invoices into a single invoice that you can send across to your customer. To avoid time spent on repetition, unnecessary manual labor, and money lost on customer confusion, businesses use consolidated invoicing as a means to bill smartly and hassle-free. How does consolidated invoicing work? A typical invoicing system creates an invoice for every purchase made by the customer regardless of the timeframe. Every subscription is treated as a separate purchase. But a consolidated invoice is generated only once in a given timeframe by aggregating all purchases made by the client in that particular timeframe. For example, in a span of five days, Alfred signs up for three different monthly subscriptions from a product or service. At the end of the month, the vendor/business owner will generate a single invoice aggregating all three subscriptions prorated accordingly, making it easier for Alfred keep track of his subscriptions, expenses and more importantly, pay for all just once. (thereby reducing the probability of churn for his multiple subscriptions) Benefits of Consolidated Invoicing Improve your workforce productivity by spending less time on mundane manual entry and reconciliation for bookkeeping. Plug revenue leakages from lost invoices and delayed payments - do away with debtors or spot them easily. Brings order to your billing and payment cycles, thus enabling you to predict and plan your income and expense far more accurately. Source: Dunning The word dunning had a very different shade in the pre-SaaS age. It used to be strongly associated with dues collection, and many companies employed persistent, intimidating procedures to demand repayment. Sometimes called Delinquent User Notification—it was, in its mildest form, a gentle reminder. More often, it was a figurative rap on the knuckles or a dreaded ‘location visit’ in which the collecting party would meet with the business who has unpaid fees. Let’s take a quick look at what the dunning process has evolved into today and why it matters. Modern Dunning Has a Lot to Do With Credit Cards and For Good Reason With the advent of SaaS, dunning processes have turned into something vastly different than a simple dunning notice. While Wikipedia still says dunning is ‘the process of methodically communicating with customers to ensure the collection of accounts receivable’, there’s so much more to it than that. If you have a recurring billing setup for a hundred customers, it’s reasonable to assume that ten transactions will fail every billing cycle for common reasons like credit card expiry, blocked cards, network issues, and credit card declines due to insufficient funds. Often customers don’t even notice these failures until their credit card statement comes in, and that's where dunning comes into the picture. It identifies mystifying transaction failures when they happen and automatically alerts customers with accurate, timely information. What We Really Talk About When We Talk About Dunning Dunning management is an automated process that lets you do things like: Set up smart retries for failed payments, which saves time and increases revenue. Send you reminders about outstanding dues from declined credit cards Alert customers through professional emails that something’s gone wrong in their last transaction Request customer opt-in so you can collect updated credit card information directly from credit card providers (a.k.a. account card updater) to increase the frequency of timely payments. Relevant Read: Dunning best practices to combat involuntary churn Fighting Involuntary Churn to Recover Revenue Involuntary churn happens when you lose customers because of payment failures. Even a 1% increase in churn can affect your overall revenue by 10% plus your MRR . And involuntary churn rates can make up a whopping 50% of your actual churn rate. Several other benefits accrue from using a well-designed dunning system from a customer perspective. These factors aren’t always a part of the dunning process itself, but they do have a demonstrably positive effect on retention and are important to consider. Improving Customer Experiences Without graceful dunning procedures and dunning emails, your business is writing its own script for ‘How to Lose a Customer for No Reason’ because: Identifying payment failures and solutions is now the customer’s problem, which hits retention rates hard Without automated retries, the payment verification process may take days Communication becomes strained because the customer (understandably) does not want to deal with this on a Wednesday afternoon at work Suspicious credit card activity can alarm people and put your trustworthiness in question An effective Dunning system introduces a vital layer of security, trust and professional friendliness into monetary conversations with the customer. A big chunk of payment failures are unavoidable, unintentional and involuntary. Good business mettle doesn’t demand that you prevent this, simply that you handle it well. Pro Tip: What if the people using your product aren’t the ones paying for it? When you send corporate users your billing emails, they’re generally forwarded to departments in charge of payments and with access to billing information. But the user still holds all the user information needed for logging into the system. The resulting coordination tangle can be a huge time suck. Dunning systems that employ a ‘one-click update’ remove the need for unnecessary coordination and let executive sponsors deal with payment failures easily. Additional Reads A shortlist of essential reading material encompassing top insider insights & pro perspectives on dunning management: Tim Wu and Lesley Park talk about how a proactive approach to dunning management can reduce the risk of unintentional cancellations on the Chargebee blog. How to reduce churn with Payments: Dunning Management Revisited “1 in 4 transactions that go through dunning are recovered.” See Chargebee’s data insights collected from a sample of over 5.36 million transactions from merchants across 45 countries and their customers spanning 79 countries. Dunning benchmarks for subscription businesses   Source: Free Trial Why Free Trials Work? A free trial model, along with its counterpart the  freemium model , is a handy way of letting your SaaS product sell itself. By opting for a free trial of your product, the customer gets a timebox for using your product - ranging from a week to a month or even two. A free trial lets users experience the product first-hand, understand its functionalities and see if the product delivers the right value for them before buying it. The magic of free trial only helps simplify your acquisition process, your SaaS business must be able to guide users through every stage of the product and assist them wherever possible. This can be implemented by providing quality customer support, offering incentives (read coupons, discounts, et cetera), and offering a smooth onboarding experience. A free trial model, along with its counterpart the freemium model , is a handy way of letting your SaaS product sell itself. By opting for a free trial of your product, the customer gets your product for a limited time, ranging from a 7-day free trial to a month or even two. A free trial lets users experience the product first-hand, understand its functionalities, and see if the product delivers the right value for them before paying any subscription fees or charging their credit card.  A free trial simplifies your acquisition process, but your SaaS business must be able to guide users through every stage of the product and assist them wherever possible. This can be implemented by providing quality customer support, offering incentives (read coupons, discounts, et cetera), and ensuring a smooth onboarding experience. When is ‘Free Trial’ NOT the right model for you? You can’t follow a one-size-fits-all approach when it comes to free trial. For the model to work, you need to answer a few important questions that actually decide if this is the right method for your company: Does your product need white-gloved assistance? If it does, then there is no guarantee that the trial user will derive the maximum benefit out of it in a limited period of time. The product at best should be easy to use and at worst be well assisted by means of tutorials and guides. Is your business built for dealing with large volumes? The need for instant support when dealing with product issues grows rapidly with an increase in potential prospects. If you are a niche player, and your SaaS business does not have a self-serve capability to meet the support requirements, free trial might not be the right choice for your company. Do users feel engaged when using your product? Converting trial users into paying customers is the most important part of a free trial, and a key deciding factor is customer engagement. Your SaaS must be able to provide an active onboarding to the customers during the free trial period, and keep them engaged with the product and your business. Additional Reads You can refer to the following to learn more about the free trial model, and about the various pros and cons of using it: Finding the right trial strategy for your SaaS might be hard. With Chargebee, you can experiment with trials and improve your conversions, at ease.  Chargebee’s Free Trial Management Suite Want to find out the right trial strategy that your business should employ? Read our guide on - Trials, and the tribulations of finding the perfect strategy that works for you. Source: Account Hierarchy Account Hierarchy When and where do companies implement Account Hierarchy? From large conglomerates to SMBs, teams are dispersed across locations, job functions and have become a norm in today’s globalized economy. But there are overlaps in the tools the members from different teams or even locations use within a single organization. For example - let's assume that you own a project management tool which is largely an open solution that can be used by many teams within a single org, like an engineering team and a design team from the same org may find it ideal but for largely different reasons. Though both these teams have their own subscription for the tool, the buck stops at the same finance team who’ll authorize the transaction for both these subscriptions. As the business owner of the project management company, it’ll make more sense for you to raise a single invoice to the billing contact regardless of multiple subscriptions. This will reduce potential confusion in payments, invoicing, billing cycles. What are the benefits of Account Hierarchy in your subscription billing system ? Having a unified bird’s eye view of an account will not only help merge several transactions and match them to a single buyer but also helps you spot the golden gooses among your customers who might require a dedicated customer success team to keep them satisfied. By configuring account hierarchy for your customers, Save time from creating multiple entries. Stop revenue leakages by consolidating your invoice avoiding delays, confusion, and churn. Bring structure to your invoices and billing cycles with consolidated invoicing. Calculate the Lifetime Value (LTV) of the customer accurately. Additional Reads More reads on Account Hierarchy, and how Chargebee maps complex-looking Org charts into simple Parent-Child relationships: Learn how to model your customer’s complex org chart. Introducing Account Hierarchy: Model your customer’s complex-looking org charts Wondering how Chargebee solves your Account Hierarchy woes? Structure Customer, Subscription and Payment Relationships with Account Hierarchy Source: Entitlement Management It ensures that subscribers receive the exact features and capabilities they've paid for, based on the pricing tiers, add-ons, and additional charges they subscribe to.  Components of Entitlement Management 1. Feature provisioning Feature provisioning defines which features are unlocked with different pricing tiers of your product or service bundles. Depending on your industry and pricing model, this can range from the number of articles a subscriber can read to the number of user licenses a company can add or the number of consulting sessions a customer can have per month. For example, Spotify Premium offers ad-free music listening and high audio quality (see highlighted portions in the image). In other words, Spotify must provide (or provision) these features in its Premium plan. But there’s more—within Premium, they offer Student, Individual, and Duo tiers with differences in subscription entitlements, such as the number of Premium accounts and audiobook listening hours. For complex B2B subscription workflows, this becomes even more intricate: Your product catalog will have more components—plans, add-ons, one-time charges, and sometimes different plan variants for different subscriber cohorts. Hybrid sales motions—some sign up for a trial and subscribe online; others go through complex sales motions, manual account activation, and provisioning. Entitlements might also have a service layer attached. For example, all paid customers can access 24/5 email support, but enterprise plan customers get live chat and a dedicated Customer Success Manager (CSM). 2. Access management Access management ensures your customers have accurate, real-time access according to your provisioning logic. For instance, each time you open a document via Google Docs, it checks whether:  Your company has access to Google Docs You, the specific user, are allowed to view that particular document You have view-only, comment, or edit access to the document (known as Role-based Access Control or RBAC). Additionally, customers may have multiple accounts and subscriptions with different plans and entitlement levels. If a user exits the company, you must revoke their access without affecting other users. You can also grant specific customers access to features that aren’t part of their plan by default. If you're still thinking this sounds simple, try asking your Engineering friends how much they enjoy managing feature provisioning—but don't say I didn't warn you :) 3. Monetization Monetization includes pricing and packaging strategies that convert your product or service offerings into revenue. This includes: Packaging experimentation: Moving features and capabilities across plans or add-ons, changing feature quantity limits, and more to experiment and achieve the optimal packaging fit. Feature usage analytics: Tracking feature usage against entitled limits helps you understand feature performance and revenue potential. Consumption tracking and paywalls: After monitoring feature usage against entitled limits, the next logical step is to deploy paywalls or equivalent mechanisms to encourage customers to move to a higher pricing tier. Automated billing: Ensuring accurate billing based on usage and considering all mid-cycle entitlement changes. Role in subscription businesses Entitlement management is crucial in your subscribers' lifecycle across different touchpoints. It facilitates: Activating appropriate products and services for each customer Allocating the right features and usage limits based on their plans Ensuring users can access only what their roles and permissions allow Overriding default feature limits for select customers as needed Launching new product capabilities to specific customer cohorts Understanding how customers use your product/service relative to their entitlements Iteratively packaging features and product bundles to maximize revenue Explore more on Entitlement Management with our top resources Mastering Entitlement Management : Overcome business and technical challenges to accelerate GTM innovation and improve monetization 5 warning signs of failing in-house entitlement management: Key questions to assess the effectiveness of your current approach to provisioning Phrase's success story: How the world leader in translation technology optimized product activation, feature provisioning, and usage-based pricing with streamlined entitlements Expert webinar: Insights from Phrase’s CFO and Engineering Lead on pricing and packaging strategies Disclaimer: The screenshot of Spotify's pricing page used above is for illustrative purposes only. Spotify is a trademark of Spotify AB. All trademarks, logos, and brand names are the property of their respective owners. Use of these marks does not imply any affiliation with or endorsement by Spotify. Source: Churn Rate "The most dangerous phrase in the language is, 'We've always done it this way.'" – Rear Admiral Grace Hopper While she wasn’t talking about churn rates specifically, her words perfectly capture the challenges of managing customer retention. Just like how sticking to the same old methods can make technology obsolete, a business’s reluctance to innovate and respond to customer needs can lead to increasing churn rates. In this article, we’re going to dive deep into what churn rate is, how it’s calculated, and what strategies can help manage it effectively. Join us as we explore this crucial business metric in detail. Understanding your churn rate Good & bad churn rate Understanding the nuances between 'good churn rate' and 'bad churn rate' is critical. Although a high churn rate normally indicates challenges, it's important to recognize that not all churn is harmful. Sometimes, a 'good churn rate' might occur as part of a strategic decision to shift focus towards more profitable customer segments or as a natural consequence of product evolution and market adaptation.  In this context, recognizing the differences in customer churn rate specifically is essential, as it provides deeper insights into the reasons customers may decide to leave, helping businesses refine their targeting and positioning efforts to optimize overall outcomes. Why churn rate matters For subscription businesses, churn rate is a critical metric that directly impacts revenue stability and growth potential. Here's why it's particularly crucial: Revenue predictability: Subscription models rely on recurring revenue. A high churn rate can disrupt cash flow forecasts and make financial planning challenging. Customer lifetime value (CLV): Lower churn rates lead to higher CLV, allowing businesses to invest more in customer acquisition and product development. Compound growth: Even small improvements in churn can have significant long-term effects due to retention's compounding nature. Efficiency indicator: Churn rate reflects the efficiency of various business functions, from product development to customer success. In today's turbulent market, churn rate isn't just a metric—it's a lifeline. Let's dive into why it's more crucial than ever:  Economic uncertainty: Fears of a potential recession are making customers more selective about their subscriptions, making retention even more critical. Increased competition: The proliferation of subscription services across industries has intensified the fight for customer loyalty. Rising customer Acquisition Costs: As digital advertising becomes more expensive, retaining existing customers is often more cost-effective than acquiring new ones. Shift to customer-Centric Models: Businesses are focusing more on customer experience and success, making churn rate a key performance indicator. Investor scrutiny: In the current funding environment, investors are scrutinizing retention metrics as indicators of business health and potential. A high churn rate isn't just a problem—it's a blaring alarm. It's screaming about deeper issues like customer service nightmares, products that miss the mark, or competitors eating your lunch. But flip that coin, and a low churn rate is your business's way of flexing. It's proof that you're not just acquiring customers; you're creating fans, advocates, and long-term partners. And in this economy? That's not just success—it's survival. What is ‌high, average, & low churn rate? Churn rates can vary significantly across industries. Here are some general benchmarks, but it's crucial to compare within your specific sector: SaaS (Software as a Service): Low: < 5% annually Average: 5-7% annually High: > 10% annually E-commerce: Low: < 20% annually Average: 20-30% annually High: > 40% annually Telecommunications: Low: < 1% monthly Average: 1-2% monthly High: > 2.5% monthly Media/Entertainment Streaming: Low: < 30% annually Average: 30-50% annually High: > 50% annually Remember that these are general principles. Business models, target markets, and company maturity can all influence whether a business is classified as high, average, or low. It is vital to: Benchmark against direct competitors in your industry Consider your company's stage (startups might have higher churn initially) Look at trends over time rather than isolated numbers Factor in your customer acquisition cost when evaluating churn impact Regardless of industry, a continually high churn rate frequently indicates severe difficulties with customer service, product value, or market fit. An average turnover rate necessitates ongoing monitoring and optimization efforts. A low churn rate is great, reflecting good customer satisfaction and loyalty; nevertheless, even then, ongoing development is essential for sustaining a competitive advantage. How to calculate churn rate? Calculating the churn rate provides clarity on how many customers you're losing over time and why it's happening, crucial for managing customer churn rate effectively. Churn rate formula The basic formula to calculate the churn rate is: Churn rate= (Total Customers at the Start of Period/Number of Churned Customers​)×100 Different Ways to Calculate Churn Rate While detailed calculation methods are covered in our dedicated blog post, it's important to understand that there are several approaches to measuring churn, each offering unique insights: Simple Churn Rate: A straightforward percentage of customers lost over a specific period. Adjusted Churn Rate: Accounts for new customer acquisitions, providing a more balanced view of customer turnover. Revenue Churn Rate: Focuses on lost revenue rather than just customer count, crucial for subscription-based models. Predictive Churn Rate: Uses advanced analytics to forecast potential future churn based on customer behavior patterns. Each technique serves a different business requirement and can be chosen based on your company's specific objectives and data capabilities. Combining various methodologies frequently yields the most complete understanding of churn, allowing for more effective retention measures. For a deep dive into these calculation methods, check out our detailed blog post on calculating churn rate. What is the difference between churn rate and customer retention rates? Understanding both churn and retention rates provides a full picture of customer engagement and loyalty. Churn rate measures the share of customers who stop their services within a particular period, which could imply dissatisfaction or aggressive hazards.  In comparison, the retention rate calculates the share of clients who stay with the service, offering insights into consumer loyalty and product satisfaction. Learn more about how they interact and oppose each other . Different metrics to track churn Each type of churn has unique implications on how you interpret customer behavior and business health: Customer churn: Loss of customers who decide to stop using your services. Revenue churn: Loss of revenue due to customer departures or downgrades. Gross churn rate: Measures revenue lost from churned customers. Net churn rate: Accounts for new revenue gained from existing customers. Voluntary churn: Occurs when customers consciously choose to leave. Involuntary churn: Happens due to payment failures or other non-deliberate reasons. Explore detailed insights on different types of churn. The broad impact of churn rate Economic implications of high churn Revenue impact: High churn rates cause a direct lack of sales as clients depart, decreasing the regular profits circulation vital for operational stability. Increased expenses: With excessive churn rates, the cost of obtaining new clients will increase substantially due to the want for improved advertising, marketing and promotional efforts to draw replacements.  Identifying improvement areas: Regular analysis of churn rates helps identify underlying issues in products or services, guiding strategic improvements and enhancing customer satisfaction. Learn how to . Strategic relevance across industries Sector sensitivity: Industries such as telecommunications, SaaS, and media streaming are mainly sensitive to churn rates due to their reliance on subscription-primarily based sales models. Customer lifetime value: In those industries, the price of client acquisition is frequently amortized over the duration of their relationship, making retention critically crucial. Explore strategies for improving customer lifetime value. Market balance: Effective churn management in these sectors is crucial for maintaining an aggressive advantage and making sure of marketplace stability, as frequent consumer turnover can cause commercial enterprise version instability. Check out more on how different industries manage churn at . Understanding annual vs. monthly churn rate Knowing the difference between annual and monthly churn rates is crucial for businesses to make informed strategic decisions. Monthly churn rates give you an up-to-the-minute snapshot of how well you're retaining customers, making it perfect for businesses that need to react quickly to changes. This rate helps spot immediate trends or issues that may arise from recent changes in the market or service strategies. In contrast, the annual churn rate smooths out short-term fluctuations and offers a clearer view of long-term trends, useful for evaluating the success of retention efforts over time. For businesses, especially those in fast-moving industries, understanding these metrics helps in better forecasting and resource planning. Aligning strategies with the appropriate churn metrics can lead to improved customer satisfaction and more effective management over different periods. Learn how to adjust strategies based on churn rate timelines. Pros and cons of focusing on churn rate Concentrating on churn rate can provide valuable information about an agency’s health, indicating degrees of consumer pride and service excellence. However, while focusing on churn can enhance consumer retention processes, it can also divert interest from other vital areas like acquiring new customers or exploring new markets. Pros: Immediate Insights: A high churn rate can quickly highlight problems, allowing businesses to address issues swiftly. Enhanced Customer Retention: A focus on churn usually leads to better customer service and engagement, improving loyalty and overall satisfaction. Cons: Overlooking New Opportunities: Too much focus on churn may cause companies to neglect pursuing new customers or innovation. Short-term Solutions: Companies might prioritize quick fixes to improve unsustainable churn rates rather than solving deeper, systemic problems. Businesses must balance their focus on churn with efforts to attract new customers and foster innovation. Discover how to maintain this balance . Growth rate vs. churn rate Balancing the increased price with the churn rate is key to a sustainable commercial enterprise boom. The churn rate suggests how many customers are leaving, while the boom rate indicates how many new customers are coming in. It’s vital for the growth rate to consistently outpace the churn rate, signaling not simply stability but also enterprise growth. Strategic Insights: Expanding Customer Base: A higher growth rate than a churn rate suggests successful market appeal and business expansion. Indicating Market Success: A low churn rate alongside a high growth rate often points to positive customer reception and product relevance. Managing both metrics involves continuous evaluation and implementing strategies that attract new customers while enhancing the experiences of existing ones. This approach helps build a sustainable business model, where new customers compensate for those leaving and contribute to overall business growth. Learn how to optimize these metrics for better business outcomes . By gaining a deeper understanding and strategically managing annual vs. monthly churn rates, the trade-offs of focusing on churn, and the balance between growth and churn rates, companies can navigate customer relationship complexities more effectively, ensuring long-term success and stability. How to reduce churn rate? Strategies to reduce churn rate Implementing centered strategies to reduce churn rates can drastically enhance client loyalty and lengthy-term business success. Here's how Chargebee can play a critical position in every strategy:  Enhancing customer support: Chargebee offers tools that streamline customer interactions and support ticket management, ensuring that customer issues are resolved quickly and efficiently. This boosts customer satisfaction and retention. Learn how to leverage these features with Chargebee's customer support solutions . Personalizing marketing efforts: Chargebee allows you to segment your customer base and tailor marketing communications effectively. This personalization enhances customer engagement and reduces churn. Explore Chargebee's capabilities for personalized marketing strategies. Establishing regular feedback mechanisms: Chargebee facilitates easy integration with survey tools and feedback platforms, allowing you to capture and act on customer feedback proactively. This helps in making timely improvements and adjustments. Discover how to implement these tools with Chargebee's guide to customer feedback strategies. Maximizing business growth by managing churn rate Chargebee considerably complements how corporations cope with customer retention and churn rates. By efficiently dealing with subscriptions and automating billing procedures, Chargebee guarantees that your commercial enterprise delivers great client reports, critical for lowering churn and boosting increase. Understanding churn and actively managing it with Chargebee's tools is crucial for sustaining enterprise growth and keeping sturdy purchaser relationships. Proactive tracking and continuous patron engagement are key to enhancing retention rates. Ready to optimize your subscription management and reduce churn? Schedule a demo with Chargebee today and discover tailored solutions that can drive your business forward. Source: SaaS Gross Margin In the past few years, SaaS businesses saw significant value multiplication, which was great for self-belief. But just as we thought that we had bested a pandemic, rising inflation threw a wrench in many businesses’ growth plans. This meant more investor caution, longer sales cycles, and declining customer budgets. While many businesses still chose to focus on acquisitions (and by extension, expanding revenue), many more have realized that poor processes, greater CAC , and churn bit into a larger share of that revenue.  The money inflow wasn’t enough for the counterbalance of leaked money, and hence profits and valuations dropped significantly — over $1 trillion has been wiped from the SaaS market since November of 2021.  This is why, investors and the business community alike, are now more concerned about profitability than simple revenue growth as a true north star to any businesses’ health. This is where SaaS gross margin comes in — the revenue your company has left over (profits) after subtracting your direct costs for delivering services. In this article, we’ll explain what SaaS gross margin is and why it’s an important metric to monitor. We’ll also look at how you can calculate it and provide actionable tips to improve it. What Is SaaS Gross Margin? SaaS gross margin is the revenue you have after subtracting your cost of goods sold (COGS), which is the cost incurred in delivering and maintaining your software-based product. It’s typically expressed as a percentage of your total revenue and serves as a good indicator of your company’s growth potential. Here’s the formula to calculate your SaaS gross margin: We’ll look at how you can calculate gross margin for SaaS businesses later on, but let’s look at why this metric is worth tracking Why Is Gross Margin Important? Gross margin is important because it helps you monitor and evaluate your company’s financial health. It also helps you determine how much you have left over to cover other financial obligations, such as wages, income taxes, and debt repayments. 1. It Serves As a Good Indicator of Profitability SaaS gross profit margin allows you to compare how much gross profit you earned relative to your revenue. It allows you to determine the percentage of profits you retain after you factor in production and delivery costs for your SaaS product. A high and positive gross margin means you’re generating more revenue than you’re spending. According to Software Equity Group, a good gross margin for a SaaS company is 75% +. Tracking this metric over time can help you determine if you’re on the right track toward profitability. It can also help with creating revenue forecasts. 2. It Serves As a Good Indicator of Scalability Scalability in SaaS applications is critical to support growth. However, not prioritizing your gross margin can make it difficult for any SaaS company to scale. A high SaaS gross margin means that you’ll have more cash in hand to reinvest in business growth after accounting for direct costs. It can help you determine which areas you should focus on growing. For example, if a SaaS product has a high gross margin, you can reinvest profits into scaling its infrastructure. 3. It Helps Investors Determine Your Company’s Valuation Building a SaaS product isn’t cheap. There are upfront technology costs, like cloud hosting services and infrastructure spending, as well as people costs, like wages and benefits. You may seek additional funding to help pay for these costs. Comparing your gross margin to industry benchmarks can help them valuate your company and determine how much funding to approve. Companies with higher gross margins have higher median enterprise value to trailing twelve months (EV/TTM) revenue — a metric that buyers use to measure performance. In economically stressful times, investors want to put their investments in companies with strong profitability. Of course, investors aren’t solely looking at gross profit margins. They also consider the “Rule of 40” — a principle that states that a company’s combined revenue growth rate and profit margin should exceed 40% or higher. To summarize, SaaS gross margin is a key metric that helps you monitor your company’s financial health and measure its growth potential. Let’s look at how you can calculate SaaS gross margin in the next section. How Should SaaS Businesses Calculate Gross Margin? To recap, the SaaS gross margin formula is as follows: Gross margin = [ (Revenue - Cost of goods sold) / Revenue ] x 100 Let’s break this down. Revenue is the total amount of income that your SaaS company receives. It typically includes the following: Recurring subscriptions Add-ons and extras Premium support Custom development work Integration services COGS refers to the direct costs associated with delivering software-based services. Calculating this figure for a SaaS company is trickier than for a product-based company — with a SaaS company, you don’t have “production” costs, like raw materials or factory overhead. Of course, your SaaS company still has essential costs that are directly linked to delivering and maintaining your software-based product. COGS for a SaaS may include: Application hosting costs Website maintenance fees Software licenses for third-party apps Employee costs for customer success Employee costs to keep the production environment running (DevOps) Subscription costs to run your product Customer onboarding costs A simple test to determine whether to include certain costs in your COGS is to ask, “Can my customers still access and use the application if I don’t pay that expense?” If the answer is no, then the expense goes into your SaaS gross margin calculation. If the answer is yes, then you exclude it Here are some examples of what you should exclude from your COGS: Product development costs Sales commissions Overhead charges Capital expenditures Advertising fees Utility costs Legal fees If a cost isn’t directly related to your SaaS product, you wouldn’t include it in your COGS. Instead, you would place those costs under operational expenses. Let’s bring this all together to look at how you can calculate your SaaS gross margin. Here’s the formula again for reference: Gross margin = [ (Revenue - Cost of goods sold) / Revenue ] x 100 For this example (and for the sake of simplicity), we’ll use the Generally Accepted Accounting Principle (GAAP). This principle states that revenue is recognized only when a customer pays for a service you fulfill. If a customer signs a $15,000 annual contract and agrees to pay $1,250 a month, the full $15,000 isn’t realized. Only $1,250 a month is recognized every month. Let’s say that your monthly GAAP revenue is $500,000. After digging into your numbers, your COGS is $150,000. Let’s plug those numbers into the SaaS gross margin formula: ($500,000 - $150,000 / $500,000) * 100 That gives you a gross margin of 70%, which means you’re earning $0.70 for each dollar of revenue you generate. Of course, this example only shows your overall gross margin. You can (and should) calculate gross margins for different revenue streams and professional services to assess their profitability. For example, let’s say that you offer custom development work. You have a small team that provides this service, and you pay for their development tools. If offering custom development work generates $80,000 in revenue and its COGS is $50,000, its gross margin would be 37.5% (($30,000 / $80,000) * 100). While it brings in some profits, the amount you spend could be better spent elsewhere, like scaling your technology infrastructure. Keep the following in mind as you calculate your SaaS gross margin: Gross margin doesn’t include operating costs or general expenses (it won’t show your bottom-line profitability) Any major swings in gross margin should be investigated thoroughly to identify the cause (increased competition, regulatory changes, etc.) Various factors can cause your gross margin to fall (e.g., software vendors may increase their prices) So, what’s a “good” SaaS gross margin? Let’s find out in the next section. What’s a Good Gross Margin for SaaS Companies? Gross margin varies between industries. Product-based companies tend to have lower gross margins due to their high overhead costs. For example, average gross margins are 14.25% for auto parts, 22.73% for construction supplies, and 28.40% for general electronics.  But it’s a different story for the SaaS industry, as you don’t have raw materials or freight costs to pay. As a result, having a lower COGS means a higher gross margin. KeyBanc Capital Markets Technology Group conducted a survey of 350 private SaaS companies. These companies had an average gross margin of 73% , which included customer support in COGS but excluded companies with less than $5 million in GAAP revenue. In a separate survey conducted by OpenView of more than 1,200 respondents, 7 out of 10 SaaS companies had gross margins over 70%. Best-in-class companies had gross margins of at least 80%. Here’s a chart that shows a breakdown of gross margins on subscription revenue: A good SaaS gross margin is anywhere from 70% to 85%. However, one thing to keep in mind is that gross margins are typically lower in a company’s early stages than in its later stages. The following chart shows different SaaS metrics by Annual Recurring Revenue ( ARR ), including gross margins (highlighted in red). Smaller software companies with less than $1 million in revenue have a gross margin of 67%. Meanwhile, larger companies have a gross margin of 75% or more — they’ve learned how to operate efficiently, and they have a more solid customer base. Of course, no matter your SaaS company’s gross margin, there’s always room for improvement.  How to Improve Gross Margin for Your SaaS Company If your gross margin falls below the Saas gross margin benchmarks outlined in the previous section, the good news is that you can take steps to improve it. Follow these strategies to improve your SaaS gross margin. 1. Reduce Your Cost of Goods Sold One way to reduce your COGS is to re-evaluate the software that you use. For example, let’s say your customer success team uses one tool to onboard new users and another to manage support tickets. Switching to a platform that includes onboarding and help desk functionality can help reduce your COGS. You can also try negotiating other costs, like software licenses. 2. Evaluate Your Pricing Strategy Setting a pricing strategy isn’t easy. Price too low, and you risk killing your profit margins, but price too high, and you’ll have a hard time attracting new customers. At the same time, you can’t afford to not experiment with your pricing because you’d only be leaving money on the table. If it’s been a while since you’ve evaluated your pricing, there’s no better time than now. Check out our definitive pricing strategy guide to learn about different pricing strategies and how to choose the right one for your business. 3. Offer a Free Trial Offering a free trial for your SaaS product has its risks — for instance, it can increase your overhead costs and lead to longer sales cycles. But it also gives users the opportunity to try your product. Plus, it lets you gather valuable data, like usage patterns, which you can use to improve your onboarding process. Offer a free trial if you don’t already, and track metrics like conversion rates to measure their impact on your gross margin. 4. Get Rid of Under-Performing Services Offering different services is a great way to create new revenue streams. But these services may not generate the results you expected. Calculating gross margins for the services you offer can help you determine which ones are worth keeping and which ones aren’t. 5. Reduce Customer Churn Customer churn is the percentage of customers that your company loses over a given period (a month or a year, for instance). While some degree of churn is inevitable, a high churn rate will negatively affect your gross margin. Ways to reduce customer churn include improving your onboarding process, providing excellent customer support, implementing dunning workflows , and developing new features. 6. Upsell or Cross-Sell Existing Customers Upselling is the practice of encouraging visitors to purchase higher-end products, while cross-selling is getting existing customers to buy more products, like add-ons. Offer premium plans, and get your sales team to identify customers who would benefit from extras, like new add-ons or support packages. Both strategies can improve your gross margin.  7. Expand Into New Markets Generating more revenue is the key to increasing profitability. One way to do it is to make your SaaS product available in more markets. Of course, this isn’t easy unless you have the right payment infrastructure in place. Learn how Chargebee helped New York-based Slidebean accept recurring payments from customers in more than 30 international markets. Improve your gross margins with Chargebee Gross margin gives you a clearer picture of your SaaS company’s financial health. A high gross margin indicates that you’re bringing in more profits for each dollar of revenue, which means you have more money to reinvest in your business. Of course, if you want to improve your gross margins, you’ll need a tool that helps you streamline your billing operations and discover new revenue opportunities. Chargebee is a subscription management platform that handles the entire customer subscription lifecycle — from simplifying recurring billing workflows to automating pricing experiments to creating self-serve portals. Schedule a demo today to see how a subscription billing and management tool like Chargebee can help scale your business and boost your growth margins. Source: Deferred Revenue Companies that use  cash-based accounting  realize their revenue as soon as payment hits the bank. In  accrual-based accounting  you record the revenue only after it’s earned or recognized. Accountants use revenue recognition principle to identify and report how much of the deferred revenue is recognized, especially in SaaS Accounting. GAAP accounting standards require methods and reporting techniques that show accounting conservatism. Accounting conservatism ensures the company shows a legal claim to its profit. The general method is to factor in the worst-case for the firm’s financial future. That means that revenue is recognized as “earned” only when service/product delivery happens as promised. Categorizing deferred revenue as earned on your income statement is aggressive accounting which will overstate your sales revenue. SaaS businesses follow the accrual accounting method.  ASC 606 / IFRS 15  are the key accounting principles that must be followed. Therefore, revenue recognition depends on the principle of the ASC 606 / IFRS 15 which state: "recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services." How to calculate deferred revenue? Here's an example of deferred revenue. Assume you have a similar pricing plan (for illustration purposes, we’ve explained it with  Chargebee’s pricing ). This is how you’ll calculate your unearned income in your balance statement. Suppose customer X signs up for the “Scale-up” annual plan on January 1st by paying $6,588. Your accountant will record the transaction in your company's journal entry as: This entry has not touched your company's balance sheet yet. When closing the books for January, your accountant will be creating your monthly financial statements. At that time, the accountant will debit the deferred revenue of $549 from your credited revenue. This reduces your deferred revenue by $549 from $6,688 to $6,139 in January’s book closing statement. This method will continue as you recognize $549 every month from your deferred revenue balance until it reaches 0. Why should deferred revenue be seen as a liability? As mentioned above, deferred revenue is considered a liability, not an asset. Here are a few reasons why that’s the case.  1. Your money isn’t realized  You still owe your customers the required service/goods that should be provided for the completed transaction. So it cannot be counted as revenue just because it shows in your bank records. If your customer wishes to terminate the service before the unfulfilled period of subscription, you’ll need to return the sum for that period. (For example: if they terminate the subscription after 5 months, the money should be returned for the remaining 7 months) 2. Prevents business over-valuation  It is easy to factor in growth based on the money that hits your bank before the promised service has been delivered. This clouds your company’s forecasting methods and creates a “growth illusion.” This can cause you to think you’ve grown and start investing the unrecognized balance to keep the growth momentum. This misleads your investors to believe that you’re growing when the reality is something different. 3. Multiple services offered  Some businesses offer multiple services along with their subscription model , like annual maintenance for two years. In this case, one part of the service you’re providing is fulfilled at purchase, whereas the other will be deferred. This will show that one part of your revenue is earned and another deferred, leading to accounting issues as there are multiple stages of delivery. Realizing these accounts can lead to false positives showing up in your cash-flow statements. Therefore, it is crucial to track your  contract terms  with your customers before realizing the revenue. Moving Forward Deferred revenue in accounting is a careful exercise. Recognizing revenue before it’s earned will misinterpret your growth numbers, spiking your growth potential. It is also important to know that this unearned cash should not be invested in your future projects until it’s earned. A conservative approach to calculating revenue will present a more realistic picture of your company’s growth. Source: Revenue Recognition Principle Understanding when and how revenue is recognized according to the principle The Revenue Recognition Principle is fundamental to accrual accounting, as established by the Generally Accepted Accounting Principles (GAAP). It requires that revenue be recorded when it is earned, irrespective of when the payment is received. This practice ensures that a company's financial statements accurately reflect its economic activities for a specific period, thereby improving transparency and comparability across different businesses and reporting periods Key principles and timing:  Contractual agreement: Revenue is recognized when there is a contract with a customer: Performance obligations: These obligations must be clearly identified within the contract. Transaction price: The price must be determined and appropriately allocated to the identified performance obligations. Recognition of revenue: Revenue is recognized when the company fulfils a performance obligation, typically when goods are delivered or services are provided, completing the terms of the contract. Detailed steps and revenue recognition methods: Five-step process (ASC 606): This includes (1) identifying the contract with a customer, (2) identifying the performance obligations, (3) determining the transaction price, (4) allocating the transaction price to the performance obligations, and (5) recognizing revenue when each obligation is satisfied. Revenue recognition methods: Methods include sales-based, installment, completed-contract, and percentage-of-completion, catering to different business models and ensuring flexibility in accounting practices. Impact on financial reporting and decision-making: Realistic financial statements: Adherence to the revenue recognition principle ensures that financial statements accurately depict the company's financial health and operational success. Informed decision-making: The transparency provided supports stakeholders in making well-informed decisions. Risk management and internal controls: Effective adherence helps manage risks and maintain robust internal controls. Building trust: Consistent application fosters trust among investors and stakeholders, which is crucial for market efficiency and ethical financial reporting Challenges in implementing revenue recognition methods Once you have a grasp of the revenue recognition principle and its operational standards under GAAP or ASC 606 (accounting standards codification), it's important to consider the practical challenges that businesses encounter when applying these rules.  Implementing these methods can be complex due to several factors:  Complexity of contracts: Navigating the labyrinth of customer contracts, with their diverse deliverables, bundled offerings, and sometimes variable pricing, can feel like solving a complex puzzle. Each contract presents unique challenges in identifying specific performance obligations and allocating transaction prices accurately. This complexity requires a keen eye and deep understanding to ensure that every detail is captured correctly, safeguarding the integrity of financial reporting. Estimation requirements: The art of estimation in revenue recognition is akin to walking a tightrope. Whether gauging the progress of a long-term project or judging the probability of payment, each estimate must be crafted with precision. Even a slight miscalculation can lead to substantial adjustments later, potentially shaking a company’s financial foundations. Changing regulatory requirements: Keeping pace with the ever-evolving landscape of financial standards such as ASC 606 (or the revenue standard) and IFRS 15 is a formidable task. It demands continuous learning and adaptation of accounting practices and consumes significant resources. Staying compliant not only tests the resilience of your team but also the adaptability of your entire organization. System and process adaptations: Introducing new accounting software or tweaking existing processes to align with updated revenue recognition standards is no small feat. It involves a substantial investment of time and money. Ensuring that systems are robust enough to handle these complexities and accurately track and report revenue as obligations are met is critical to maintaining operational efficiency. Cross-departmental coordination: Revenue recognition impacts various areas of a business, from the bustling sales floor to the quiet corners of the finance department, and even the tech-savvy realms of IT. Effective implementation hinges on flawless communication and seamless cooperation across these departments. In large organizations, where silos are common, fostering this unity is both vital and challenging. Risk of non-compliance: The shadow of non-compliance looms large, threatening audits, financial restatements, and even damage to your company’s reputation. The stakes are incredibly high, especially for businesses that cross borders or operate in heavily regulated sectors. Maintaining rigorous accuracy and strict adherence to standards is not just important—it’s essential for safeguarding your company’s reputation and future. By confronting these challenges directly, businesses can enhance their ability to manage the complexities of revenue recognition. This not only fortifies trust with stakeholders but also strengthens the overall strategic decision-making process, ensuring that financial statements genuinely reflect the dynamism and realities of business operations. Five-step revenue recognition model The ASC 606 revenue recognition model provides a comprehensive framework for handling contracts with customers in industries such as SaaS, where goods or services are exchanged. This revenue recognition framework is crucial for SaaS businesses to grasp as it directly impacts how revenue is recognized, ensuring accuracy and compliance with established accounting principles.  Under ASC 606, recognizing revenue involves a structured five-step process that addresses various contractual scenarios that SaaS companies frequently encounter.  Here’s a breakdown of the five steps crucial for proper revenue recognition in SaaS: Step 1: Identify the contract with the customer Customer contracts are very straightforward in SaaS businesses. The price and the value exchanged are clearly laid out on the website. However, the contractual terms are subject to changes over time, such as: When a customer upgrades their subscription When a customer downgrades their subscription When add-ons are purchased In many cases, these situations might not require a new contract, only slight modifications to the existing contract terms, such as updating payment terms or license terms. Step 2: Identify your contractual performance obligations Don’t let the term ‘performance obligation’ intimidate you. It simply means the product or service you are delivering to the customer for that particular period. In many cases, it might just be "a month’s worth of access to your service." Step 3: Determine the transaction price The sales price of SaaS products is usually predetermined and mentioned clearly on your company pricing page. However, one should be aware of custom enterprise deals such as discounts, rewards, rebates, usage, and other strategies that cause the customer’s contract to deviate from the standard price that is taken into account at the beginning. Step 4: Allocate the transaction price to separate performance obligations It is important to realize the value of the service provided. In SaaS, the product is delivered continuously; hence, there is no separate performance obligation. Instead, it's a continuous performance obligation. To do this, the overall billing value is split and allocated to each month which falls as part of the service agreement. This is similar to the principles of the completion method. Step 5: Recognize revenue as each performance obligation is fulfilled This is the end goal where the revenue is recognized. In most cases for SaaS, revenue from contracts is recognized over a period of time, not at a specific point in time. This is because, as mentioned above, most SaaS performance obligations are satisfied over time. Revenue recognition examples Depending on the nature of the performance obligation and the specific contract terms, there are different methods and timing for recognizing revenue: SaaS and digital subscriptions: For SaaS companies selling annual subscriptions to cloud-based tools, revenue recognition involves recording upfront payments as deferred revenue and recognizing revenue monthly as services are provided. This aligns with the revenue recognition principle, ensuring accurate financial statements and compliance with accounting standards Retailers: In the retail sector, revenue recognition can be complex, especially when products are sold but not immediately delivered. For example, a retailer selling appliances may recognize revenue when the products are delivered to the customer, even if payment was received earlier. This ensures revenue is recognized when goods are transferred to the customer, reflecting the revenue recognition principle Subscriptions with fulfillment obligations: Subscription-based businesses with fulfillment obligations must recognize revenue over time as services are provided to customers. For instance, monthly subscription plans require revenue recognition at the time of payment, while annual plans involve recognizing revenue gradually over the subscription period. This approach ensures revenue is recognized as services are delivered, maintaining compliance with accounting standards and providing transparency in financial reporting. These examples showcase how revenue recognition principles are applied in various business contexts. They emphasize the importance of accurately recognizing revenue to reflect the true economic substance of transactions and comply with accounting guidelines. Learn more about Revenue Recognition . How does revenue recognition differ in SaaS business models? In SaaS businesses, customers pay upfront for a few months (monthly contracts) or for the whole year (annual contracts). However, the service's value is recognized throughout the contract period. In SaaS, there's always a risk of the customer terminating the contract at any point. So, what you see when you acquire a new customer is cash, not revenue. This cash cannot be recognized until it’s earned over the period of your customer’s contract. The journal entry for it would call it a liability instead of a sale. This has a huge impact on the income statement. The cash payment that is collected upfront is deferred. This means that whenever an invoice is raised, you would route it through deferred revenue, which helps point out that an advance payment needs to be recognized for the rest of the subscription period. Must read: How to Confidently Tackle SSP and Grow Your Business Why is the revenue recognition principle needed in SaaS? The Financial Accounting Standards Board (FASB) controlled how companies earned revenue. However, when software moved to the cloud, SaaS revenue recognition fell into a grey area. A new revenue recognition standard was put up with the help of the International Accounting Standards Board (IASB). New compliance standards such as ASC 606 jointly developed with (International Financial Reporting Standard) IFRS 15 provided a solution to account for revenue that fell through the cracks in earlier accounting principles for revenue recognition. This new, core principle helps improve comparability with companies that adopt GAAP financial statements for their bookkeeping. Under ASC 606, now companies can recognize revenue at the time when goods and services are transferred to the customer, in proportion to how much has been delivered to that point. This also changes the perspective of SaaS accounting , by moving it from a cash basis to an accrual basis. This helps to break the chicken and egg problem of collectability and spending money that is not claimed yet. Must read: Understand, implement, and automate ASC 606 revenue recognition. Non-compliance is not an option, as the consequences are severe. In addition, even if you want to raise money in the future, investors and VCs look for compliant companies. Knowing these principles leads to a bigger question. At what point does a performance obligation count as being fulfilled? Under ASC 606, there are 5 key criteria that must be met for the bills to be recognized as revenue: Risks and rewards transferred from seller to buyer The seller has no control over the goods being sold The collection of payment is reasonably assured The amount of revenue can be reasonably measured The cost of earning the revenue can be reasonably measured How Chargebee streamlines revenue recognition for your SaaS business Running a SaaS company comes with its set of challenges, especially when it comes to subscription management and financial reporting. That's where Chargebee makes a significant difference.  This platform transforms the way businesses handle the complexities of revenue recognition. Effortless subscription management At the heart of many SaaS operations is the challenge of managing subscriptions where customers often pay upfront, yet the services are provided over an extended period. Tracking this can get complicated, but Chargebee makes it straightforward. By automating subscription management and billing, Chargebee ensures that revenue is accurately recognized throughout the duration of each subscription, keeping your financial operations running smoothly without any headaches. Flexible contract adjustments In the SaaS world, customer needs can change quickly, leading to frequent updates in their subscription plans. Whether it's an upgrade, a downgrade, or an add-on, Chargebee adjusts these on the fly without the need to draft new contracts. This flexibility means you can always keep your financial statements aligned with your current business activities without any extra headaches. Reliable financial reporting One of Chargebee's standout features is its ability to automate transaction price allocation and recognize revenue as services are provided. This ensures that your financial reporting is transparent and accurate, giving you a true reflection of your company's financial health. Keeping compliance in check With stringent standards like ASC 606 in place, staying compliant can be daunting. Chargebee simplifies this, managing the risks associated with revenue recognition and helping you avoid the pitfalls of non-compliance. This peace of mind is invaluable for any SaaS business looking to grow and scale confidently. Insights for strategic decision-making Beyond just managing numbers, Chargebee offers powerful analytics and reporting tools that provide insights into revenue trends and customer behaviours. These insights are crucial for strategic planning and can help you make decisions that propel your business forward. See how Chargebee’s RevRec solved Repsly’s integration and efficiency challenges.   Why Chargebee is the perfect fit for your SaaS business Choosing Chargebee means more than just adopting a tool; it means partnering with a leader to simplify the complexities of subscription management and revenue recognition. With Chargebee, your SaaS business can operate more smoothly, allowing you to focus on growth and innovation rather than getting bogged down by compliance and accounting challenges. Ready to see Chargebee in action? Discover how Chargebee can revolutionize your financial operations. Streamline your revenue recognition process with Chargebee. Schedule a demo today, or expand your knowledge and get certified in Revenue Recognition at our Subscription Academy . Dive deep into efficient SaaS Revenue Recognition and enhance your expertise. Keep Reading If you’d like to read more about how you should record SaaS revenue recognition for your business , check out the below articles Best practices in revenue recognition Recognizing revenue with Chargebee’s integrations Have you checked all the boxes with ASC 606? Source: Recurring Payments These payments can be set up via recurring billing for any frequency that’s agreed upon between the customer and the business. It could be weekly, biweekly, monthly, quarterly, or on an annual basis. What Types of Businesses Use Recurring Payments? Most businesses using recurring payments follow a subscription business model where customers have the flexibility to choose the duration and frequency of their subscription and can renew or cancel it at any point.  Subscription businesses are becoming increasingly popular across a wide range of industries as they provide businesses with a predictable revenue stream and offer convenience for customers. The global SaaS industry has grown 500% in the last seven years. Especially during times of economic uncertainties, when businesses need to focus on maximizing their cash flow, subscription businesses are a good bet for business owners and investors alike.  A variety of businesses offer recurring payments for their products or services, such as: Streaming Services: Hulu, Amazon Prime, Netflix eCommerce & DTC: Blume, Feastables Fitness: Gym Memberships, Practo SaaS: Chargebee, Slack Education: Udemy, Study.com Magazines & Publications: Bloomberg, The New York Times  How Do Recurring Payments Work? Simply put, recurring payments work as an agreement between the customer and the business, where the customer agrees to make payments on regular intervals, and the business agrees to provide the product or service for as long as the payments are being made. Once the contract ends, the customer can choose to continue or terminate the subscription. Here’s a detailed step-by-step process to understand the recurring payments workflow: Once the customer has subscribed to your product or service, they can choose the payment method (Credit Card, Direct debit, ACH or SEPA). The customer can then enter their payment details for the first payment. These details are saved in a payment gateway for processing the subsequent payments securely. Then the payment intermediaries, the acquiring bank, credit card network and the issuing bank approve the transaction and the payment is transferred to the merchant account. The payment is debited according to a predetermined billing schedule until an active subscription. This removes the need to manually type in the payment details for every payment cycle.  Types of Recurring Payments Recurring payments can be categorized based on the payment modes used and based on how the payment to be charged is calculated. Based on Payment Modes: 1. Recurring Card Payments: This refers to a recurring payment that’s done by providing credit card or debit card details to the merchant. 2. Recurring Direct Debit Payments: This is a payment method that allows the merchant to automatically charge the customer's bank account on a regular basis. 3. Recurring ACH Payments: This is an electronic bank-to-bank payment in the United States. ACH is an effective way for subscription businesses to accept recurring payments from customers without incurring large fees. 4. Recurring SEPA Payments: Similar to ACH, SEPA (Single Euro Payments Area) is a payment system in the European Union that enables electronic money transfers between banks within the EU.  All of the above payments involve the payment intermediaries that can decline the transaction resulting in a payment failure . Hence, it’s advisable to provide your customers with multiple recurring payment options for your subscription business.  Based on Usage: 1. Fixed Recurring Payments: When a specific amount of money is charged at regular intervals, such as a monthly or annual subscription fee, it’s termed as a fixed recurring payment.  For example, a gym membership that charges a fixed fee of $50 per month for access to the gym facilities. 2. Variable Recurring Payments: These payments vary based on usage or consumption. For example, a mobile phone plan where the customer is charged based on the number of minutes or data used.  Most SaaS and other subscription businesses offer both fixed and variable recurring payment options in their plans. For example, Basecamp, a real-time communication tool for businesses offers two plans depending on business size. A fixed payment plan for large businesses with a monthly fee of $299/ month, billed annually with all-inclusive features and no per-user charges. They also offer a pay as you go plan for smaller teams with all-inclusive features and a $15/ user per month fee. As the number of users increases, the monthly recurring fees increases as well.  Benefits of Recurring Payments Business leaders across the globe agree that a subscription-based model can foster sustainable growth for their businesses. According to a research by Gartner, all new software entrants and 80% of historical vendors now offer recurring payments.  From a customer’s standpoint, they are automated making it one less thing to worry about on their to-do list. Additionally, they can make budgeting easier for customers since they know the exact amount they will be charged on a recurring basis. For businesses, subscription payments have a lot of advantages, including: 1. Predictable Cash Flow: With subscription payments, businesses can more easily predict how much revenue they will be generating each month, which can help with budgeting and revenue forecasting. 2. Customer Retention: Subscription models offer deeper customer insights as opposed to one-off purchases. A continued customer relationship provides the opportunity to develop a strong understanding of consumer behaviors and preferences. Businesses can alter their products or services according to their needs and nail the customer experience. In addition to personalized offering, the “set and forget” nature of subscription payments increases customer convenience and helps in customer retention.  3. Minimal Manual Effort: Once you’ve set up recurring billing for your customers, you can put collections on autopilot. A strong billing software eliminates manual collection and errors, thus saving business time and money.  4. Easy to Upsell or Cross-sell: If a customer is already committed to your product/ service and is paying via recurring payments, they may be more likely to consider additional products or services you offer. This can increase revenue and customer lifetime value for the business. Pricing Models for Recurring Payments As a growing SaaS business, if you’re not pricing your product or service right, you’re leaving money on the table. “#1 tip for pricing strategy is to treat it as an experiment.,” says Yoav Shapira, Director Of Engineering at Meta. Building a successful product that ensures recurring revenue hits your coffers boils down to an essential factor - pricing . The right pricing strategy will help you monetize your product or service better and keep your business in good health. Various pricing models can work for recurring payments based on the business model. Some of the most common recurring revenue pricing models are: Flat-rate Pricing: Flat-rate pricing charges a customer at a pre-determined price offering a fixed set of features with no options or variations to choose from. It is based on the idea that one price fits all customers, regardless of the number of users or the usage level. Customers are charged the same amount on a regular basis, whether it be monthly or annually. Example, Basecamp ’s pricing model for smaller teams. Tiered Pricing: In this case, a customer can choose a bundle of features that have different pricing points. When a customer upgrades or downgrades, their pricing varies accordingly. Additionally, this model can be used to upsell customers incrementally by offering additional features as they scale up. Example: Hubspot Usage-based Pricing: When customers are charged based on their usage, it’s termed as usage-based billing . Post a pre-determined schedule, an invoice is generated based on the customer’s usage. Customers often consider this pricing model as fairest as it directly proportionates to their usage. If they use more, they’re charged more. It’s considered more transparent with no hidden fees whatsoever. Example: Chargebee User-based Pricing: Here, customers are billed according to the number of ‘users’ that use the product or service. Example: Canva How to Accept Recurring Payments? To start accepting recurring payments , one of the most critical things you must solve is the pricing strategy or the billing logic. Once you have sorted your price calculations, grandfathering , invoice proration , etc., you can request a recurring payment. The actual payment from a customer’s account to your merchant account is done via a payment gateway. So, in essence, accepting recurring payments requires two blocks, a billing engine and a payment processor. But, it’s not so simple.  Finding a payment gateway and a billing system that scales with your business can get overwhelming.   Let’s talk about payment gateway first. There’s no dearth of payment gateways out there, Stripe, Paypal, checkout.com..the list is endless, but it’s a mammoth task to compare, evaluate, and pick out the best solution to process your recurring payments. You need to look for these factors while choosing a payment gateway:  What billing logic do they support? What’s the time gap to transfer funds from your customer’s bank account to yours? Do they support multiple currencies and payment types? Can you build a custom checkout process on your website or they’ll redirect customers to a different platform? We know that no two payment gateways are the same. That’s why we built a comprehensive tool to help you compare and choose the best payment processor for your subscription business, specific to your country. Give our free tool a try here .  Next, let’s talk about a billing system. As a rapidly growing SaaS or Subscription business, your billing needs will constantly evolve. Global expansion, pricing experiments, add-ons, discounts…the list keeps on growing. A homegrown billing system can indeed generate invoices automatically but cannot handle complex billing logic.  To future-proof your business, you need to ask yourself, is your billing engine scalable enough ? Set up Recurring Payments with Chargebee Chargebee enables you to accept recurring payments in minutes, from anywhere in the world. All you have to do is: Sign up for a free trial and configure your billing rules and payment methods in our sandbox.  Choose your preferred integrations with 30+ payment gateways and 100+ currencies. You can also process payments offline through bank transfers and checks. Customize invoicing and checkout experience for your customers.  Setup payment retry settings, and dunning logic to combat payment failures. Once everything is set according to your needs, just flip a switch and go live! As growth partners to 6500+ subscription businesses, we understand the importance of robust recurring billing software. That’s why we built Chargebee, an adaptive revenue management software to enable businesses across the globe to not just accept recurring payments, but Recover failed payments automatically and collect both online and offline invoices with end-to-end accounts Receivable software . Increase with personalized cancel experiences. Automate compliant revenue recognition . Weave an accurate and insightful revenue story with an exhaustive dashboard for subscription analytics. And a lot more! If you want to onboard a reliable recurring payment solution, get in touch with our experts and we’ll take it from there.  Source: Calendar Billing How is Calendar Billing implemented in SaaS? There are many cases on how calendar billing helps SaaS Businesses: Consolidating multiple billing dates into a single billing date for a user who has multiple subscriptions by generating a single consolidated invoice containing all the details of the user’s subscriptions. This helps businesses reduce churn, delayed payments and helps the user overcome friction during payment processing/confirmation. Providing a unique billing date for the user upon their request to help align their financial cycle to your billing cycle. Aligning all subscriptions to a new fixed billing date helps set up a single payday for the businesses enabling them to better predict, track, and monitor their revenue. Calendar Billing for E-Commerce: In E-commerce based subscription businesses, calendar billing is used to determine the billing date for the subscription by considering the shipping date of the product. Generally, physical product subscriptions follow a fixed shipping cycle with a cutoff date which helps businesses determine the number of products that need to be shipped in that cycle. For example, let us assume that a subscription box company has its shipping as 15th of every month with the cut-off date as the 10th of every month. If you sign up for the service on the 09th, you’ll be billed by the 15th of the same month and the product will be shipped at the same time. But if you’ve signed up on the 12th (or on any date post 10th of that month), your product will be shipped only in the next month and you’ll be billed only for the next month. Source: Freemium Popular examples of cloud software companies employing the freemium business model include: Freemium vs Free Trial: What’s the difference? A freemium business model often looks like a  free trial  strategy at the outset. However, a freemium approach is not time-limited. Freemium users can use the basic free version for free, forever. The freemium model allows users to experience and get hooked to products by removing initial barriers to adoption. As users realize incremental value over time, they are willing to pay for premium features and capabilities. SaaS businesses use freemium as a customer acquisition model to greatly increase conversion rates on their website. However, freemium strategies work best when the size of potential users is extremely large, and the learning curve of the product is fairly flat. Early-stage startups also typically employ a freemium approach to acquire early adopters and test viability of their product-market fit. A successful freemium strategy requires a relatively easy learning curve and onboarding experience. The product needs to continually engage customers so they can eventually switch to the premium version. It’s always your that product dictates whether you choose a freemium model or not. Never the other way around. When should you NOT try a ‘Freemium’ model? Freemium is not for every SaaS business out there. Here are some questions that might help you decide if freemium is right for you: Is there really a market for your product? If there isn’t a massive Total Addressable Market (TAM) for the product, it shouldn’t be offered for free. The vast majority of free users will never convert into paying customers, implying extra pressure on your existing resources. Is your product built to self-serve? A freemium model is a volume game. If the product dictates heavy hand-holding, sales assistance and human-touch to onboard users, a freemium model may not sufficiently scale. Is there a reason for users to upgrade to a paid version? Unless new, attractive and useful premium features offer users incredible value as they engage with the product, they may not have the right incentive to ever upgrade to a paid plan over their current freemium solution. Explore other SaaS Pricing Models from our Comprehensive Guide As with every pricing strategy , Freemium also has its fair share of pros and cons that should be carefully considered while gauging its viability. Related Read: Freemium Pros and Cons Advantages of Freemium: The free product serves as the perfect user base for experimenting with new features and getting valuable feedback without upsetting the workflow of your paid customers. Increases brand value as you start attracting more users through word of mouth and referrals from your existing user base. Helps you to undercut competitors and stand out in a competitive market alongside gaining a significant amount of market share in no time. Monetization of the free plan by introducing ads which also serves as a motivation for some users to upgrade to premium services. Reduce Customer Acquisition Cost ( CAC ) by minimizing spend and letting your product drive acquisition. Disadvantages of Freemium: Not striking the right balance between your freemium product and premium product – if the freemium plan isn’t attractive enough, then you won’t attract new users, and if the freemium plan is too heavy, then the new users won’t move to the premium plan. Bleak conversion rate from free to paid According to "Free", a book authored by Chris Anderson , only 5% of your entire customer base will belong to paid services. So, the revenue generated from 5% has to support the rest 95% of your free users. The unnecessary and ever-increasing burden imposed on your operational resources resulting in ballooning costs which are predominantly caused by serving free users. Conclusion: As Rob Walling, Founder of Drip put it wisely, Freemium is like a Samurai sword: unless you’re a master at using it, you can cut your arm off. Want to explore more about Freemium? Check out  Wielding Freemium , a video series produced exclusively for breaking down the Freemium business model - featuring experts from Spotify, Atlassian, Appcues, Chargebee and more. Source: Grandfathering Grandfathering: An Essential Piece of Your Pricing Puzzle Verizon and AT&T are once again in the news for their notorious grandfathered unlimited data plans. To cut a long story short, these carriers have been unable to sustain their cheaper legacy plans for early customers and are now revising those prices to general ire. Pricing strategy changes are inevitable as businesses grow and scale. But it’s not the price revision itself that rubs customers the wrong way. It’s the fact that they feel that these mobile carriers are dishonoring their grandfather clauses with bait-and-switch tactics. So how can you introduce pricing changes for your customers without alarming or inconveniencing them? Keep Your Existing Customers to Upgrade Them When it comes to SaaS pricing, a grandfather clause is one which lets your existing customers remain at the same price point at which they first signed up for your product, while you change your pricing plan for new customers. It’s all too common for businesses to price themselves lower than they should when they start out. And it’s not uncommon to see SaaS pricing plans start from $0 either. Having an inexpensive or free plan is a great way to give people an opportunity to use your product with no strings attached. (We have one ourselves). But problems start creeping up when you tell customers that your free plan is free forever. Ultimately, you want to convert your most valuable customers on a free plan to a higher pricing tier. However, your own ‘lifetime free’ label can block you from the possibility of ever upgrading them. And you’ll soon find that it was an impractical promise that may be impossible to keep. Business Benefits of the Grandfather Clause Often, mismanaged expectations are responsible for pricing changes gone awry with customers. Simply considering the necessity of grandfathering as you build out your first pricing plans will put you on the track of thinking ahead to the point when you will eventually change them. But once you’re on the brink of change, what benefits do grandfathered-in plans provide? On the surface, it may look like you’re forgoing revenue. But dive deeper and you’ll see that grandfathering lets you: Run pricing experiments with higher retention rates Customer acquisition costs are a big part of any company’s expenditure. So it makes sense to understand all the aspects of a trade-off between losing customers on a free or low-paying plan and the cost of acquiring an equal number of new, engaged customers. Mostly, it’s better to retain rather than to acquire. Maintain long-term customer satisfaction The relationships you build with your early customers are often more personal than the ones you make as you scale. And they will likely be your strongest supporters in the long run. Grandfathered-in plans respect your early relationships. Of course, grandfathering is only one of several ways to shift customers gradually from the old to the new. While it works in most cases, there are other variations and methods you can adopt depending on your pricing model and SaaS product. Some of them are explained in Patrick Campbell’s guide to changing SaaS pricing linked below. The important thing to remember is that pricing plan changes shouldn’t come as a sudden shock to the people using your product or services, but as a chance for them to reassess your product or service’s value in a positive way. Additional Reads Ready to ring in the new and grandfather your old plan? Here’s a quick list of must-reads before you embark on your pricing journey: Understanding the process of changing SaaS prices A complete guide to changing your SaaS pricing A quickie on how grandfathering assists in executing a successful pricing change What is grandfathering of prices and its role in SaaS? Krish Subramanian from Chargebee stresses the importance of grandfathering from the perspective of a subscription-based pricing change. Source: CAC Payback Period Becoming a profitable business is not as simple as signing up a customer and immediately being in the black. As lovely as that sounds, that's not the reality SaaS businesses are dealing with. Software companies selling a subscription need to price competitively, which means reaching profit usually takes several months with each new customer.  If a customer churns too early, you lose money. Understanding the CAC payback period is essential to a company's long-term success. It helps you identify ineffective marketing channels and invest your advertising dollars more effectively. The CAC payback period is the time it takes for your company to recover the cost of acquiring a customer . Potential investors will be very interested in this fundamental metric as it provides an accurate view of a company's growth potential. This article will break down what the CAC payback period is, how to calculate it, and why it matters for your business. We'll also provide advice on creating a shorter payback period so that you can get a better return on your investment What Is the CAC Payback Period?  The CAC payback period measures how long it will take to make back the money spent on acquiring a new customer. Signing on a new customer should be a positive for any business, but if they bounce during the CAC payback period, you've lost at least some of the money spent on marketing.  Acquiring a customer isn’t free. There are costs associated with every new customer, such as marketing and advertising costs. Even for organic leads, there’s the salaries of your sales and content team. On average, it will cost a company $205 to acquire organic customers. Subscribers gained from inorganic methods like advertising will set a business back by $341.  Since SaaS companies use a subscription model to generate recurring revenue, they need customers to stay on the service long enough to start profiting. A SaaS business is in good health if the CAC payback period is somewhere between 5 - 12 months. The longer the payback period, the more time it takes to make a customer profitable. Since SaaS companies use a subscription model to generate recurring revenue, they need customers to stay on the service long enough to start profiting. That’s the thing. If you’re spending hundreds of dollars to acquire a single customer, you need them to stay with you for the long term. So your product needs to be worth paying for and offer enough features to keep your clients happy. Otherwise, they may choose to end the relationship early. Who Uses the CAC Payback Period? The CAC payback calculation is a board-level target metric. It indicates whether a company is priced correctly and has a viable marketing strategy. Getting it right requires cross-department collaboration, including marketing and sales. So key sales and marketing staff (VP of marketing, head of sales) often use it as a “north star metric” to help them decide which marketing channels to focus on to contribute effectively to the bottom line. How To Calculate CAC Payback Period Figuring out the CAC payback period is a simple process, so it's worthwhile for any business to know how to do it. First, you need to calculate the customer acquisition cost ( CAC ) before the payback period can be determined. Speak with marketing and sales to get the figures for ad spend, content creation, publishing costs, and the department overheads. Once this information has been gathered, divide the total costs by the number of customers gained. This is the average acquisition cost for the business, and now you'll be able to calculate the CAC payback period. Calculating the CAC payback period is as simple as taking the customer acquisition cost (CAC) and dividing it by the monthly recurring revenue ( MRR ). CAC Payback Period Calculation If your CAC works out to be $200 for each new customer, and they pay $20 per month, then you will break even on month ten. However, if the customer leaves the service before month ten, you will have lost money. $200 / $20 = 10 months By using this CAC payback period formula, you can track and monitor the progress of your customer retention programs, as well as the effectiveness of any changes in marketing strategy. If customers are churning before the breakeven point, it's a strong indicator that something's wrong. Ineffective marketing can increase customer acquisition costs. You can identify where your ad dollars are better spent by breaking down the CAC payback period by advertising channels. CAC Payback Period Benchmarks  Reaching profit quickly means your company is doing something right. Gaining your investment back means there's more money to play around with. You can take bigger risks with marketing to see what attracts new customers (or turns them off).   Various things can affect the time to reach profitability, and some companies will manage it much sooner than others. A strong marketing strategy helps, as does having a product that solves people's pain points. The average payback will change as your business grows. Factors like changes in the market, competition increases, and new operational costs can increase or decrease the CAC payback period. Early in a startup's journey, it's typical for the payback period to fluctuate, but anything under 12 months is a good sign that the company is on the right track. In the case of larger, well-funded SaaS companies, the CAC payback period benchmark may be longer. They have access to extra funds, which means they don't need to be as quick to make a profit.  According to the 2021 Financial & Operating Benchmarks Report , to be considered 'best in class' for seed funding, your payback period should be 15 months or less. The report reveals that the acceptable period varies depending on your business's funding series . It can be as high as 28 months for Series C funding. If your SaaS model is coming in under these numbers, it's a good sign that you're doing something right. Investors may not be willing to fund your business if it takes too long to break even. Why is the CAC Payback Period Important?  CAC payback period keeps the reality of business growth clear. New subscribers might be growing in number, but if the cost to acquire new business is growing at an equal or greater rate, the payback period will increase. 1. It Helps You Find Where You Are Overspending 10,000 new subscribers look good on paper, but if the acquisition costs have 10x'd in the same period, it will take 10 times as long to break even. The payback period helps to identify when things aren't working. If your company charges a monthly or annual fee that doesn't cover the acquisition cost upfront, you'll need to keep each customer around. A longer payback period risks that you won't recover the investment spent acquiring them. 2. It Helps You Spot Issues With Retention and Churn When a product is sold in a shop, the cost of manufacturing, materials, labor, and profit is acquired in a single transaction. SaaS companies don't operate in this manner. Customers sign up for a subscription which generates recurring revenue. This allows software businesses to offer a smaller upfront fee to their customers but exposes them to the risk of not recovering the costs spent on sales and marketing.  By measuring your CAC payback period, you can quickly identify any issues you have with retention and churn. If most customers stop their subscription before fulfilling their CAC payback period, you’ve got a serious issue on your hands. If a company has a high churn rate , it'll need to keep acquiring new customers at an ever-increasing rate just to keep existing. Try to find any commonalities among those who have churned. If people from certain channels are leaving after month 6, what could be happening to cause that? 3. It Helps You Get Your Pricing Right Creating the right pricing structure takes experimentation to get right. Many factors come into play, such as the perceived value of the product, what the customer is willing to pay, and what will ensure a healthy margin. If the CAC payback period is too long, it might indicate that the product is priced too low. The company can try increasing prices or introduce premium or enterprise tiers to see if it affects the payback period positively. Alternatively, a product priced too high won't get as many conversions which increases the CAC payback period. 4. It Can Inform Your Marketing Strategy The CAC payback period metric is a good way to assess whether current marketing efforts are working. If the payback period is too long, it might indicate that the company is overspending on marketing or that you are pursuing the wrong target market. Poorly converting ads is a common cause of high CAC. A change in strategy can significantly reduce the cost of acquisition and the payback time. Break down the CAC payback period by looking at the different marketing channels. If YouTube ads are bringing in more customers at a lower CAC, it's a good idea to focus more marketing resources on this avenue. Adjust the campaigns that aren't converting as well to improve the ROI. Example: If you spend $1,200 on Facebook Ads and onboard two clients at $25 per month, it will take two years to profit from these customers.  Tweak the ad campaigns by changing the target audience, adding the Facebook Pixel to your website, and run multiple ad groups with different ads to see what's resonating with the type of people you want to convert. A change in strategy could lead to more conversions or a larger average deal size. If you instead onboard 2 customers, but they both opt for the premium $50 per month plan, it reduces the CAC payback period by 50%. CAC Payback VS LTV:CAC Ratio: Which Is More Important?  CAC Payback is not the only metric SaaS companies use to analyze their growth. Nowadays, many startups prioritize having a 3:1 LTV:CAC ratio instead of the length of their payback period. CAC payback is a metric marketing and sales teams can use to gauge the efficiency of different channels, and the overall performance of all acquisition efforts. With LTV:CAC, you instead divide the average lifetime value of a customer by your acquisition cost, making it a more detailed measure of the return on your investment — it literally shows if your marketing is profitable or not. The formula looks like this:  LTV:CAC = (Revenue Per Customer – Expenses Per Customer) / (1 – Retention Rate) / (Number of Customers Acquired / Marketing Spending) The problem with LTV:CAC is that it looks at averages, so it’s not necessarily useful for evaluating the results from a single specific channel. It’s also only an accurate measurement when you have years of high-quality data on churn, customer lifetime value, and customer acquisition costs for each cohort. And, it’s not always going to help you make smart marketing decisions for your business (especially for newer or smaller companies). Your LTV will change as your company grows and you expand to new marketing channels (usually for the worse), which means you could be losing money on advertising without realizing it. The CAC payback period isn’t a perfect metric, but it can be calculated with less information and can be more helpful to guide critical business decisions. For example, even if you’re a brand new SaaS with only 3 months of customer data, you can use CAC payback to make data-based marketing decisions. It immediately highlights how long it will take you to profit from customers from different channels and zeros in on any leakage in your marketing funnel. It also indicates the level of risk you’re exposed to with your current marketing campaigns. For example, even with an LTV:CAC ratio of 4:1, if it’s going to take you 2 years to recuperate your marketing costs, your startup may run out of runway if you don’t have enough funding. So the CAC payback period here is the more important indicator of campaign performance. It’s also easy to calculate your CAC payback period in the early stages of the new campaign, as you can forecast it based on the average monthly revenue of the new leads generated. How to Reduce the CAC Payback Period  The payback period is not set in stone; you have the tools to change how long it takes to make a profit. It requires experimentation and a keen understanding of your business and its customers. 1. Experiment With Pricing Promoting an annual subscription can lead to profit quicker if your CAC payback period is less than 12 months. Convertkit is a company that offers a yearly subscription that comes at a reduced cost. Everyone walks away from this deal better off. The customer gets a good deal saving two months on their annual spending, and you get a lump sum when they sign up with you. If the CAC payback period is less than 10 months (2 months for free), you're in profit. 2. Analyze Marketing Strategies and Focus on Channels That Drive Higher Deal Values There is a lot of room to play with marketing. Campaigns need constant experimentation and analysis to ensure they're optimized. Evaluate what's working and what isn't. Make changes to your strategy and test how they affect the payback period. What’s important is that you use an analytics platform and your CRM or billing platform (as well as customer surveys) to identify the lead source, and compare the average revenue per customer between platforms. Once you have this data, you can start prioritizing between digital channels like SEO, content marketing, or PPC. Even if Facebook ads has the cheapest CAC at $277, it doesn’t matter if the average customer from Facebook only stays on for 3 months on a $50 per month plan. Focus on channels that drive larger deals and premium plans, not the ones that drive the most freemium users. 3. Expand to Higher Value Market Segments If you’re currently mainly focusing on small-scale mom-and-pop shops, expanding your service to enterprise customers is something that can immediately reduce your CAC payback period. Firstly, these types of companies are more likely to want yearly contracts and pay in lump-sum (which means you typically recuperate the entire CAC up-front), even if they’re on monthly contracts, the high monthly cost means you can quickly pay down any marketing costs and start profiting. To break into these markets, connect with potential customers and ask them what additional features they’d like to see from your product (like two-factor authentication, user access controls, etc.). Then address those needs in a custom plan for enterprises at a much higher price point. (If you’re based in a country with low average income, like India, this could also mean expanding your offerings to countries with higher median household incomes, like the US or Norway.) 4. Focus on Upselling New SaaS businesses often underestimate the potential value of their existing customer base. It may seem counterintuitive to focus inward instead of bringing as many new customers into the business as possible. But the fastest-growing SaaS companies on the planet owe between 20-40% of their revenue growth to “expansions revenue” — added revenue from upselling to existing customers. Plus, since you don’t need to pay for access, upselling is also a lot cheaper than acquisition. It can be as simple as adding an automated “Did you know you can do this with premium?” email to your onboarding drip campaign. 5. Decrease Churn A significant churn rate is very bad for business. If customers leave before you break even on their CAC, you're losing money on advertising (not to mention other running costs).  Some level of churn is bound to happen, and it presents a valuable learning opportunity. Introduce a non-pushy exit interview to determine what's causing a customer to leave. Gather and analyze this information, and then develop an action plan to fix any issues. For example, you can develop new features that help your customers address additional pain points mentioned during the interview, or set up a more comprehensive onboarding process if that was highlighted as an issue.  Then, you have the last resort — if a customer opts to leave, try offering them an incentive to stay. For example, you can use a discounted rate or access to a higher tier to tempt customers into staying. Conclusion  It may sound like a cliche, but it's true, you have to spend money to make money. CAC payback helps ensure the money you're spending isn't wasted on lousy marketing campaigns or customers who leave soon after signing up. The key is to constantly learn and evolve your tactics to ensure you're getting the most out of your customers. For pricing models that suit your business, check out Chargebee's Subscription Management service to help reduce your CAC payback period. Source: Order to Cash The sales cycle is important to your business. But if you want to stand out from the competition, you can't underestimate the importance of an efficient order-to-cash process.  But what is Order to cash? We're here to answer that question, plus break down this crucial process step-by-step. Understanding the order-to-cash cycle  — and doing it right — can have a huge impact on cash flow, customer satisfaction, and ultimately, revenue growth. Let's dive in. What Is (Order to Cash) OTC Process? Order to Cash ( O2C or OTC)  is a critical business process that involves receiving and fulfilling customer orders, invoicing, and collecting payment. It ensures smooth operations from order placement to revenue realization, optimizing efficiency and customer satisfaction. The O2C process isn't to be confused with the quote-to-cash process .  Quote-to-cash (QTC) is the end-to-end business process that includes all sales processes, the reviewing of contracts and payment terms, order management, invoicing, and the accounts receivable process. O2C vs. QTC: What sets them apart? O2C activities are a subset of the quote-to-cash process — whereas QTC starts with customer purchase intent and ends with realizing revenue, O2C starts with the moment the order is made The Order to Cash Cycle (OTC Cycle) Are you struggling with constant billing issues? Delayed fulfillment times?  Outstanding invoices? Dissatisfied customers? You might be able to blame your O2C processes. If your team doesn't fully understand it (or it's just plain inefficient), that can lead to these problems and more.  Here's your ultimate step-by-step overview of the process, so you can make sure everyone is on the same page. 1. Order Management  The O2C cycle kicks in the moment your system receives an order from the customer. It might be an online order placed directly on your website, or through your sales team over an email. Either way, if you want to improve your O2C performance, make sure you have order management software with automation capabilities.  2. Credit Management Effective credit management at the beginning of the Order to Cash (O2C) process is crucial in preventing potential issues later. For cases involving credit, each new customer placing an order should undergo a seamless credit approval process. Utilizing automated software streamlines simple approvals or denials, with finance personnel alerted for more complex reviews. Returning customers with current credit approval should be fast-tracked to fulfillment by the order management system. On the other hand, those previously denied credit or applying for the first time should be treated as new customers. Automated credit management simplifies accounts receivable tasks, and strategic credit policies ensure that only deserving customers receive credit. By implementing efficient payment processes and guidelines, businesses can enhance their financial health and maintain strong client relationships. This proactive approach speeds up the O2C cycle and guarantees that resources are allocated effectively towards fulfilling orders and managing cash flow efficiently. 3. Order Fulfillment and Shipping The next step in the cycle is order fulfillment and shipping. If you're a business that deals with physical products, then this includes inventory management and the fulfillment process.  In cases of digital services or Software as a Service (SaaS), this could mean granting access to the product or service for which the order is raised. 4. Invoice Creation and Payment The third step in the cycle is invoice generation and payment. The customer should receive an accurate invoice for the order that includes individual line items, as well as applicable taxes and discounts. The customer should also have multiple options for making a payment. This is the best way to ensure a great customer experience, plus minimize credit card failures and payment delays.  5. Account Receivables and Reporting  The cycle is completed once the payment is logged in your accounting books as part of the accounts receivable against the raised order. Effective data management is essential for the order-to-cash (OTC) process, allowing businesses to efficiently handle and analyze customer and order data. This capability is crucial for driving revenue growth and improving cash flow. The process involves collecting, storing, and processing vast amounts of data from various sources, such as customer information, order details, and payment history. Utilizing this data, businesses can identify trends, optimize pricing and inventory, and streamline order fulfillment and invoicing. Advanced analytics and business intelligence tools offer real-time insights into customer behavior, enabling companies to detect potential issues and make informed decisions. Consequently, this enhances the overall OTC process and significantly boosts customer satisfaction. Order to Cash for Subscription Businesses: The O2C process, in principle, is the same for any kind of business. However,  the actual mechanics change significantly in a subscription business model .  There's huge O2C automation potential for subscription and SaaS businesses. In a subscription model , a sale or order is never complete. There is always a recurring order the next day, week, month, or year — without automation, you can't realistically scale.  There are also many other complexities including setup cost, discounts, proration based on usage, refunds, write-offs, upgrades, downgrades, and beyond.  In a SaaS or subscription-based business, the contract period also dictates how the O2C process works. If it is a monthly recurring order, the cycle repeats for every order and that’s pretty straightforward. But if it's a one-year contract paid upfront, or a yearly contract paid monthly, that makes a big difference. In that case, the O2C process must be adjusted to ensure accurate revenue recognition through appropriate deferred revenue reporting. Conclusion: Transform Your Order-to-Cash Process Mastering the order-to-cash (OTC) process goes beyond efficiency—it's about creating a seamless experience for your customers and elevating your business to new heights. Every step, from order management to payment collection, is crucial in keeping your operations smooth. By using automation and advanced analytics, you can gain real-time insights, make smarter decisions, and stay ahead of the competition. Take Action Now Ready to improve your OTC process? Schedule a demo call with Chargebee to see how our solutions can revolutionize your order-to-cash cycle.  Don’t miss out on expert insights and training—subscribe to Chargebee Academy for exclusive tips and strategies to optimize your subscription management . Start your journey today and experience the impact of a streamlined order-to-cash cycle. Additional Reads More reads on the Order to Cash process, and how it impacts the Finance operations of subscription businesses: Learn how Chargebee helps FinOps teams of subscription businesses. It’s Time SaaS Finance Operations Moved Out of Spreadsheets Read about accounting for annual contracts in subscription businesses. How to Account for Revenues and Expenses with Annual Contracts in SaaS Read about reporting account receivable leakage. Where’s Your SaaS Revenue Leaking? Source: Pay As You Go Pricing Model No matter how exciting a customer finds your SaaS product, one of the first things they want to know is, “how much does it cost?” That’s why choosing the right pricing model is as critical as developing the right features or having a strong sales strategy.  A flat-rate pricing model is simple to understand and implement, but will it give you the competitive edge? Before you make a decision about SaaS pricing, consider the pay-as-you-go model.  This article tells you everything you need to know about pay-as-you-go, including what it is, its pros and cons, and how to get started.  What is the Pay-As-You-Go Business Model?  The pay-as-you-go (PAYG) pricing model means that users pay based on how much they consume. For example, a cloud storage service provider could charge based on the amount of storage used, while many phone carriers bill based on minutes used.  You’ll also hear pay-as-you-go referred to as a usage-based or consumption-based model.  It’s not as common as a per-seat pricing model, which is what 42% of Inc. 5000 SaaS companies use, or the flat-rate model used by 37% of those businesses. But it’s still popular at 21%.  And pay-as-you-go is growing in the SaaS world. A quarter of the businesses that currently use a usage-based model introduced it within the past 12 months. Meanwhile, 61% of companies that don’t use pay-as-you-go pricing are planning to launch or test it in the near future.  It’s likely that pay-as-you-go will be the dominant SaaS pricing model soon.  What are Examples of Pay-As-You-Go Pricing? Pay-as-you-go pricing can take many forms and is customizable to a company’s needs. Let’s look at what pay-as-you-go looks like for two well-known SaaS companies.  1. AWS Cloud resources are a common pay-as-you-go use case. One of the most famous examples is Amazon Web Services (AWS). AWS offers over 200 cloud services, each of which has its own pay-as-you-go pricing system.  For example, if you choose to run applications on the EC2 virtual server, you pay for computing resources by the hour or second. Or, you could use an AWS storage solution and pay based on the size of the objects you store and how long you store them.  2. MailChimp An example of a different type of pay-as-you-go model is the email marketing platform MailChimp. In addition to its usual tiered pricing plan, MailChimp offers a credit-based pay-as-you-go plan.  In this plan, you can buy as many or as few email credits as you need. Each email credit can be used to send one email, and credits expire after twelve months. What are the Types of Pay-As-You-Go Plans?  As you can see from the examples above, pay-as-you-go plans come in two main types. Consumption-Based The first is consumption-based. The more you use a certain resource (like transactions, storage, bandwidth, minutes, and so on), the more you pay.  For example, for credit card payments, payment processing service Stripe charges 2.9% of each transaction plus 30¢. You don’t have to pay a monthly fee, just a pay-per-use price for each transaction.  Credit-Based The second type of pay-as-you-go model is credit-based. In a credit-based system, you purchase credits that can be exchanged for a service.  The main difference is that you typically use what you want and get billed accordingly with a consumption-based plan. In a credit-based system, you purchase what you need in advance and then use it.  An example of a credit-based service is Audible, which lets you purchase audiobooks for credits. You get credits every month that you’re on a subscription plan, but you can purchase more using a pay-as-you-go system if you run out.  Credit-based pricing models are appealing to the company because you get paid upfront. But they’re a risk to end users — they don’t always know if they’ll use all of the credits or let some go to waste.  What Are the Benefits of the Pay-As-You-Go Pricing Model?  Pay-as-you-go plans are becoming more popular because they benefit the business and customer alike.  1. Lower Upfront Costs Attract Users Potential customers might like your business but feel intimidated by committing to a subscription plan. A pay-as-you-go model has a low upfront cost — all the customer has to pay for is what they’re going to use right away.  This low level of investment often leads to customers making a quicker purchase decision. They also like how pay-as-you-go puts them in control. They won’t pay for anything they don’t use.  Pay-as-you-go is ideal for businesses that won’t use your product or service consistently from month to month. If you offer an email platform, the customer can pay to send 5,000 emails one month and pay nothing the next month when they send none.  2. You Can Charge More for High Consumption Some customers use more resources than others. This typically costs you more, so you should be able to charge them more. But in a flat-rate system, these major users pay the same amount as everyone else.  Even with a tiered system, some customers in the higher tier may be using a lot more resources than the others who are paying the same rate. Pay-as-you-go accounts for that.  3. You’ll Learn About Your Customers A pay-as-you-go plan helps you understand exactly how much your customers use and when they use it. This information is valuable for determining future offerings and prices.  4. Revenue Grows Faster with Pay-As-You-Go Some SaaS companies worry that the inconsistent nature of pay-as-you-go customers will hinder growth, but the opposite is true.  That’s because pay-as-you-go is naturally scalable in real-time. When customer usage increases, so does the money you’re making. Immediately. You don’t have to bother with reworking your monthly rates and rolling them out to existing customers gradually.  The result is that companies with usage-based pricing models have a YOY revenue growth of 29.9% . That’s more than the SaaS average of 21.7%  What Are the Disadvantages of the Pay-As-You-Go Pricing Model?  Pay-as-you-go is taking the SaaS world by storm, but not everyone loves it. Here are a few disadvantages of the model.  1. It’s Challenging To Retain Customers Businesses with monthly subscription plans often require customers to pay for several months or a year at a time. Others offer a discount if the customer pays annually rather than monthly.  Even without these requirements or incentives, customers are likely to stick with a monthly subscription service whether they’re using it every month or not.   But pay-as-you-go customers may drop away quickly since they haven’t made any commitment. This can result in increased churn rate for your Saas business. (That said, pay-as-you-go also has an advantage for customer retention: if a customer can’t afford their usual rate for a month, they don’t have to cancel their subscription.) 2. Revenue Is Unpredictable With pay-as-you-go, you have no idea how much each customer will pay per month or year. This makes it hard to forecast revenue.  For example, an enterprise customer might test your service with one small team first. They like what you have to offer, and suddenly the whole company is signed up. Usage goes up by 2000% overnight.  3. Pay-As-You-Go Is Complex  Want a payment model that’s easy for your customers to understand and easy for you to calculate? Use a flat-pricing model (Charge everyone $25 per month, every month) Or use a tiered pricing model to charge end users at three or four price points.  Pay-as-you-go gets a bit more complicated, especially if you have separate pricing schemes for different types of resources (like our AWS example). It’s hard to know much you’ll pay if it’s calculated on a per day or per gigabyte basis. So some customers will opt for a company with a simpler flat rate. Typically small startups and medium-sized businesses with limited budgets like the predictability. What’s the Difference Between Pay-As-You-Go and Other Subscription Models?  If you’re not choosing a pay-as-you-go pricing system, what other options do you have? Flat Rate Pricing Your customers all pay the same amount for your service. They’re usually billed for this amount monthly or annually.  For example, Basecamp charges every customer $99 per month. They all get the same thing — unlimited projects, unlimited users, and 500 GB of storage space.  Tiered Pricing A more common type of flat-rate pricing involves offering several different pricing tiers. The higher-priced tiers offer more features or resources than the lower tiers. Each tier costs the same amount every month or year.  Per User Pricing Some SaaS service providers charge based on how many users will be on your account. This is often combined with a tiered system. For example, the lower tier charges $20 per month per user, while the higher tier charges $40 per month per user.  Hybrid Pricing You don’t have to stick to just one pricing type. There’s an endless variety of hybrid plans you can create to suit your organization’s needs.  Some companies, like MailChimp, offer a monthly flat-rate subscription as well as a separate pay-as-you-go plan.  Other businesses offer pay-as-you-go as an add-on service. For example, your monthly subscription gets you 20 GB of storage and you pay-as-you-go for every GB after that.  Related Read: Learn about the other SaaS pricing models here.   Is Pay-As-You-Go Right for Your Business?  Pay-as-you-go can be customized for many companies in a wide variety of industries, but it’s not right for everyone. Here’s how you know that pay-as-you-go is a potential fit for your SaaS business.  1. You have a diverse user base If all of your customers use roughly the same amount of resources, you might as well charge them all the same rate. Likewise, if you can easily break your customers into two clear groups based on their usage, a tiered plan might suit.  Pay-as-you-go makes the most sense when your customers range from super users who would be willing to spend a lot of money with you to frugal newbies who just want to test the waters for a low rate.  2. You can precisely track customer usage It’s pretty straightforward: you can’t charge for bandwidth if you don’t know exactly how much bandwidth each customer is using.  Make sure you’re set up to track usage easily and precisely. This is also important for customer loyalty — if there’s any suspicion that your subscription billing is based on incorrect information, it will be damaging to your reputation.  3. You’re prepared for higher short-term costs With a subscription plan, you can cap customer usage. No one is going to use more storage space than their price tier allows.  What if you switch to a pay-as-you-go system and a few of your customers start using ten times their previous maximum storage allowance? Can your cash flow support it? These big usage jumps are exactly what allows pay-as-you-go businesses to scale quickly, but they can also cause you to incur costs quickly. If you’re not prepared for that possibility, you should hold off on switching to pay-as-you-go.  4. Your customers frequently move between plans A sure sign that your customers would be happy with a more flexible pricing model is if they frequently jump between tiers of your existing subscription plan.  They’ll be grateful when you make their lives easier by letting them pay as they go.  How To Implement a Pay-As-You-Go Model for Your Business in 4 Steps You’re convinced — pay-as-you-go is the future of SaaS, and you’re on board. But unlike your current subscription plan, pay-as-you-go is complex. How do you get started? Making the change doesn’t have to be daunting. Just follow these four steps.  1. Choose Your Metric or Resource What resource are you charging your customers for? Sometimes the answer is obvious, like a cloud storage company choosing to charge for storage space. But sometimes, you have more than one option. For example, some web services may be able to charge for storage, bandwidth, or hours of usage.  If you’re not sure of the best option, step 2 might help you decide.  2. Track and Analyze Usage Before you implement your pay-as-you-go model, you need to do some analysis of current customer usage.  Start by tracking any metrics that might be used for billing. As we discussed, it’s important to make sure your tracking is precise and reliable.  Tracking usage will help you optimize how much you should charge for each billable unit of the resource. It can also help you figure out which of two resource types will be the best to charge for.  When you’ve chosen your metric, you can use that information to bill customers.  3. Determine Time and Frequency of Billing First, you have to decide between a pre-pay (credit-based) or post-pay (consumption-based) pay-as-you-go plan.  The advantage of a credit-based plan is the upfront cash flow. The customer pays you before you incur costs for their services. It also makes things a little more predictable — if a customer has only pre-paid for 500 emails, they can’t unexpectedly send 5,000.  On the other hand, customers aren’t always thrilled with pre-paid systems. They may not know how many minutes of cloud computing they need in advance, or the credits might expire before they use them. Overpaying doesn’t give customers a good impression of your business.  You’ll also need to decide how frequently your customers will be billed. A monthly billing model is common but not the only option. For example, some companies send a bill once a certain balance is reached.  Google Ads is an example of a company with a mix of billing practices. You can be billed monthly or receive a bill whenever you’ve spent a predetermined amount. 4. Rely on the Right Tool The biggest problem with pay-as-you-go pricing is that it’s more complicated than other models. But the right subscription billing solution can make it simple.  You need a tool that can take a customer’s usage statistics and accurately bill the customer without requiring you to do a lot of extra work. Chargebee's metered billing offers everything you need for pay-as-you-go pricing.  With minimal setup using API and webhooks, you can automatically calculate a customer’s usage rate and integrate it into the billing process. You just have to create a subscription and indicate which resource to charge for and how often to send a bill.  You can completely automate your pay-as-you-go billing workflow, but that doesn’t mean you lose flexibility. You have the power to intervene and override charges at any point. Reporting and analytics are essential for any pay-as-you-go tool. You need to be able to see how resource usage varies from month to month and how consumption patterns affect your monthly recurring revenue ( MRR ). You should also be able to take your usage-based insights and apply them to decisions across the business.  Chargebee's RevenueStory gives you visibility into your subscription analytics. It helps you identify what factors are driving revenue, subscriptions, signups, activations, churn, and other metrics. With over 150 ready-made reports, you have actionable insights into new sales, payments collected, MRR, activations, churn, and other metrics.  Pay-as-you-go is on its way to becoming the dominant SaaS pricing model. That’s not surprising considering that it provides a positive customer experience and allows businesses to grow rapidly. With pay-as-you-go, you can acquire customers at a low cost and scale to unlimited heights.  If you’re ready to be a part of the pay-as-you-go revolution, we can help you get started. You can try Chargebee for free .  Source: Credit Notes We encounter credit notes most commonly in retail. When you return the extra night lamp you received as a gift, exchange your defective toaster for a cheaper model or show that you’ve been overcharged for the thingamajig by mistake, the store gives you credits which you can use to buy other items from them. Subscription billing credit notes are similar. They’re sent out when the business owes the customer money (think of credit notes as the opposite of an invoice). But because of the nature of recurring billing , there’s more to a credit note than meets the eye. Myth #1: Returning Money to Your Customers is Easy If you run a subscription business, it’s not uncommon to find yourself in situations where you owe your customers money. What may come as a surprise, is how tricky it can be to actually give it back. Reasons why you may be in the situation of providing credits to customers: Subscription changes & cancellations When customers downgrade or cancel their plan before a billing cycle ends, you need to adjust the next invoice amount to reflect the downgrade. Customer dissatisfaction If a customer raises valid issues of dissatisfaction with your product or service, you may refund a part of their invoice or the full amount paid according to your terms and conditions. Waivers & write-offs What if you have an exception where you find that you need to write off or waive someone’s invoice? Perhaps, they’ve made an offline payment. You still want to have enough control to be able to do this. The common thread that runs through these reasons for credit is that you cannot always anticipate them. They are changes initiated by the customer or prompted by unusual circumstances and have to be handled separately. But how can you incorporate these credits into your accounting system after the invoice has been generated? And how do you keep track of credits for tax purposes? These questions can be intimidating if you’ve just set up a basic billing system . Even for established businesses, it can be a nightmare in overheads and tracking. But this is precisely where credit notes can make your life simpler. Myth #2: Credit Notes are Complicated All of us have heard of and used invoices, but not many of us get credit notes. It seems like another feature that we may or may not use, one more thing to know about and remember. Easily dismissable with a ‘We’ll cross that bridge when we come to it’.ere you owe your customers money. What may come as a surprise, is how tricky it can be to actually give it back. But it’s a bridge that comes sooner than you think. As a business, you want to offer flexibility and transparency in all transactions, and credits are a big part of that. Customer perception of your business depends on whether you honor your promises in a way that’s easy for them, without a lot of complicated hemming and hawing. Would you rather: Manually create a negative purchase invoice every time you’re dealing with returns or cancellations Painstakingly integrate these manually-created notes into your otherwise automated system Or: Create a credit note in a few easy steps Have safeguards and logic in place to anticipate different kinds of subscription billing credit scenarios and the ones you deal with the most Automatically have it integrated into all your revenue calculations An important thing to note, however, is that credit notes are neither refunds nor promotional credits. With refunds, you are essentially returning the money customers have paid you already and promotional credits are discounts given in the form of credits. Credit notes are a way to record negative charge changes in invoices and provide credits to settle them. Yes, it’s one more billing feature to look for when you set up subscription billing. But it’s far less complicated to check for credit notes support ahead of time, instead of opting for a DIY job that’s unscalable. Take it from us, it’s the easiest legally binding way to return an invoiced amount. Pro Tip: How do I return money if a customer hasn’t paid my invoice yet? We see credit notes in two ways: refundable and adjustable. If a customer has paid the invoice, the refundable credit either gives them a credit that can be applied in future invoices or a straightforward refund. If the invoice has been generated and the customer hasn’t paid it yet, there’s a chance to ‘adjust’ the invoice amount so the customer doesn’t have to pay for the deduction in the first place. Additional Reads Some useful reads to throw light on what a credit note is and how it is used: Not all credits can be treated the same. Learn more about Detangling the credit snag in subscription billing A common subscription billing case where credit notes come in handy: Proration. SaaS proration: The logical way to handle mid-cycle subscription change Source: Subscription Management A good chunk of all the digital and physical services we use today are subscription based. Dollar Shave Club or Birchbox at home. Slack, AWS or LinkedIn Premium at work. A food or salad subscription for lunch at the desk. Spotify or iTunes for a workout. Gmail for work emails. Netflix, Hulu or Amazon Prime Videos to wind down. SaaS companies, media outlets, education portals, eCommerce sites and many other businesses see the value of turning one-time customers into recurring subscribers. Adopting this pricing structure has led to big changes in the way they build revenue, often providing more stability and confidence in their projections. And when recurring revenue spurs growth, retention becomes one of the most-watched metrics in a business and subscription management comes into stronger focus. But what exactly is subscription management? Untangling Subscription Management from Recurring Billing and Payments Every business that has a subscription-based pricing structure keeps track of customers, processes payments and cancellations, records buying history, sends invoices at the right time, triggers payment failures, and much more. But it’s not necessary that one solution service all of this. This is what subscription management is NOT: Recurring Billing: A ‘bill’ is typically defined as a printed or written statement of the money owed for goods or services. Recurring billing is an automated process involving the customer, the merchant and a way to keep track of a periodic transaction between the two. At its simplest, it takes care of invoice accounting for factors like proration and regional taxes. Recurring Payment Processing: This involves storing sensitive payment data and facilitating the secure transfer of funds between the customer and the merchant. Some popular payment processors are Stripe, Braintree and PayPal. A  subscription management solution  works on top of a payment processor to support recurring billing and allows teams to take actions that cannot be automated. In other words, it allows you to address many of the customer-related actions that come into the picture when payments recur. But why do businesses need it? The fact is, when customers return to you week after week, month after month, your relationship changes from being a simple transaction into a long, involved conversation. Here’s Why Subscription Management Really Matters Let’s look at why subscription management is vital with three scenarios from a typical customer lifecycle: A customer signs up. Have they signed up for a trial? If they are undecided whether to continue using your product after this period, are your customer service executives empowered to extend the trial period? With subscriptions, making people stay after a sign up is just as important as getting them to sign up in the first place. A customer’s using your product or services. Customers need a host of billing-related services when they are actively using your product. They may need to upgrade or downgrade. If this happens in the middle of a recurring billing cycle, is this reflected in your System of Record? (Which is just a fancy way of saying, ‘Is this data updated everywhere it needs to be in your master digital ledger?’) Can you initiate a conversation at this point, to calculate credits, track ad hoc charges or provide discounts to a plan you want them to switch to instead? Subscription management takes the manual labour out of keeping accurate records of the many billing conversations you have with your customers. A customer leaves. The loss of a paying customer when you have a recurring billing pricing model is a loss equivalent to the Lifetime Value (LTV) of that account, not the loss of a single sale. The impact of churn is much larger, making it important to understand what requests were made, how they were handled and if recurring billing was augmented with a layer of subscription management. Recurring billing and subscription management are always tightly integrated with each other, one offering automation and intelligence, and the other, flexibility and more control. So when subscriptions are poorly managed, customers lose trust in the business and stop wanting to deal with them. Prove that payments happen securely, responsively and seamlessly on the business end, and customers forget about billing, focussing on the value and the experience you provide instead. The basis for the success of any recurring business is its ability to build strong, positive relationships with its customers. With a well-built subscription management system , every sign up can be the start of something beautiful, instead of an operational headache. Additional Reads More insightful reads on the nature, nuances and necessity of a subscription management solution: What separates the leaders and the stragglers in the subscriptions game? Some excellent practical advice on how businesses built on subscriptions aim for success. Subscription business models are great for some businesses and terrible for others The list of things we said a subscription management solution will enable your business to do? We talk about them in more detail here. Getting started with subscription billing and management software — A definitive guide What happens when you start paying attention to your billing infrastructure as you scale? You find that subscriptions can become quite...complex. Scaling SaaS billing: How to plan for the insanity   Source: Tiered Pricing Model Tiered pricing as a strategy is used by companies to provide their products/services at different price points by limiting or expanding the features/functionalities corresponding to each tier price. Now that we’ve got the definitions out of the way, let’s dive a little deeper. Tiered Pricing as a Model: Tiered pricing as a model works best for businesses that sell seats, licenses, widgets, etc., The tiered model is a great way to incentivize your customers. It helps you push your customers to buy more and qualify for discounts. Before we get into the details of the Tiered Pricing Model, we need to understand the difference between Tiered and Volume Pricing as both of the pricing models are often used interchangeably. While the former helps you generate higher revenue and the latter enables you to acquire a lot of customers. Tiered vs Volume Pricing: Tiered model: The price per unit you’re selling is within a particular price range. Once you fill up one tier you move to the next. Volume Pricing: The price of all the units you’re selling is within the set price range. Still difficult? Let’s understand the difference using a simple example. Suppose you’re a business who is selling widgets. Here is how your prices would vary if you either opt for a tiered pricing model or a volume pricing model. How do you calculate pricing for the Tiered model? You’ve sold 60 widgets to your customer. In a tiered pricing model, you calculate your total like this: [($20x10) + ($10x20) + ($5 x 30)] = $550 You move to the next tier only when one tier is completely filled. Whereas, in a volume pricing model, the total is calculated as ($5x60) according to the total number of widgets bought which falls under the 30-100 widgets price range. Tiered Pricing / Price Tiering as a Strategy: Many companies in the SaaS space most commonly have three tiers to differentiate the price points and some, even more. The main idea behind a tiered pricing strategy is that your prices and features should be tailored according to the various needs and use cases of the customers you’re selling to. You will have to be careful about  deciding the value metric  and the cost for the respective tiers. Your value metric with which you set your prices can be either quantitative, usage, feature sets or based on how your customers perceive the product. The number of tiers should allow you to capture the market by targeting different market segments without losing out on revenue. Let’s look at how you can structure your pricing model based on tiers. Tier Pricing Structure (Popular Three-Tier Strategy): Basic Tier: The basic model will provide your customers with the essential features at affordable pricing. This model will basically allow your customers to start using your product and solve the problem they face. Standard Tier: The standard model is usually a combination of the basic features along with some advanced features. This will give your customers benefits that will save money for them and as well as bring in a lot of revenue for your business. Premium Tier: This model is usually made for big enterprise customers or for customers who know what they want and how will they benefit from all the advanced features your product offers. The Premium tier will be priced more and will bring you the highest return for every unit sold. Examples of Tier Pricing Strategy: Freshdesk , a cloud-based customer service platform, provides the most efficient and user-friendly Help Desk features available. So here is how they have priced their services in incremental tiers based on different feature bundles so that they can attract a customer base from small businesses to enterprises. As the business scales, they’ll be able to upgrade the plans based on their needs. Chargebee Let’s see another example of tiered pricing based on usage. Chargebee is a subscription billing software that powers end-to-end billing for SaaS businesses. Below, is the image of the  pricing plans . The features are bundled together in different tiers at different price points. The customer is charged based on their usage of that particular plan. The main goal of your pricing strategy should be able to maximize the  lifetime value of the customer . You should make sure that you don’t overwhelm them with a lot of pricing options or worse confuse them. Therefore, having different pricing tiers to appeal to every one of them and allowing them to choose the one best suited for their needs is important. Source: Total Contract Value SaaS companies utilize a variety of insightful revenue metrics to understand financial performance, create accurate predictions, and make informed decisions. The list of possible metrics to use is expansive and includes a number of highly similar terms that often get confused, conflated, and misunderstood. For example, TCV (Total Contract Value), ACV (Annual Contract Value), and LTV (Customer Lifetime Value) all appear to provide very similar insights into the value of an average customer deal. Of the three, TCV is one of the least understood and, therefore, often underused. In this article, you’ll learn what total contract value is, how to calculate it, and how SaaS companies can use this helpful metric to understand marketing ROI, improve sales effectiveness, and make more informed revenue decisions. What Is Total Contract Value?  Put plainly, Total Contract Value (TCV) is the total amount of revenue you receive from a given customer. It includes all recurring subscription revenue as well as one-time fees that may be associated with the contract, such as implementation fees. For example, let’s say you’ve closed a deal with a new customer, and they’re paying $5000 per month on a 24-month contract. The deal also stipulates an implementation fee of $8000 to get the customer set up on your platform, import data, and train their team members. Your TCV would include this fee, as well as the recurring revenue ($5000 x 24 months + $8000 = $128,000). This is a critical metric for SaaS business as it’s a direct reflection of the revenue you’ll receive over a given period of time. By understanding TCV across all customers, subscription-based startups are better able to make investment, expansion, and spending decisions. How To Calculate Total Contract Value ? Total Contract Value includes all of the revenue you’ll receive from a given customer over the duration of their contract. To calculate TCV, you need the following information: Monthly recurring revenue ( MRR ) for the contract Length of the contract Any one-time fees included  The formula for TCV is as follows: TCV = MRR x contract term length + one-time fees  Let’s illustrate with an example. Take HubSpot’s pricing model for its marketing software platform. Let’s say HubSpot wants to calculate TCV for a new enterprise customer. This customer has signed up for the Enterprise plan for 36 months, with a monthly recurring revenue value of $3200. However, the client also needs to migrate from their existing marketing platform. This requires data migration and a customized setup and onboarding process so the HubSpot team can train key users of the product and set the system up in a way that works best for their current workflows. This process is going to cost an additional $11,000. Applying the Total Contract Value formula (TCV = MRR x contract term length + one time fees): TCV = $3200 x 36 months + $11,000 Meaning HubSpot’s Total Contract Value for this specific client is $126,200. Any change, then, in either the length of the contract or the value of MRR affects the final TCV calculation. Why Is TCV Important?  As you’ve seen, calculating TCV isn’t particularly difficult, but what does it offer SaaS revenue leaders over other revenue metrics? One of the major benefits the Total Contract Value metric provides is its inclusion of one-time fees. Many other revenue metrics, such as Annual Recurring Revenue ( ARR ), don’t include this figure. While these metrics are valuable, they don’t paint a comprehensive picture of your revenue situation. This is particularly important for companies targeting enterprise clients, where one-time implementation and onboarding fees are more common. The other major reason TCV should form a crucial part of your revenue monitoring is that it's a true measure of your company’s financial health. Where metrics like Customer Lifetime Value (LTV) appear impressive to investors and can help to validate growth claims, they aren’t realistic measurements of financial health because they’re predictions. LTV is a running estimate of the projected revenue you’ll receive from a given customer. TCV is calculated using real-life contracts that existing clients have signed. This has important implications for making revenue decisions. For example, let’s say you’re planning a headcount for the next financial year and need to determine how many new sales reps to hire to meet your revenue goals. While this is partially based on your objectives, it’s also going to be crucially tied to your current cash flow (you can’t hire beyond what you can afford to pay). Metrics like LTV can lead you astray in this scenario, as they’re not true indications of financial health.  TCV, on the other hand, tells you exactly what you can expect to receive from your current customers over a specified time period, meaning you can make more informed, accurate financial decisions such as hiring. How Can SaaS Companies Use TCV Indicators?  TCV has a number of insightful uses. Let’s review the four most important ways that SaaS companies can leverage TCV indicators. 1. Better Understanding of Client Base Makeup TCV is a powerful metric for understanding the structure of your existing client base from a financial perspective. Revenue leaders can perform an analysis of their primary customer segment, determine which segments deliver the highest TCV, and prioritize those clients in marketing activities. If you sell a CRM platform, for instance, an analysis of your TCV across each segment might reveal that small and medium sized businesses are your most lucrative clients, so marketing efforts such as content creation should be geared toward this audience to maximize revenue impact. 2. Optimize Sales Targeting TCV can also help SaaS companies understand how to prioritize sales rep outreach. By analyzing the data you have on your existing customers (such as buying characteristics, behaviors, and demographics), you’ll be able to pull out the key identifiers that point to high-TCV clients. For example, a marketing automation platform may identify that across their largest TCV customers, a common factor driving the purchasing decision was the need to scale. This information can be applied to lead scoring by prioritizing inbound leads that include the word “scale” (or specified synonyms) in their lead capture form. 3. Understand Marketing Efficiency Metrics can be helpful in isolation, but they’re often much more valuable when analyzed together. SaaS revenue leaders can combine TCV with CAC ( Customer Acquisition Cost ) to understand the return on investment on marketing spend. The simple calculation, in this case, is: ROI = TCV / CAC For example, if you have a Total Contract Value of $140,000 and your CAC is $4,000, your ROI on this spend is 35:1. Breaking this down by segment helps us determine where marketing spend should be prioritized. 4. Make Stronger Revenue-Based Decisions SaaS companies use TCV to make data-backed decisions. Where values such as LTV are useful forecasters, they are inherently predictions, meaning they can be unreliable metrics for making revenue decisions based on. Total Contract Value, on the other hand, is grounded in actual bookings , not projections, so you can more confidently rely on this metric to make revenue decisions. For example, a company looking to expand into new territory might use TCV to understand their expected revenue for the next 36 months, the timeframe in which they’ll be investing heavily in marketing activities in this new region. Problems With Using TCV as an Indicator  While TCV is an important metric for revenue leaders to track, it’s not without its problems. The main drawback of using Total Contract Value is that it’s assumptive. That is, you’re making the assumption that just because a contract is signed, that revenue is 100% guaranteed. It may be in theory, but in practice, it is anything but. Contract cancellations do happen, and while you may have cancellation clauses built-in, enforcing these is unlikely to recoup the totality of the revenue loss. Plus, you need to consider whether you’re really going to enforce that clause (often, cancellation clauses are used more as a deterrent than actual punishment, like a dummy camera set up on a busy streetside). Let’s look at an example. You close a customer on a 36-month term, with an MRR of $3500 and one-time fees of $2000. Your TCV looks like this: $3500 x 36 + $2000 = $128,000. Unfortunately, after the first year and a half, your client is acquired by another firm that uses a competitor product and wants to cancel their contract to ensure uniformity across their entire organization. Let’s imagine, in this scenario, you have a cancellation clause that stipulates early contract cancellations pay an additional three months of their one year contract, and you decide to enforce it. In this case, then, your TCV calculation is: ($3500 x 18) + ($3500 x 3) + $2000 = $75,500 In the end, the contract amounted to just 59% of your projected TCV. While situations like this may be the exception rather than the rule, they are an expectation at scale, meaning Total Contract Value as an indicator should be used with some caution. Difference Between TCV and LTV  TCV and LTV are two commonly used and important SaaS metrics. However, there are some crucial differences SaaS leaders must understand. TCV (Total Contract Value) measures the total value of revenue you receive (recurring and one-off) from a given customer. LTV (Customer Lifetime Value) is a projection of the amount of revenue you’ll earn from a given customer. While these seem to be describing the same metric, the crucial difference is that LTV is based on your projections (that is, what you expect the average customer to look like), whereas TCV is based on actual contracts you have with real customers. There is also less consensus on calculating LTV than there is with TCV. The formula for TCV is pretty clear cut: TCV = Monthly revenue x duration of contract (in months) + one-time fees With LTV, there are a few ways that you can arrive at this figure: Average monthly revenue per customer x Average customer lifespan Average monthly revenue per customer / Monthly churn rate Average order value x Number of repeat sales x Average customer retention time in months The method you choose for calculating Customer Lifetime Value will inevitably depend on your revenue model. If you sell a physical product, for example, you’re unlikely to have an “Average monthly revenue value,” so the last formula on the above list will be more suitable. The opposite is true for SaaS and other businesses operating on a subscription model , such as publishing companies .  Difference Between TCV and ACV  TCV (Total Contract Value) and ACV (Annual Contract Value) appear, at least on the surface, to be very similar revenue metrics. While they are, there are two crucial points to make in the Annual Contract Value vs. Total Contract Value debate. The first is obvious: ACV measures the value of a given contract for a single year. TCV, on the other hand, measures it across the duration of the contract. You’d expect, then, that for a 36-month contract, TCV would be exactly three times the value of ACV. However, this calculation ignores the second distinction: TCV also takes into account one-time fees (such as onboarding and training fees). As such, the calculations for these metrics are as follows: TCV = Monthly recurring revenue x Duration of contract [in months] + one-time fees ACV = (Total Contract Value - one-time fees) / Duration of contract [in years] Are TCV and Total Revenue the Same?  Total contract value vs. revenue: are they the same thing? The short answer is no; these metrics are crucially different. TCV demonstrates the total amount of revenue you gain from a single customer. Total revenue, on the other hand, is what your company earns from all customers However, it’s not quite as simple as just adding up all of your different TCV values. Consider Metadata, a paid advertising platform that also offers managed services to clients who need actively managed demand generation services, not just an ad platform. In Metadata’s case, their total revenue would include the TCVs for each of their monthly subscription clients, as well as revenue from these consultancy-type arrangements. Conclusion  Having a comprehensive understanding of the myriad revenue metrics (and how to apply them) is crucial for those in charge of revenue growth at subscription enterprises. Total Contract Value is an important indicator of growth (if TCV is moving upwards, your efforts to target higher-value clients are paying off), but it shouldn’t be viewed in isolation. To learn more about revenue metrics, check out our article discussing Bookings vs. Total Contract Value vs. Revenue . Source: Revenue Run Rate Businesses use a few key metrics to prove their financial health and potential to investors, lenders, and other stakeholders. Forecasting the financial future or long-term results of a business is essential for making the right business decisions. For a SaaS company , calculating your revenue run rate is a quick and easy way to understand and represent your business’s financial performance. Revenue run rate is one of the simplest metrics you can use to forecast your company’s future cash flow. This calculation uses the revenue data you already have to estimate what your revenue for the entire year will be. In this article, we’ll cover what exactly revenue run rate is, how you can calculate it, the limitations and pitfalls of using revenue run rate, and the situations where it’s most valuable. What is Revenue Run Rate?  As mentioned, revenue run rate is a very simple forecasting method for estimating your company’s annual revenue (the total amount of money you make in a year). It uses past financial performance to project future revenue. To calculate revenue run rate, you will use existing revenue data from a discrete period of time and convert it into an estimate of annual revenue.  To be clear, revenue and revenue run rate are not the same things. Revenue is a tally of the money you took in over a set time period. Revenue run rate is a prediction about future performance based on your existing revenue numbers. RRR is a quick way to forecast your annual revenue, even if you don’t have a full year’s data (or if your growth makes old data less relevant). Let’s go over a quick example. Let’s say you have been doing business for one month, and you generated $1,000 in revenue. You could use the revenue data from that month to estimate your annual revenue by multiplying one month’s revenue by 12. In this case, your revenue run rate is $12,000.  You can then use your RRR to line up funding from venture or angel investors in an early-stage startup, or adjust your sales goals and strategy going forward. How to Calculate Revenue Run Rate? How easy it is to calculate your revenue run rate depends on how much revenue data you have. Since we know there are twelve months in the year, using one month’s revenue makes the calculation very simple. But even if you have a less convenient starting point, you can still calculate revenue run rate with a simple formula.  Revenue Run Rate Formulas Here are a few ways to calculate revenue run rate, starting with one month’s data. One month’s revenue x 12 = Revenue Run Rate If you have revenue data from your business’s first quarter, the revenue run rate formula is even simpler. One quarter’s revenue (3 months) x 4 = Revenue Run Rate But what if you have another data set? For instance, let’s say you had $14,000 in sales revenue over the past 75 days. Even though this short time period doesn’t fit neatly into months or business quarters, your revenue run rate formula only requires one more step. First, divide your total revenue by the number of days over which it occurred. $14,000 in revenue / 75 days = $186.67 daily revenue Next, you multiply this daily revenue number by 365 to determine your revenue run rate. $186.67 daily revenue x 365 days = $68,134.55 You can always fall back on this formula to determine your revenue run rate, no matter what period of revenue data you have. (Total Revenue / # of Days in Period) x 365 = Revenue Run Rate Revenue Run Rate Calculation Example For a more detailed example, let’s consider Company X. They want to calculate their revenue run rate based on their past two months of data. In the past two months, they had $25,000 in revenue.  Because there are six two-month periods in the year, we can multiply that $25,000 by six and arrive at a revenue run rate of $150,000. $25,000.00 x 6 = $150,000.00 revenue run rate. This is the simplest way of calculating revenue run rate with this data. But another option is to use the daily revenue formula. If the revenue data is from March and April, that means we need to divide $25,000 by 61 days, which gives us $409.84 in daily revenue. Then, we could multiply that by 365 days to get a revenue run rate of $149,591.60. $25,000 / 61 days =  $409.84 daily revenue $409.84 daily revenue x 365 = $149,591.60 revenue run rate As you can see, just a slight change in how you calculate your revenue run rate can result in different numbers. That’s just one reason RRR is a very temperamental metric. For another example, we can look at DocuSign, an eSignature and document management tool. The SaaS company reported that their revenue in the first quarter of 2021 was $469.1 million . To calculate DocuSign’s revenue run rate, we multiply that quarter’s revenue by four, which gives us $1.876 billion. In reality, however, Docusign achieved greater revenue in each quarter of the year, resulting in total annual revenue of $2.1 billion . In this example, the revenue run rate was actually a conservative estimate, but that isn’t always the case. In the next section, we’ll see how other factors (that revenue run rate doesn’t consider) can make this a less accurate and reliable way of forecasting annual revenue. Risks and Limitations of Revenue Run Rate  Revenue run rate is an attractive tool for businesses and entrepreneurs because it’s so simple. If you can divide and multiply, you can calculate it. But there’s a reason companies don’t just calculate RRR and call it a day. This metric’s biggest flaw is that it assumes everything will stay the same. And there are many factors that impact businesses that make it unlikely for revenue to stay constant for longer time periods. 1. Seasonality Many businesses’ revenue fluctuates based on the time of year. As a result, if they calculated revenue run rate based on their busiest months, the run rate will be inflated. On the other hand, if they calculated using off-season data, their revenue run rate could be much lower than their actual annual revenue. Consider H&R Block, the tax software and preparation company, as a prime example of why seasonal industries and businesses can’t rely on revenue run rate for a realistic estimate of annual revenue.  Their 2021 Annual Report notes that, given that most people file their taxes between February and April, “we generally operate at a loss through the first three quarters of our fiscal year.”  The rate of Google searches illustrates just how impactful seasonal fluctuations are. If H&R Block calculated their revenue run rate based on data from February, the estimate they arrived at would be wildly inflated. Conversely, if they calculated RRR based on revenue numbers from the summer, the annual revenue estimate would be far below accurate. This is one reason why businesses within industries prone to seasonal fluctuations sometimes calculate with quarterly revenue run rates. 2. Industry and Economic Changes Even businesses with more consistent demand will face fluctuations based on current events. The coronavirus pandemic is just one example of how world events can drastically change the economy and affect industries. No one anticipated that toilet paper would suddenly become a hot commodity in the spring of 2020. Conversely, rising gas prices have been shown to lead to increased demand for smaller, more fuel-efficient vehicles. Many other industries are at the whim of public opinion and popular trends. The volatility of your industry will impact whether RRR is an appropriate method of financial performance forecasting. 3. Changes in Products, Services, or Pricing Of course, a company’s own actions can also make past revenue data less relevant in predicting annual revenue. If your company releases an exciting new product with a lot of buzz, your actual annual revenue may be higher than what you calculated using revenue data from before the release. Pricing model changes can affect the efficacy of revenue forecasts, both by changing the revenue earned through consistent sales or by increasing or decreasing sales. Even improving your billing process efficiency could significantly affect your revenue. 4. Churn For any subscription-based business (including software as a service), customers discontinuing their membership or subscription can take a huge bite out of your forecasted revenue. For instance, if you have multiple large accounts that cancel your service, the revenue data you used in your run rate calculations would become obsolete. Consider calculating your churn rate to forecast how this factor will affect future performance and revenue. Or, if you don’t want to crunch numbers manually in spreadsheets, you can use a tool like Chargebee that provides these insights automatically. Our Churn Watch dashboard helps you track crucial customer and revenue churn metrics in real time. When to Use Revenue Run Rate ? Even with all these potential pitfalls, there are still valuable use cases for revenue run rate. As long as you recognize the metric’s limitations, RRR can be a valuable tool in the following situations. 1. New Businesses Revenue run rate can be helpful for early-stage companies that don’t have a great deal of revenue data. If you don’t have a full year’s actual revenue, revenue run rate may be your best stand-in as you prepare for valuation and other milestones. Just keep in mind that your limited data is unlikely to remain truly constant. But revenue run rate is still better than empty guessing since it’s rooted in some actual data. 2. Rapid Growth and Scaling Many startups experience rapid growth in their early years or may weather several periods where they “scale up.” When an agile company is scaling, data from just a few months ago can become an inaccurate representation. If your revenue has shot up over the last three months, you can use that data to generate a revenue run rate that may better forecast your revenue than if you calculated using the past year’s revenue data. Just remember that companies’ growth rates are often inconsistent and what you assume is growth could just be an anomaly. 3. Evaluating Changes Remember how changes in pricing or services as well as product experimentation can affect your revenue? Revenue run rate is actually an effective way to measure the effects those changes have on your business. You can use data from before and after a change to see whether the RRR was positively or negatively affected. For example, if you change a part of the sales process and the RRR improves, it might be evidence that the change was an improvement that you should stick with. Of course, your revenue is affected by many different factors and so comparing RRR before and after a change is not a perfect test. 4. Budgeting for marketing and R&D as a SaaS Both marketing and research and development (R&D) are essential to the success of a software as a service company. The trouble is that neither provide immediate return on investment. This makes it difficult for businesses to properly budget for these expenses. Revenue run rate can be useful in this case because it is a very conservative revenue estimate for a growing SaaS company. For instance, if your company’s revenue has been growing steadily quarter over quarter, a RRR based on your past three months will likely be less than your actual annual revenue. By using this conservative revenue estimate while budgeting for marketing and R&D, a business is unlikely to overspend. For SaaS companies, RRR can serve as a guardrail against overly optimistic budgeting. Revenue Run Rate vs. Annual Recurring Revenue (ARR) vs. Monthly Recurring Revenue (MRR) Revenue run rate is sometimes called sales run rate, annual run rate, annual revenue run rate, or even annualized revenue run rate. Besides these terms, there are also several other revenue metrics it could be confused with. Here, we’ll explain a few of these other metrics and how they differ from RRR.  Annual Run Rate vs. Annual Recurring Revenue Annual recurring revenue ( ARR ) is a measure of how much revenue you can expect in a year, based on the annual subscriptions or memberships you have. It consists of the total subscription revenue you receive in a year, minus the revenue lost due to cancellations.  For instance, consider a SaaS company that charges $12,000 per year and has 1,000 annual contracts, their annual recurring revenue would be $12,000,000. As long as their number of clients remains the same, that’s how much subscription-based revenue they can expect to make in a year.  Most helpful for SaaS businesses and others using a subscription business model , annual recurring revenue is another metric whose accuracy depends a great deal on churn. One of the ways ARR differs from revenue run rate is that it deals specifically with recurring revenue (most often subscription-based). If the same SaaS company also offers other products or services (like short-term consultations or hardware, that revenue would not be included in ARR. Because revenue run rate is based on total revenue over a given time period, RRR would include that additional income. If the SaaS company has revenue data for August, in which they collected their usual subscription fees but also collected $75,000 for professional services, their RRR would reflect that. To calculate their revenue run rate, you would multiply the month’s total revenue by 12 to get an RRR of $12,900,000. $1,075,000 x 12 = $12,900,000 revenue run rate. This would mean that the ARR would differ from the RRR by $900,000. The nature of your business and they types of revenue you collect will determine which of these metrics are most useful. Revenue Run Rate vs. Monthly Recurring Revenue Like annual recurring revenue, monthly recurring revenue ( MRR ) is a measure based on subscriptions or membership fees. Therefore, it’s also well-suited for subscription companies or SaaS businesses. The difference between the two is that monthly recurring revenue is a measure of your expected monthly revenue, as opposed to an annual basis. One way to think about monthly recurring revenue is like a salaried job. You expect to make a certain amount each month and will budget accordingly. Annual recurring revenue would be similar to your annual salary. Like a salary, recurring revenue is based on existing agreements between two parties, but there’s still the chance that the arrangement could be ended. Be Flexible With Forecasting Forecasting revenue is always a tricky task. There are so many factors that can impact revenue positively and negatively. Nevertheless, predicting your revenue in the future is an important part of managing a company, budgeting, fundraising, and more. If you want to forecast revenue for a very new company with little data or evaluate changes, revenue run rate is an easy way to estimate your revenue for the next year. The simplicity of calculating RRR makes it attractive but can also make it unreliable. If you keep in mind the limitations of revenue run rate, however, it can be a valuable tool in planning for the future. Source: ACV and ARR Foundership is a daunting undertaking, not least for the sheer number of terms, industry jargon, and acronyms you have to master. Among them is the slew of revenue metrics one must memorize, understand, and distinguish, despite many of them being painfully similar. For example, many founders of SaaS companies (perhaps like yourself) are unsure of the difference between ACV and ARR — two revenue-related metrics regularly thrown around in the boardrooms of subscription-based companies . However, it’s important for leaders to gain a high degree of clarity when it comes to terms like these, as these SaaS metrics drive important decisions related to hiring, investment, and expansion. In this article, we’ll outline the difference between ACV and ARR, and provide multiple examples of each calculation to illustrate. You’ll learn where each metric is most useful, and understand the important insights these calculations provide. What is ACV?  ACV (Annual Contract Value) is a revenue metric that describes the amount of revenue you receive from a given customer each year. ACV can be used whether you’re operating on an annual or monthly subscription model, using tiered or flat-rate pricing , as well as when you have multi-year contracts.  By averaging and normalizing the value each account brings to your SaaS business on an annual basis, you’re able to compare and contrast specific accounts, segments, and industries, to determine where your sales and marketing efforts are best directed. So, how is Annual Contract Value calculated? How to Calculate ACV ? To calculate ACV, you’ll need the following information: TCV (Total Contract Value) Total Contract Value is the total revenue you receive for a given customer contract. It includes one-off fees and subscription revenue for the entire length of the contract. The Total Contract Value formula is: TCV = Monthly Recurring Revenue (MRR) x Contract Term Length + Any One-time Fees. One-time fees One-time fees includes onboarding, implementation, or consultation charges associated with the contract. Contract length Lastly, we need the length of the contract in years. ACV Formula and Example The Annual Contract Value formula is as follows: ACV = (TCV - one-time fees) / total years in contract To illustrate, let’s look at a few examples of Annual Contract Value in SaaS billing agreements. Scenario 1: Basecamp, who uses a flat-rate pricing model , signs a new customer on a 36 -month contract There are no onboarding fees to consider in this example, so our figures are: Total Contract Value - $3,564 Length of contract - 36 months Applying our ACV formula: ACV = ($3,564 - $0) / 3 = $1,188 As may be apparent, in simple scenarios like this, you could simply multiply the account’s monthly revenue by 12 ($99 x 12 = $1,188). However, things get a little more complicated as we incorporate different pricing tiers, one-time fees, and discounts, such as in the following Annual Contract Value example. Scenario 2: GitHub, who use a tiered-pricing model , signs a deal with a new client on a four-year term. The customer signs up for the Enterprise plan, which is charged at $252 per user, per year, but discounted to $210 for the first 12 months. The contract is for a total of 154 users and includes a one-off implementation cost of $12,500. To calculate ACV, we need to know three things: TCV One-time fees Length of contract in years We know there are $12,500 in fees, and the contract is for four years. We need to calculate TCV. For the first year, the cost is $210 x 154 users = $32,340. For the next three years, the cost is $252 x 154 users = $38,808 (x3 years = $116,424) So, our TCV is $32,340 (Year 1) + $116,424 (Years 2-4) + $12,500 (implementation fee) = $161,264. Applying the ACV formula (ACV = (TCV - one-time fees) / total years in contract): ($161,264 - $12,500) / 4 = $37,191 What is ARR? ARR ( Annual Recurring Revenue ) is a metric that describes the revenue, normalized annually, that you can expect to receive for your existing clients in a given year. ARR is inextricably connected to growth. For the subscription business, ARR growth is revenue growth. It’s the annualized version of MRR ( Monthly Recurring Revenue ). Annual Recurring Revenue is a measurement of revenue across all customers, rather than a single account. How to Calculate ARR  The formula for calculating Annual Recurring Revenue is: ARR = (overall subscription cost per year + recurring revenue from add-ons or upgrades) - revenue lost from cancellations There are three components that make up the ARR calculation. 1. Overall Subscription Cost Per Year  This is the revenue you start the year with. For example, if your company uses a flat-rate pricing model with 14,000 users paying $50 a month, your total value per year would be $7m. 2. Recurring Revenue Gained from Add-ons or Upgrades.  This should only include expansion revenue that will be recurring. For example, revenue from an existing customer who also purchases a one-off consulting package from your company should not be included in the calculation. There are three main methods for expanding revenue. The first is the purchase of add-ons, like Pipedrive’s LeadBooster add-on. The second is a tier upgrade, such as an existing Pipedrive customer moving from the Advanced plan to the Professional plan. The third is adding additional users, if you’re operating on a pay-per-user model. 3. Revenue Lost from Cancellations or Downgrades.  This includes any reduction in the number of users, downgrade to a lower tier and removal of add-ons. Let’s look at an example of ARR to illustrate how the formula works in practice. ARR Calculation: Let's say the company Copper, has 800 users across three plans: Basic - 250 users Professional - 450 users Business - 100 users During the year, the following events take place: 5 Professional users downgrade to Basic - Revenue loss of $2,400 2 Business accounts add 10 more users each - Expansion revenue of $30,960 10 Basic users upgrade to Professional - Expansion revenue of $4,800 3 Professional accounts remove 3 users each - Revenue loss of $7,452 2 Professional users upgrade to Business - Expansion revenue of $1,440 4 Basic accounts add 2 more users each - Expansion revenue of $2,784 The figures we require to calculate ARR are as follows: Overall subscription cost per year = $614,400 Recurring revenue from add-ons or upgrades = $39,984 Revenue lost from cancellations = $9,852 Applying the ARR formula: $614,400 + $39,984 - $9,852 = $644,532 Annual Contract Value vs ARR: Understanding the Difference  Though ACV and ARR both measure revenue on an annual basis, there is one crucial difference between these two revenue metrics: ACV measures a single account; ARR measures all accounts at the same time. For instance, let’s say you have 150 accounts, each with a different number of users, spread across your four pricing tiers. Each account has an ACV, and it’s calculated individually for that account. ARR, however, is the total amount of your annual revenue across all accounts. When to Use ACV and ARR?  ARR is a powerful metric for measuring year-on-year revenue growth in subscription businesses.  Startups and organizations focused on monthly subscriptions (over annual contracts) might prefer to use MRR, though the two are fairly interchangeable. ARR is most helpful for C-suite executives, founders, and revenue leaders as a measurement of overall revenue growth, as a means of comparing against the competition, and for demonstrating growth to investors. ACV is a more useful metric for sales and marketing to track.  It can be used to understand sales team performance (how are our cross-sell/upsell initiatives aimed at increasingly ACV performing?), and to determine where marketing efforts should be aimed (segmenting users by industry and then analyzing ACV can tell you which markets generate the most revenue). Whereas with ARR, we always want to see growth, there is less need for ACV to continue growing (though it’s often a good sign), and companies can still win even with a fairly low ACV. Consider the pricing structure for HubSpot’s CMS product: Revenue growth can come from any segment. Enterprise clients will obviously have a higher ACV than Starter clients — $14,000 a year vs $270 a year. However, it may be easier and more cost-effective for HubSpot to attract 50 Starter customers than it is to close a single Enterprise contract. Though their ACV would stay low ($270), their ARR would grow just as much as if they signed one Enterprise customer. ACV and ARR Calculation with Examples  To understand how ACV and ARR differ in practice, let’s look at a theoretical example using Pipedrive’s pricing model. Let’s say Pipedrive has four customers (for the sake of simple calculations): Customer 1 - 5 users on the Essential plan, 3-year contract, no one-time fees Customer 2 - 3 users on the Professional plan, 1-year contract, $2,000 in one-time fees Customer 3 - 10 users on the Advanced plan plus Smart Docs add-on, 2-year contract, no one-time fees Customer 4 - 7 users on the Professional plan, 2-year contract, $5,000 in one-time fees We calculate ACV on a per-customer level, using the following formula: ACV = (TCV - one-time fees) / total years in contract Customer 1 ACV = $3,240 / 3 = $1,080 Customer 2 ACV = $4,124 - $2,000) / 1 = $2,124 Customer 3 ACV = $8,700 / 2 = $4,350 Customer 4  ACV = ($14,912 - $5,000) / 2 = $4,956 ARR, on the other hand, is calculated at the level of the organization, using the formula: ARR = (overall subscription cost per year + recurring revenue from add-ons or upgrades) - revenue lost from cancellations To calculate ARR, then, we need to know the changes that occurred during the year: Customer 1 - added two users Customer 2 - downgraded to advanced plan Customer 3 - added five users but removed the Smart Docs add-on Customer 4 - no change Calculating the required figures: Overall subscription cost per year: $1,080 + $2,124 + $4,350 + $4,956 = $12,510 Recurring revenue from add-ons or upgrades: $432 + $1,980 = $2,412  Revenue lost from cancellations: $936 + $390 = $1,325 And applying the ARR formula: $12,510 + $2412 - $1325 = $13,597 Having a strong understanding of metrics like ACV and ARR is crucial for today’s SaaS revenue leaders, but it’s only part of the picture. To put your knowledge into practice, you’ll need a robust method for tracking and reporting on these revenue metrics. Book a demo with Chargebee today and find out how our subscription billing solution can help you grow, measure, and report on ACV and ARR. Source: Expansion MRR In simple terms, Expansion MRR is the amount of additional revenue coming from the existing customers. Expansion MRR is a very important metric that can better inform marketing efforts to maximize returns. There are multiple types of expansion MRR and it is vital to use all during evaluation and planning. Types of Expansion MRR Additional revenue is generated by customers in subscription business when the following activities happen, Upsells - moving from a free plan to a priced plan or moving from a lower-priced plan to a higher-priced plan. Cross-sells - purchase of other additional non-core products offered by you. Add-ons - purchasing of other recurring add-ons that are not part of the customer’s current subscription plan. Reactivation - Reactivating a canceled subscription. Importance of Expansion MRR This additional revenue from existing customers indicates customer loyalty and satisfaction which is valuable in the long run as it expands the customer lifetime value (LTV) . However, the primary benefit of expansion MRR is that the company need not incur extra cost to earn the additional revenue. Other important benefits include: In other words, no Customer Acquisition Costs (CAC) are involved in generating expansion MRR. Christopher Janz , co-founder & managing partner of Point Nine Angel VC says that “Most of the best later-stage SaaS companies get a significant portion of their growth from existing customers.” How to calculate expansion MRR? Expansion MRR is an important metric to gauge whether or not your existing customers are buying more or less of your product and offerings. In other words, its proof of customer loyalty. Calculating this on a monthly basis gives more insights into how you can improve your customer success strategy to meet customer expectations. [(Expansion MRR at the end of the month – Expansion MRR at the beginning of the month) / Expansion MRR at the beginning of the month] x 100 = Expansion MMR percentage rate For example, if the MRR expansion at the beginning of the month is $2000 and $3000 at the end of the month, the expansion MRR rate would be, [(3000-2000) / 2000] * 100 = 50% The expansion MRR percentage is 50% How should a business interpret expansion MRR? An increase in this number indicates revenue growth from your existing customer base and is a great sign. But one should not solely rely on this metric to gauge customer satisfaction, because it could be misleading especially if you’re losing a lot of customers month on month. This metric should be used simply to get a better picture of current customer loyalty and retention which can inform future marketing and retention efforts. For this reason, it is essential to keep an eye on your churn while looking at this metric. Churn can mean two things, the number of customers you lose (customer churn) and the amount of revenue you lose (revenue churn) . However, negative churn is good. Your company would have a negative churn rate when current customers stay subscribed and spend more money in the current month than they did in the previous month, which directly correlates with expansion MRR. How to use Expansion MRR to expand revenue Monitoring Expansion MRR will help you understand customer satisfaction better. But how can it be used to expand your business? Understanding your customer’s needs with regard to your product features is very powerful. Regular monitoring of your customer data and listening to your users can help you experiment with new features that could solve your customer problems. This will also help you with your upselling activities and keep downgrades from customers at bay. Upselling will also help increase negative churn. Make upgrades attractive with the help of discounts and trial periods. However, before giving away a portion of your product for free, it is better to check with your finance leaders on the health of your cash flow statement. Ensure that the upgrades are easy and obvious . An automated upgrade process can help give the customers a good experience. Harness customer feedback. Be proactive in marketing your higher subscription models and add-on services by highlighting the customer pain points and problems you’d be solving. Source: Customer Acquisition Costs Why is CAC important? Let's assume you're the founder of a fictitious helpdesk company named Helpme. You're at the funding party, celebrating your Series-A when an old but wise friend walks up to you. After congratulating you on acquiring the 85349th helpdesk customer, she utters the dreadful three words: "Are you profitable"? You are unsure because you haven’t dove into one of the most important metrics for determining profitability. The simple math to build a profitable business is to make sure you make more money from customers in their lifetime than you spent in acquiring them. Understanding CAC is vital to understand how cash efficient your SaaS business is and how successful it could be in the future. CAC often determines the marketing spend for companies. A clear picture of your CAC gives you a better perspective and helps you balance your spending and inches you towards profitability. Customer lifetime is roughly the average number of years customers use your product and contribute to revenue growth. Similarly, customer lifetime value (CLV) , or the average value of that individual customer’s lifetime is critical information in determining if your business is profitable. When you know your customer base down to how long they will likely be a customer and how much revenue they will likely contribute, you can effectively optimize the cost of acquisition and your marketing efforts and marketing expenses can be better tailored toward a more successful business. How to calculate CAC? CAC is calculated by first adding the marketing & sales spend for a given period and dividing that total spend by the number of customers gained during that given period. What forms the total sales and marketing spend? It's made up of any costs that you incur in acquiring a customer. It could be money spent on ad campaigns, events, cost of PPC campaigns, SEO, content marketing, etc. Some factors to consider while calculating CAC. If you have a freemium product, it's important to add the product & support costs to the total sales and marketing cost too. This is because your product acts as your acquisition channel. The number of customers taken into account should be your new paying customers that you acquired in that given period. Most people tend to miss out on some of the following expenses Cost of all tools used Salaries of the marketing & sales teams Referral costs Overhead costs It's important that sales and marketing salaries are considered because ultimately, these teams are on the ground rallying for the cause. They are contributing to an increase in the revenue directly. If salaries, or any of the other commonly missed costs are forgotten, your customer acquisition costs are going to be inaccurate. The missing piece: Time Period The way customers discover your product might be different. Here's a common discovery process: Prospect reads a blog -> comes to your website -> evaluates your product -> comes back later to make a purchase. After the initial discovery, for someone to recognize your product and come back to make a purchase, it takes a considerable amount of time. If you calculate CAC for just a month, it might not be the ideal measure of what happened in that month. Say you spent $20000 in the month of January but your revenue was $10,000 it's not necessarily from this month. And the amount you spend now could be helping you in acquiring customers the following month. It's advisable to look at CAC over a period of time say 3 months. You can also try  Hubspot's way of calculating CAC  which factors in the sales cycle. How do you look at CAC? CAC can be evaluated in two ways: Blended and Paid. Blended CAC is when you account for all different types of marketing channels including the ones you don't pay for directly such as: content marketing. It's the total acquisition cost for a period / total customers acquired in that period. Paid CAC, on the other hand, is the total acquisition cost / customers acquired via paid channels. While blended CAC gives you an overall snapshot of your business, looking at Paid CAC will help you figure out the channels that need work and if your paid channels are profitable. It's crucial to break down your cost of acquisition and segregate what matters. There might be sunken costs that did not necessarily lead to any revenue. It’s always best to include the costs that have a direct correlation to your revenues. But understanding CAC is just a part of the picture. To completely understand the unit economics of a customer, you should consider it in tandem with the Lifetime Value (LTV) of a customer. Source: Accounts Receivable aging report AR report helps determine the effectiveness of credit & collection functions and identifies existing irregularities in the collection process. Example of AR Aging Report An AR aging report segregates the past due date invoices in date ranges (like 30 days) from the day the invoice was issued to the customer. For example, John Doe of XYZ company’s AR aging in his balance sheet will look like: 30 days overdue: $100 60 days overdue: $200 60+ days overdue: $700 Here’s what an accounts receivable aging schedule looks like: The AR aging report helps you understand the average age of your outstanding invoices.  It will help you collect bills within a stipulated period, improve efficiency, and move the money to your bank account. Importance of AR aging report Tracking your AR aging report regularly (weekly or monthly) will help you identify concerns before the situation escalates to cash-flow problems. By analyzing customers’ late payment history, you can tweak your AR processes accordingly to maximize the collection efforts. It will also help you withhold product/service offerings until the customer pays the amount on the specific due date. It will ensure you don't lose money by providing your service/product without payment. It gives a deeper insight into your customers’ business, and aligning your invoice timeline with theirs will increase the chances of getting paid on time. How to Create AR Aging Report Here’s how you can create accounts receivable aging report: Start with reviewing all outstanding invoices. Segregate the invoices using the aging schedule and the amount due. Now you should have a list of customers with overdue accounts. Categorize these customers based on the total amount due and the number of days outstanding. If you have revenue analytics integrated with your accounting software, this process becomes a whole lot easier. This is how an accounts receivables aging report in Chargebee Analytics looks like: How to Use an AR Aging Report The accounts receivable aging report gives a snapshot of the status quo of your pending invoices and presents some actionable insights to improve your AR workflows. You can use the AR aging report for: Determining the average collection period Based on your customer payment trends, you can calculate the average collection period, which is the average number of days it takes to collect your receivables. If the ratio goes up over time, then it is time to evaluate your payment terms. The average collection period can be calculated using the formula: Avg. Collection period = [(Days in period x Avg accounts receivable) / Net credit sales] Revisiting credit policies If you notice the number of doubtful accounts creep up, it is time to revisit the credit terms and policies. You also need to review your dunning workflows and experiment with dunning emails to see what works best. You can introduce payment terms to extend the payment periods by 10, 15, 30, 45, or 60 days. It gives customers the time to review invoices and plan for their accounts payable and can be particularly valuable for small business owners. Proactively tracking potential cash flow problems A company’s accounts receivables are vital to maintaining a healthy cash flow. AR aging report can help surface potential credit risks and lets you take preemptive measures to keep your cash flow healthy. Here’s more on managing your AR during a crisis . Strategize collection efforts AR aging report helps you plan your collection efforts better. For example, if you have outstanding invoices for more than 60-90 days, you may need more rigor in your collection efforts. You can even work with collection agencies for these accounts. For invoices that are pending for less than 30 days, smart dunning mechanisms should suffice. Estimating bad debts and allowances The accounts receivable aging report helps estimate the amount of bad debt and doubtful accounts.  When a receivable is deemed uncollectible from an account, it’s called a doubtful account and the amount becomes a bad debt. Bad debts need to be written off in financial statements, and allowances must be made for doubtful accounts to ensure accurate and compliant bookkeeping. Head here for some best practices on AR automation . Conclusion An accounts aging report helps you maintain a healthy and continuous cash flow. It helps in eliminating receivables problems early on and reduces the risks of bad debts. Having a clear understanding of the customer’s invoices (invoice dates, amount outstanding, and the payment history) will help you estimate how the money will flow into your business. It is important to get real-time reports on your receivables and automate your payment reminders in sync with your pending invoices. Chargebee is a subscription billing management platform that automates your recurring billing . Here’s how Chargebee can help you  automate AR aging reports and set up follow-up mechanisms to send timely reminders . Source: Current ratio Current ratio formula Current ratio = Current assets / Current liabilities Current assets include cash, inventory, accounts receivable, marketable securities, and other current assets that can be liquidated and converted to cash within one year. Current liabilities include wages, accounts payable, taxes, and the currently due portion of a long-term debt. A current ratio that is lower than the market average indicates a high risk of default. A current ratio that is way above the market average indicates inefficient use of assets. Difference between Quick ratio and Current ratio Both Quick Ratio and Current ratio are indicators of a company’s liquidity. The fundamental difference between both is that quick ratio is a more conservative indicator of liquidity. The current liabilities taken into account in both cases are the same. But, for the current assets part, quick ratio doesn’t include comparatively less liquid assets like inventory, prepaid expenses, and other current assets that are less liquid. Fallbacks of Current ratio Retail stores nearing the holiday season see a sudden spike in their current ratio because of an increase in inventory due to holiday stocking. If a company’s Current ratio is matching up to the market average but most of their current assets are in the form of inventory which is hard to liquidate in the short-term, then the company isn’t really in a solvent or liquid position. Source: Contraction MRR What is Contraction MRR? Contraction MRR is the total reduction in MRR due to downgrades and subscription cancellations (or churn) compared to the previous month.  At the most basic level, contraction monthly recurring revenue is a measure of customer churn for a subscription business .  It’s important for subscription-based businesses to know this number so they can accurately measure financial performance and make informed decisions. Your business may need to respond to high contraction monthly recurring revenue with pricing changes or other adjustments. If your contraction MRR is low, though, it’s usually good news that means your subscription company has a steady cash flow and your customers are overall, happy.  What causes monthly recurring revenue to contract? Contraction MRR has many causes, some of which are less obvious than others.  Here are a few reasons that your MRR ( Monthly recurring revenue )could contract (or reduce) when A customer cancels a monthly subscription or stops paying for the product. A customer downgrades from the existing plan to a lower-priced one. A new customer avails a discount. A customer removes any add-ons (like additional features, users, etc.) How to calculate contraction MRR? Contraction MRR takes into account both downgrade MRR and churn rate Contraction MRR = Downgrade MRR + Cancellation MRR How should your business interpret contraction MRR? Contraction MRR helps you understand how well your business is able to retain customers is and how well your product scales with your customers’ growth. If your contraction MRR is high it could mean Your customers are canceling their subscriptions or in other words, churning. Your customers are downgrading to lower plans as they either don't find value in your higher price plans. Source: PCI DSS Compliance The Payment Card Industry Data Security Standard (PCI DSS) consists of security protocols set in place to make sure all companies accepting, processing, storing or transmitting card information operate in a safe and secure environment. The Payment Card Industry Security Standards Council (PCI SSC) started on September 7th, 2006 to take-up incorporating changes to the PCI security protocols, with an aim to keep improving payment account security of the transaction process. The PCI SSC, consisting of major card networks (Visa, MasterCard, American Express, Discover and JCB) manages the PCI DSS. Who does PCI DSS apply to? The PCI DSS applies to any company; no matter where it’s located, its size, or the number of transactions it processes. If the company is involved in the payment process of accepting, transferring or storing card information, these rules apply. Failure to comply with the PCI DSS rules results in paying a fine to even losing permission to accept cards for your business. Is PCI compliance necessary for debit card transactions? Yes. Any credit, debit and prepaid cards that carry any of the five-card networks’ brands, namely Visa, MasterCard, American Express, Discover and JCB, require PCI compliance. Additional Reads If you’re curious to know more about PCI compliance and get into its nuances, here are some references: Learn more about Chargebee’s PCI compliance Deep dive into PCI compliance here .  Source: Purchase Order What is a Purchase Order Template? A purchase order lists all the relevant details that are required by both the customer and the business that sells the product and creates an invoice that can be tracked by them. Usually, a template or format is followed while preparing a purchase order. These include: A purchase order number, customer number, order date. Product/Service purchased. Quantity of the product/service and the price per unit. Tax rates and discounts if applicable. Authorized signature of buyer. Delivery information and billing details. Payment terms (fixed time period/on the day of delivery of the product). Following a purchase order template simplifies the business process, by keeping track of all transactions that are either processed or not. A purchase order also helps businesses improve their inventory accuracy - by letting them know in advance if they have the bandwidth to deliver certain products to customers. How to use a Purchase Order? Usually, buyers who are interested in purchasing a product from a business, request for a PO form. Once issued by the business, the customers complete the form by filling up their requirements and send it back. If the business can satisfy the customer’s needs, the purchase order gets approved. All necessary details, such as the billing information, payment date, and delivery information are included in that PO and an invoice is created. PO helps both businesses and customers. The customers can schedule their payments and the delivery of the product they ordered, while the businesses can keep track of all their orders, and improve their financial accuracy. In cases where multiple orders are placed over a certain period of time, a blanket order is used. Additional Reads: More reads about Purchase Order for subscription businesses: From increasing cash flow to improving retention to delaying churn, Annual Contracts play a vital role in SaaS. How to Account for Revenues and Expenses with Annual Contracts in SaaS? Where does an invoice come into the picture? The 7 Essential Elements of an Effective Invoice . Source: Sales Tax How does Sales Tax work? Sales Tax is usually charged only to the end customer, during the purchase of products and services from a business. This is followed so that businesses that are intermediary don’t end up paying the entire tax that is charged on top of the final product. Sales Tax is similar to a Value Added Tax collected on goods and services. Take the example of a Teak company that sells raw Teak wood and an end-user who wants to buy a chair. However, there are businesses in-between that help in manufacturing and selling this chair that isn’t the end users. To prove that, they must obtain a resale certificate from the government stating that they are not the end-users of the product so that they don’t pay the tax charged on the chair. Does Sales Tax affect your SaaS business? A SaaS business selling products in a particular region is obligated to follow the sales tax of that region. Your business must verify if your SaaS product falls under either of the following classifications of taxable software: Canned software: an off-the-shelf software solution that can’t be altered Custom software: custom software solutions that are developed on top of canned software. Another important rule to be followed is to check if the region recognizes a ‘Nexus’ on your company. A Nexus is a ‘tax presence’ of your business in the region you sell your product in. It refers to the connection between your business and taxing jurisdiction of that region. It can be your business established in that region, or having employees/affiliates in that region. Each region has its own rules for determining Nexus. If the SaaS company fails to charge sales tax on their product, a hefty fine will be imposed on that company - and that may lead to a severe penalty. In order to be compliant, your business needs to abide by the tax code of all regions that you sell to. Additional Reads More reads about Sales Tax, and how Chargebee can help your business make them less taxing See how Chargebee helped Proxyclick automate the configuration of sales tax rates for each jurisdiction they were selling in, as they Scaled to Newer Territories with Optimized Subscription and Revenue Operations. How does Chargebee accurately calculate taxes for your company? Tax invoices for SaaS and Subscription Commerce Businesses. Source: PSD2 Introduction to PSD2 The second edition of the Payment Services Directive (PSD2) is set to bring about a sweeping change in the payments, finance as well as the SaaS world. PSD2 aims at using rapid changes in technology to bring in more competition and innovation to the European market along with strengthened payment security and in turn, consumer protection. The Second Payment Services Directive (PSD2) is structured around three parts of the first Directive brought in 2007. The areas are — harmonizing consumer protection and rights, policies for third-party payment providers to access account information and enhanced security. With new types of payment services coming up, the European Commission decided to revise the PSD1 regulation. The new payment service providers brought in innovation and competition by bringing in less expensive alternatives for online payments. The problem was that they were not regulated properly. By including them in the revised edition of PSD meant an increase in innovation with participation from non-banks to level the playground, boost transparency and security for consumers. For users, this means having a single place to access all their bank data, compare fees charged by the banks, review their historical data, more secure and faster transactions, and more transparency in their account information. One of the main focus areas of the revised edition of the PSD law is more security for online payments through Strong Customer Authentication (SCA). For consumers, it is an increase in customer rights, faster payments, and clearer information on payments and refund rights. What Does PSD2 Mean for Subscription Businesses? Strong Customer Authentication (SCA) will apply to both customer-initiated as well as merchant-initiated transactions. A merchant initiated transaction is a transaction made with a customer’s saved card when they aren’t present. Merchants using a subscription business model will have to embed all the SCA flows on their checkout page once the PSD2 regulation goes live. For subscription payments with a fixed amount, merchants need to apply SCA only the first transaction. However, if the customer upgrades to a higher plan, or couples add-ons to their plan, their subscription amount changes, which will require 3D secure verification for the first transaction with the changed amount. Complying with PSD2 can get especially challenging for subscription businesses that bill their customers based on usage because the amount would vary over time. Since these transactions are marked as “merchant-initiated transactions”, they will be exempted from PSD2 and SCA requirements. Even though a merchant initiated transaction is exempted from PSD2, the first transaction will require 3DS 2 verification and we’d recommend you have it enabled for all transactions so that payments don’t fail. Additional Reads Here are some additional resources for you to get an in-depth understanding of PSD2 and its implications for subscription businesses: Learn more about the what, the why, and the how of PSD2 and SCA with our guide , and learn about the exemptions you can apply for. See how Chargebee can help you achieve PSD2 compliance . Source: Customer Churn What is voluntary and involuntary churn? Voluntary churn happens when customers actively decide to cancel their service due to dissatisfaction, seeking alternatives, or other personal reasons. This type of churn is often within the control of the business, as it is influenced by customer experience and satisfaction. Involuntary churn occurs when subscriptions lapse unintentionally, often due to payment failures or customers not updating their account information. This article will primarily focus on voluntary churn. Understanding and addressing the reasons why customers choose to leave can provide actionable insights into improving service quality, increasing customer engagement, and ultimately reducing churn. Why is customer churn rate important? Acquiring new customers is six times more expensive than retaining existing customers. Churn could happen for a number of reasons, including an improper onboarding process and poor customer service. Beyond just being a measure of lost customers during a given time period, customer churn has profound implications for the bottom line of a business. Core to recurring revenue: In SaaS businesses, customer churn directly impacts Monthly Recurring Revenue (MRR), which is essential for financial stability and predictability. High churn rates can severely disrupt this stability, highlighting the importance of maintaining customer relationships over the long term. Cost efficiency and lifetime value: Customer churn and customer lifetime value are inversely related. A higher churn rate not only means losing revenue from existing customers but also necessitates higher spending on marketing and sales to acquire new customers. This is why reducing churn is crucial, as it increases Customer Lifetime Value (LTV) and ensures a healthier balance between the cost of acquiring new customers and the benefits derived from long-term customer relationships. Revenue from existing customers: Lowering churn rates maximizes revenue from existing customers, who are more likely to buy again and are open to upselling and cross-selling opportunities. This makes them significantly more valuable than new customers, thereby enhancing overall business profitability. Strategic importance: High churn rates impose tighter restrictions on your customer acquisition strategies and lower the confidence potential investors have in your business. Reducing churn signifies effective customer satisfaction, a robust product-market fit, and a sustainable business model. This is crucial for maintaining profitability and driving growth without disproportionately increasing marketing and sales expenses. Managing customer churn effectively is not just about retaining customers but is fundamental to building a robust, scalable, and profitable business. This is why keeping churn rates low is essential for the health and growth of the company. Why is customer churn prediction important? Predicting customer churn is crucial because it allows businesses to identify at-risk customers before they leave, offering an opportunity to implement targeted retention strategies effectively. By understanding which customers are likely to churn and why, companies can address issues proactively, improving customer satisfaction and retention. This predictive insight helps optimize marketing efforts, refine customer service approaches, and adjust product offerings to better meet customer needs. Ultimately, it reduces costs associated with acquiring new customers and enhances overall business stability and profitability. That said, customer churn is mostly inevitable and is caused by a variety of reasons, categorized as voluntary and involuntary churn . While it’s inevitable, there is such a thing as high churn. A figure of 5-7% annual customer churn is acceptable by most standards—anything more requires deeper investigation and redressal. What does a high churn rate mean? Well, a high churn rate often sends a clear signal — a pause, a moment of concern. It could mean several things, not least of which is that something might be amiss with how the business is connecting with its customers. Perhaps it’s a sign that the customer experience isn’t quite hitting the mark, or maybe the product isn't living up to expectations. It’s more than just a number; it’s a reflection of customer dissatisfaction and a prompt for urgent introspection within the company. High churn rates can decrease revenue and increase the burden on your remaining customers and acquisition efforts. They can also dampen morale within the company, as seeing customers leave frequently isn't easy on anyone involved. Importantly, it challenges businesses to look inward and dig deep into their operations, customer service, product quality, and overall strategy. It's about turning those insights into action, ensuring that the issues leading to high churn are addressed promptly and effectively. A 5% monthly customer churn rate translates to approximately 46% annual churn. That is, a business with a 5% monthly customer churn rate will end the year with half the customers it had at the beginning of the year. In other words, it will have to add 50% more customers during the year just to break even with the customer base it had at the beginning of the year. Must read: A complete guide to analyzing and reducing churn How do you calculate customer churn rate? Churn rate is one of the most important metrics for growing SaaS companies. It is calculated as the ratio of the number of customers lost during a specific period of time(typically a month or a year) and the number of customers present at the beginning of that time frame. Customer churn is usually expressed as a percentage. Customer Churn Rate = ([Customers at the beginning of a time period] - [Customers at the end of that time period]) / [Customers at the beginning of that time period] For example, if the total number of customers at the beginning of the year 2024 is 250,000 and through 2024, 100 of those customers cancel their subscriptions, the churn rate is 10/250000 or 0.0004%. Customer churn rate can be expressed as a monthly figure or an annual figure. Monthly Customer Churn Rate = (1 - ([1-annual-customer-churn%] ^12) Annual Customer Churn Rate = (1 - ([1-monthly-customer-churn%] ^(1/12)) Four ways to reduce customer churn Explore key strategies to significantly reduce customer churn and boost business growth: 1. Enhance communication and resolve bottlenecks: Throughout the customer journey: Maintain open and consistent communication with customers at every stage of their journey to ensure they feel supported and valued. Identify and address pain points: Regularly identify and solve bottlenecks that could hinder customer satisfaction or disrupt their experience. Impact on profits: Improving customer retention by just 5% can significantly boost profits by more than 25%. 2. Leverage churn analysis for better experiences: Deep dive into churn causes: Regularly analyze why customers are leaving to gather actionable insights. Implement improvements: Use these insights to refine your product or service, enhancing the overall customer experience and reducing future churn. 3. Introduce an annual pricing plan: Increase conversion rates: Offering annual subscriptions can encourage longer commitments from customers, with a conversion lift seen in about 6.5% of cases. Boost revenue: This strategy can lead to an approximate 4% increase in revenue, stabilizing cash flow and reducing the frequency of renewal decisions. 4. Adopt a smart dunning management system: Reduce transaction failures: Implement advanced systems to handle failed transactions efficiently and minimize the risk of losing customers over payment issues. Enhance customer retention: A proactive approach in dunning management can help retain customers who might otherwise churn due to payment lapses, thereby securing revenue. Final thoughts: Navigating the landscape of customer churn Dealing with customer churn is more than a metric; it’s a vital part of growing a healthy, sustainable business. Whether it’s voluntary or involuntary churn, understanding the reasons behind customer cancellation can help you make smarter decisions to keep them happy and engaged. From using insights gained through churn analysis to implementing effective communication and pricing strategies, every step you take toward reducing churn can significantly improve your company’s future. Ready to increase subscriber retention and proactively mitigate customer churn? Dive into our Subscription Academy courses for expert tips on keeping your customers longer, and check out our success stories like Condé Nast to see these strategies in action. Start making changes today and build a stronger, more resilient subscription business. Additional Reads From Unit Economics to Negative Churn: Hitchhiking to SaaS Growth The Craft and Craftiness of Interpreting Churn Source: Friendly Fraud What does Friendly Fraud look like? How’s it different from Chargeback Fraud? Friendly Fraud typically happens when your customer is not satisfied with your product/service; some examples could be the shipment didn’t reach in time or there was a discrepancy between what was agreed upon to that of what was delivered. When the customer is honest about a reasons for the chargeback claim, it is deemed a ‘friendly fraud’. But in recent years, after the surge of e-commerce and cloud products, the occurrence of such friendly frauds have risen. Fraudsters and cyber attackers use this dispute process to claim a chargeback despite having received the goods/services. Such dispute claims with malicious intent are labeled as Chargeback Frauds. The effects of such fraud are beyond just the cost of goods. There are other additional implications such as: Additional chargeback fees. Loss of transaction fees. Overhead expenses to dispute charges. The threat of being listed as a high-risk merchant. How can you minimize Friendly/Chargeback Fraud? Chargebacks are often thought of as an inevitable evil that businesses have to live with, but it can be minimized to a fair degree by getting a few basics right: Notification to customers before every recurring payment. Having a mechanism to capture goods/services delivery. Enabling customers to claim refunds or cancellations easily to avoid chargebacks . Regular and timely communication with your customers. Use of a billing system software to detect any malicious behavior and automatically block such customers. Source: SaaS Sales Forecasting Forecasting can be done using historical sales data, economic trends, and more. Sales leaders and decision-makers often struggle to forecast sales accurately. Inaccuracies often lead to botched investments and missed opportunities. Accurate sales forecasts are important  because they help in decision-making, re-adjusting priorities, budgeting, and risk management. It also helps in setting revenue and sales goals for the next year. SaaS Revenue and MRR Before you begin with the forecasting process, let's look at some basics of SaaS revenue and other top-line metrics that influence sales forecasting. Bookings in SaaS Bookings  indicate the value of a contract signed with a prospective customer for a given period. Bookings estimate the revenue that is won by sales, including non-recurring bookings. And that's why bookings are a primary indicator of future revenue growth. Monthly Recurring Revenue (MRR) MRR ( Monthly Recurring Revenue ) is the predictable monthly revenue that is earned from active subscriptions. MRR is one of the most crucial top-line metrics and is an essential consideration in SaaS sales forecasting. An important point to keep in mind is that MRR is not the same as 'recognized revenue'. Only after successful service delivery, you can 'recognize' the revenue for that month, as per GAAP rules. Nuances of SaaS Sales Forecasting There are various components to the MRR that affect sales forecast: New MRR It is the additional MRR earned from new subscriptions acquired in that month. Essentially, this MRR comes from new sales. While forecasting new sales, various factors must be taken into accounts, such as your available pipeline, the strength of your sales team & resources at your disposal, and the competitiveness of the market you are in. A quick and dirty way to predict new MRR in a particular time period is to check the past sales data for a matching timeframe. Expansion MRR Expansion MRR is nothing but the additional revenue earned every month from your existing customer base. It includes Upsells (moving to a higher-priced plan), Cross-sells (purchase of other supplemental products), add-ons, and reactivations of canceled subscriptions. While these are not new sales, they add significant value to the SaaS revenue stream. In this case, forecasting sales can be done using various factors such as the past performance of the sales reps and the customer's business viability. Forecasting these can be tricky, but constantly tracking the historical data from the MRR cohorts can give insights into which customers can be prospective sources of expansion MRR. Contraction MRR Contraction MRR or Churn MRR consists of MRR lost due to downgrades cancellations of subscription. This has a negative impact on the SaaS revenue. To avoid overestimating revenue while forecasting sales, churn needs to be kept in mind as well. SaaS Sales Forecasting Checklist Now that you know the 'what' and 'why' of SaaS Sales Forecasting, let's go to the 'how'. The following checklist involves the steps involved in SaaS Sales Forecasting. Centralize your Data Your sales forecasts' accuracy depends mostly on the quality of the sales data you are working on. The most time-consuming part of any predictions is aggregating the rollup of estimates from all your sales reps. Moving between email tools and spreadsheets where your data resides can be cumbersome and prone to errors. Make sure you have a well-documented process to enter all forecast information into a single shared system. Having a centralized system not only saves you a great deal of time but also improves your forecast accuracy. Analyze your Pipeline It would help if you looked at how the opportunities you originally forecast to close at the beginning of a quarter evolved. Then, analyze the percentage of deals won in the quarter, the ones that got rolled into the next quarter, and the lost deals. The percentage of deals won will give your marketing and sales team a good idea of the pipeline coverage they will need to hit the next quarter's target for bookings. Focusing on improving the percentage of deals won in a quarter will enhance the business's overall efficiency. Define your Sales Cycle SaaS sale cycles are different because they involve a different set of touchpoints. There's  self-serve SaaS , and then there's  sales-driven SaaS . Depending on the product, define the funnel stages and document the steps in your sales cycle clearly. Factors like the average sales cycle and conversion rates are critical considerations for accurate forecasting. Automate the Process Invest in CRM. With all the information about your leads and customers in one place, everyone in the organization can get valuable insights about your sales pipeline's health. CRM solutions like Salesforce, Freshsales, or Hubspot streamline the sales process, give real-time information about opportunities, and help you identify top lead sources. Once you define your sales cycle and workflows, look to automate the process. Automating the process enables you to forecast further into the future, focus more on customers and respond better to changes in the competitive landscape. Choose a Sales Forecasting Method The last and probably the most critical step is to choose a sales forecasting method depending on the stage of growth your SaaS business is in. There are multiple sales forecasting techniques out there. Not all of them might fit into your business model and growth rate. For new businesses in the early stages, excel templates should suffice. But for rapidly growing businesses, looking at just past sales data is not enough. You need to consider other parameters, such as conversion rates, deal size, and other essential sales metrics. This involves deep analysis, market research, and demands a good forecasting tool. Choosing the right forecasting model determines the accuracy of your cash flows. Some of the sales forecasting models are: Lead-driven forecasting Length of sales cycle forecasting Opportunity stage forecasting Historical forecasting Multivariable analysis forecasting We have done a detailed analysis weighing the pros and cons of these  sales forecasting methods here . Factors that May Affect SaaS Sales Forecasting Various factors influence sales forecasting. Internal factors to be considered by sales managers and business leaders include the availability of resources, new product launches or change in pricing strategy. External factors such as market trends, competitive pressures and seasonality play a key role when forecasting sales for your SaaS as well. Let's explore a few more factors you need to consider to get accurate forecasts: Economic Factors Long-term economic conditions can have a significant impact on your company’s growth rate. When the economic outlook remains weak, the sales cycle takes longer than usual due to protracted decision-making processes. Factors like inflation can also influence consumer behavior. It can affect the purchasing power and consumer’s risk appetite. So, it needs to be factored into the forecast. Market Factors Increasing competitive pressures in a market can affect consumer behavior as well. Your market share can change based on your competition. In a bid to gain a larger chunk of the market, competitors can reduce prices, introduce new products, or invest more in sales and marketing efforts, all of which can affect your revenue inflow. Regulatory Factors Regulatory factors involve the introduction of new trade policies or laws that could affect your operations globally. Taking these changes into consideration can help in accurate forecasting. Related Reads Everything you Need to Know About SaaS Sales Forecasting Methods The Importance of Sales Forecasting Source: Revenue Backlog Almost every business tracks revenue. Who doesn’t want to know how much money the company is making? Many even report on a variety of revenue metrics, like annual recurring revenue , monthly recurring revenue (MRR) , average revenue per user , or revenue churn .  But there’s a revenue measurement that’s commonly missed, and it’s a useful one: revenue backlog.  Revenue backlog can give you, your investors, and your internal stakeholders a more accurate picture of your company’s performance. But not everyone knows about it or how to use it.  We’re here to help. This article answers all of your revenue backlog questions.  What is Revenue Backlog?  Revenue backlog is the value of contracted revenue or bookings that have not yet been recognized. In other words, it’s money that customers have promised to give you for a future service. You don’t have the cash yet, but you can count on receiving it. Knowing about it helps you get an accurate view of your current and future financial situation.  Revenue backlog differs from revenue in that it is money that you expect to receive for a future service rather than money that is actually in your account. The GAAP (Generally Accepted Accounting Principles) are strict about the way revenue is recognized and accounted for in your financial statements. Here’s an example of revenue backlog: say your customer has committed to a $1,200 one-year subscription to your service to be paid monthly. On January 1, you bill them $100 for the first month. Your revenue backlog is now $1,100. On February 1, you bill them again, and the revenue backlog decreases to $1,000. It’s not relevant for all business models. For example, if you’re not a SaaS business and instead you sell physical products, you probably don’t have a meaningful revenue backlog. Who Should Track Revenue Backlog? You’ll sometimes see revenue backlog referred to as “unrecognized revenue” or revenue that isn’t “recorded.” That just means that public companies don’t have to include it in their financial statements until the product or service is delivered.  It isn’t an official GAAP metric, and you’re not required to disclose it in your company’s annual 10-k reports. But it can still be a very valuable metric for you to track and report on internally. Any type of business can monitor revenue backlog, but it’s especially important for SaaS companies that run on subscription models because subscriptions naturally create a backlog.  Tracking revenue backlog helps SaaS businesses with accurately forecasting cash flow, monitoring the financial health of the business, and attracting investment.  Examples of Revenue Backlog  Your revenue backlog can include a variety of sources. Some common ones for SaaS companies include:  Active subscriptions: The future value of active subscription agreements. Pending or uninstalled subscriptions: Subscription commitments that won’t be paid for until something is installed or activated. Future training and implementation: Training or other professional services that customers have committed to but haven’t used. These services can be recurring or one-off.  Investments: The future value of investment commitments. For other companies like a wedding planner or caterer, it could be future bookings (minus the paid downpayment or deposit). Why is Your Revenue Backlog Important? For SaaS companies, tracking your revenue backlog gives you a more complete picture than revenue alone.  For example, it lets you know how risky your projections are. Will you reach your revenue target by collecting on existing contracts, or do you need to fill the gap with a lot of new customers? You can use this information to set sales quotas and decide on sales commissions.  Many SaaS contracts are multi-year, so looking at your revenue backlog can help you project your revenue years into the future. Revenue backlog is also an important part of the valuation of your company. Investors want to see a robust revenue backlog because it’s an indication of the overall financial health of your organization — it shows your ability to fulfill the value of your current contracts. Boards and internal stakeholders are interested in revenue backlog for the same reasons.  Finally, tracking your revenue backlog helps you keep up with demand and budget for the future. You know what products and services are in demand, which makes planning and investing in R&D easier.  How Does Revenue Backlog Affect the Revenue of a Business?  Your revenue backlog doesn’t affect the official revenue you report on balance sheets and other financial documents. It does, however, affect your internal revenue forecasting.  For any subscription business, knowing your backlog is a big part of understanding your company’s finances. It reflects the cumulative value of your existing agreements, meaning you can count on the total of your backlog appearing on future revenue statements.  How to Calculate Revenue Backlog ? The revenue backlog calculation isn’t complicated. But you have to be sure you have an accurate picture of your current contracts and agreements.  Start by adding together the value of any existing subscription agreements. Then add your expected income from any other future commitments, like training services you’ve agreed to provide or investments that will be coming your way.  The criteria are simply that you have evidence that these commitments will come through, like a signed contract.  Subtract anything you’ve already charged your customers for. For example, if a customer has already been billed for $5,000 of a $10,000 subscription, subtract that amount. The resulting number is your revenue backlog.  Of course, a SaaS company typically has multiple customers at once, and they might be on different subscription plans . Here’s an example of what that might look like:  You can use this information to create a revenue forecast by also factoring in monthly users, churn rates, and potential new subscribers. The different lengths and starting points of each contract means that your forecasted revenue will be quite different if you change the defined period of time. What is the Difference Between Backlog and Deferred Revenue?  Revenue backlog is often confused with deferred revenue . The mix-up is understandable — both terms refer to revenue for something you’re going to provide in the future.  Here’s the difference: deferred revenue comes from advance payment for products or services that haven’t been delivered yet, while revenue backlog is contracted services that haven’t been paid for.  You can think of revenue backlog as pending revenue. You know you’re going to earn it, but you don’t have it yet. Deferred revenue is money you do have — you just haven’t fulfilled your side of the deal yet.  For example, if you haven’t charged a customer for their subscription agreement yet, that amount goes into your revenue backlog. But if you’ve invoiced for six months of a subscription that hasn’t been delivered yet, that’s deferred revenue. Deferred revenue, unlike revenue backlog, is a GAAP financial reporting number that goes on your balance sheet. But that doesn’t mean that you should just report on deferred revenue and skip your revenue backlog.  One important difference is that your revenue backlog is more consistent and predictable than your deferred revenue. Deferred revenue may go up and down depending on how and when you invoice your customers. Revenue backlog just counts steadily down as contracts get paid off.  Tracking both backlog and deferred revenue will give you the most complete understanding of your organization’s finances.  How Does ASC 606 Affect Backlog Disclosure? We’ve mentioned the concept of recognizing revenue a few times. For companies using accrual-based accounting, revenue is considered recognized when a performance obligation is satisfied. For example, revenue for a product is recognized when the customer takes possession of it.  Since 2018, companies have to follow a new revenue recognition standard called ASC 606, or the Accounting Standards Codification Topic 606, which dictates how revenue is recognized. ASC 606 is a significant change from past standards.  Under ASC 606, revenue is recognized if:  Risks and rewards have been transferred from the seller to the buyer. The seller has no control over the goods sold. Collection of payment is reasonably assured. The amount of revenue can be reasonably measured. Costs of earning the revenue can be reasonably measured. So what does this new revenue standard have to do with your revenue backlog? ASC 606 requires you to make disclosures about your unfulfilled performance obligations. Companies have to report qualitative and quantitative information on the amount of the remaining obligations and when those remaining amounts will be recognized as revenue. This overlaps with the revenue backlog but doesn’t include all of it. For example, the ASC 606 backlog doesn’t include contracts for which “neither party has performed and which can still be terminated,” like a multi-year SaaS contract that can still be canceled.  Learn more about revenue recognition under ASC 606.  Conclusion Revenue backlog isn’t a complicated concept, but tracking it can be a lot of work if you don’t have the right tools. You need a revenue recognition solution that can automatically calculate and analyze your revenue backlog and other accounting metrics.  We know just the one.  Chargebee RevRec lets you automate ASC 606-compliant revenue recognition for your subscription business.  You can design workflows that define, implement, and translate performance obligations into your General Ledgers and recognize revenue accordingly. Financial operations are always efficient, thanks to documented audit trails and accounting controls.  Subscription businesses can be complex with implementation fees, mid-cycle subscription changes, cancellations, and premature renewals. Chargebee is made for companies like yours. Chargebee RevRec can automate calculations for any subscription use case.  Learn more about how Chargebee can help you simplify the revenue recognition process.  Source: Downgrade MRR For instance, if a subscription (customer) has moved from plan A (MRR $500) to plan C (MRR $100) then the Downgrade MRR would be $400. In other words, the Downgrade MRR of a month is the sum total of MRR lost from active subscribers in a month compared to their MRR ( Monthly recurring revenue ) contribution in the previous month. This could happen due to subscribers: Moving from their existing plan to a lower-priced one Reducing their subscription quantity (like agent seats for a helpdesk software) Removing recurring add-ons Availing discounts How to calculate Downgrade MRR? Downgrade MRR (This Month) = Sum (MRR lost this month compared to last month from active subscribers of this month) How should a business interpret downgrade MRR? High Downgrade MRR means customers are not finding enough value in their current plans for the price they pay. Hence, the downgrade. So when you see Downgrade MRR rising, make sure you talk to customers to understand the grievances and relay it back to the product. The eventual solution might be to add relevant high-value features to your higher subscription plans or to invest further in customer marketing and customer success initiatives. Note: A price change event could also trigger downgrades. Source: Involuntary Churn As a SaaS/subscription business, you’re probably already looking at the churn and how it affects your revenue.  Customer Churn  and  Revenue Churn  are the most commonly addressed metrics that businesses look at–day in and day out. Churn is when a customer stops paying for your product/service. However, when your subscribers churn without actually intending to stop using the service–this is termed as Involuntary Churn. How does Involuntary Churn occur? Involuntary churn occurs when a customer undergoes a payment failure , leading to their subscription being canceled. Not only do you lose your customers, but a part of the monthly recurring revenue ( MRR ) is lost, too. It can happen for any of the following reasons: Not updating their subscription billing information/credit card information (using expired cards) Hard declines when a card is lost or stolen Soft declines when a credit card has maxed out its limit≥ Banks can decline the card for other reasons Voluntary Churn VS Involuntary Churn Voluntary churn is the purposeful cancelation of a subscription. And unlike involuntary churn, voluntary churn indicates an underlying problem. Your customer experience could be subpar; your pricing strategy could be off, or maybe you’re attracting the wrong customers. Neglecting this type of churn could push your  customer acquisition cost  to unreasonable levels. In comparison, retention of customers would cost you five times less. If you’re finding it difficult to pinpoint the problems in your business: we’ve put together a  comprehensive guide to analyzing churn . How should businesses interpret Involuntary Churn? About  20-40%  of churn is usually from the involuntary churn. And, the most striking truth about involuntary churn is that almost all of it is avoidable. Therefore, reducing involuntary churn is one of the easiest and most direct ways to increase  customer lifetime value  (LTV), leading to higher returns on your  customer acquisition cost (CAC) . As you can see from the image below, a mere 2% decrease in the involuntary churn rate results in a substantial revenue increase. Beyond its negative effect on revenue, involuntary churn hurts your relationship with the customer as well, who wakes up one day to realize that their subscription got canceled, unintentionally. But, like we said: almost all of it is avoidable. With Chargebee Receivables , you can build custom payment recovery programs for different customer types to get paid faster and beat payment failures, automatically. How to reduce Involuntary Churn? Between the issuer and acquiring bank, there’s a complex interlink of payment gateways, payment processors, and card networks––a host of things could go wrong. Taking failed recurring-payments into consideration, we’ve split its lifecycle into six stages: It makes it easier to utilize various tactics at different stages–as shown below. If you’d like to read a step-by-step guide on reducing involuntary churn, click  here . Source: Net MRR Growth Rate Your monthly recurring revenue changes month-on-month because of new revenue earned and lost revenue due to churn. Net MRR Growth Rate is an important metric that helps you keep track of these variations. Why is Net MRR Growth Rate important? Net MRR Growth considers new revenue, expansions, and contractions (downgrading and cancellations). There are three key factors to ensure overall profitability — minimize  MRR churn rate , drive upgrades from existing customers, and add new paying customers. Net MRR Growth shows you how fast your SaaS business is growing. Quick Ratio  and NRR tend to flatten out minor, recent variances in data. The net MRR growth rate allows you to look out for any changes in recent trends. For example, notice that the Net MRR trend allows you to spot the shrinking new MRR or an uptick in cancellations or paused MRR. How to calculate Net MRR Growth Rate? Net MRR = ( New MRR + Reactivation MRR + Upgrade MRR ) - (Cancellation MRR + Downgrade MRR ) Net MRR Growth Rate = ((Net MRR of Current Month - Net MRR of Last Month) / Net MRR of Last Month)*100 Where, New MRR  is the additional monthly recurring revenue earned from new subscriptions acquired during a month. Reactivation MRR  is the monthly revenue earned from previously churned or canceled subscriptions that are reactivated during the month. Upgrade MRR  is the monthly recurring revenue generated when subscriptions are moved from existing plans to higher plans. Contraction MRR  is the total reduction in MRR due to  downgrades  and subscription cancellations (or  churn ) compared to the previous month. For month-on-month growth, you can calculate this every month and compare with the previous month. To see a trend, calculate it for a longer period (12-16 months). For example, Let’s assume that your net MRR for January is $1000. In the month of February, there was $800 of new MRR addition, $400 added from existing subscription upgrades, and $100 of reactivation MRR . However, there was $200 of customer churn. So your net MRR for February = (800+400+100)-200 = $1100 Net MRR Growth Rate = ((1100-1000)/1000)*100 = 10% Industry benchmarks for Net MRR Growth Rate While there are no definitive benchmarks for the net MRR growth rate, there are some guidelines that SaaS businesses in different stages of growth can keep in mind. Let’s take a look at what these experts have to say: Tomasz Tunguz (Venture Capitalist, Redpoint)  says that an MRR growth rate of 15-20% is a reasonably good target for post-Seed/pre-Series A SaaS startups to aim for. According to Jason Lemkin (Founder, SaaStr) , SaaS companies should have the potential to go from $1m- $100m in ARR in 7-10 years. He goes on to say >=20% growth MoM is an outlier, but possible. Most SaaS companies fall under 10-15%. Pros and Cons of Net MRR Growth Rate How to increase your Net MRR Growth Rate An obvious way to boost your net MRR growth rate is to increase the number of customers (duh!). But other than that, you can do these things to increase your MRR growth rate: Focus on increasing the expansion MRR Expansion Monthly Recurring Revenue (Expansion MRR)  is the additional monthly recurring revenue generated month-on-month from your existing customers. It doesn’t include  new MRR  acquired from your new customers. An increase in the expansion revenue contributes to MRR growth with very little added cost. You can increase your expansion MRR by the means of: Upsells - upselling is when customers move from a free plan to a priced plan or moving from a lower-priced plan to a higher-priced plan. Cross-sells - cross-selling means the purchase of other additional non-core products offered by you. Add-ons - purchasing of other recurring add-ons that are not part of the customer’s current subscription plan. Reactivation - Reactivating a canceled subscription. Lower your churn rate Churn rate  is the rate at which your customers are canceling their subscriptions. When your customer acquisition strategy is complemented with an effective churn mitigation strategy, boosting your MRR becomes achievable. Begin with understanding where your churn is coming from. There are two types of customer churn. Voluntary churn occurs when customers: Pause the subscription. Downgrade to a lower plan. Cancel the subscription. When high-value customers try to cancel/downgrade/pause, it’s important to earn their trust and do all you can to make them stay on for longer. You might want to understand the reason behind the churn, such as price sensitivity or value expectation, and reassess your pricing & packaging structures. For example, you can try opening up a few premium features for them or upgrading them to a higher plan for free for the first 6 months. On the other hand, you have involuntary churn. This occurs when customers are churning due to payment failures and card declines. It’s important to have  dunning mechanisms  and  smart retries  in place to mitigate that. Experiment with your value proposition The perceived value of your product and your pricing should go hand in hand. To boost your MRR growth, you can experiment with your packaging and pricing to find the sweet spot that works best for your customers. Conclusion To summarize, the net MRR growth rate is an important metric to track the growth of your SaaS company. It depends on the new MRR, expansion MRR, and contraction MRR. A Net MRR growth rate of 10-20% is said to be good by the industry experts. To boost your MRR: Acquire new customers Reduce churn Increase upgrades, upsells, cross-sells, etc Experiment with pricing and packaging Other relevant SaaS metrics and KPIs Annual Recurring Revenue ( ARR ) Average Revenue Per User (ARPU) Customer Acquisition Cost (CAC) Customer Lifetime Value (LTV) Bookings and Billings Source: Upgrade MRR It takes into account the increase in the MRR ( Monthly recurring revenue ) caused by factors such as add-ons added to the subscriptions. It’s indicative of an increase in the subscription quantity or movement to a higher dollar plan. How is Upgrade MRR calculated? If a subscription is moved from plan A (MRR $50) to plan B (MRR $150) then the Upgrade MRR would be $100 How should a business interpret Upgrade MRR? An increase in upgrade MRR indicates your product is scaling as your customer’s scale. When you have the right set of features in all your plans and are constantly adding valuable new features, it encourages your customers to upgrade. If this number is not increasing, you are probably offering too much value in the lower plans. And your customers don’t have a reason to upgrade. You’ll have to revisit your plans and pricing. Added Hint: Also seeing churn numbers will tell you if there is a value problem (high churn, low upgrades) or a pricing problem (low churn, low upgrades) Source: Net Dollar Retention The NDR measures the net revenue leftover in a set period, considering the total revenue minus any revenue from downgrades or churn, plus revenue from expansion due to upsells, cross-sells, and upgrades. How to Calculate Net Dollar Retention (NDR)? The formula includes current MRR, expansion revenue, downgrades, and churn. NDR = [(Starting MRR + expansion — downgrades — churn) / Starting MRR] * 100% * If you’re more comfortable with annual calculations, you can go ahead and switch the MRR inputs with ARR ( Annual recurring revenue ) values. Although, it is recommended to perform monthly calculations as well to dig deeper into the components that make up your net revenue retention. Monthly Recurring Revenue( MRR ): The predictable recurring revenue earned from subscriptions in a particular month. (MRR * 12 = ARR) Expansion MRR : The additional MRR from all customers who have upgraded to a higher pricing plan from a lower-priced plan or purchased a recurring add-on, including MRR contribution from reactivation of a previously canceled subscription and free-to-paid conversions. Churned MRR (or Cancellation MRR): (A component of Contraction MRR) The MRR lost due to canceled or churned subscriptions. Contraction MRR : The MRR lost due to cancellations, downgrades to lower price plans, removal of recurring add-ons, or even because of availing discounts. Company A starts the month with $10000 in recurring revenue. Over the month, it adds $3000 in expansion revenue, $1500 in downgrades, and $500 in churn. NDR = 110% MRR = $11000 Company B starts the month with $10000 in recurring revenue. Over the month, it does not see any expansion revenue but adds $5000 in new subscriptions, $1500 in downgrades, and $1000 in churn. NDR = 75% MRR = $12500 By looking at the MRRs alone, you would say that Company B fairs better. However, going by the NDRs, not so much. This is where calculating NDR plays a pivotal role in recurring revenue valuation for SaaS companies. The Importance of Net Dollar Retention Looking at the above examples, you can see that NDR gives a comprehensive view regarding the shifts in MRR changes. Without measuring NDR, we wouldn’t have caught the revenue leak caused by downgrades and churn in Company B despite an increase in MRR. This also shows that Company A, despite not having gained new customers, has a better retention game, which is what Company B should be focusing on to improve its NDR and long-term revenue health. What is a good NDR? An NDR >= 100% denotes a net positive MRR, whereas an NDR <100% denotes a net negative MRR. Hence, an NDR > 100% - the higher, the better - should be the aim. And high NDRs are something markets, and investors take note of. Here are the NDRs of a few successful scale-ups on their IPO day: Snowflake - 169% Twilio - 155% Datadog - 146% Slack - 143% Zoom - 140% There aren’t any hard and fast benchmarks, but going by the data (that you see above), if your net dollar retention rate is: 100% or below, figure out what could be causing this. 110%, you’re at the median. 120-130% and above, you’re on the right track. What is GDR, and how is it different from NDR? Gross Dollar Retention (GDR) - aka Gross Revenue Retention (GRR) - rate is similar to the NDR in that it measures the changes in recurring revenue caused due to shifts within the revenue from existing customers. However, the GDR considers only the total revenue minus any revenue from downgrades or churn and does not account for the revenue from expansion due to upsells, cross-sells, and upgrades. Additionally, the GDR measures the net revenue over time as opposed to a set time period like the NDR. Gross revenue retention is always <= net revenue retention < 100% Compared to NDR, the GDR is more a long-term indicator for revenue retention and is a better churn indicator.  For a comprehensive picture of churn, it is essential to look at both SaaS metrics - NDR and GDR. High NDRs and GDRs are necessary numbers to make for a tempting investment opportunity. How to Improve your NDR? Focus on Customer Retention to Beat Churn Did you know that customer acquisition cost (CAC) can be five times more than the cost of retaining your current customers? Apart from that, there are several benefits to retaining customers like increasing customer lifetime value (LTV) , creating a loyal customer base, word-of-mouth promotion, and most importantly - boosting your NDR. Methods of retention like smooth customer onboarding, creating an amazing user experience, diversifying your offerings, upselling, optimizing product pricing, and so on, will not only help improve your retention rates and reduce churn, but it will lead to a great NDR that will have investors banging at your doors. For more information on the best retention strategies, visit our blog: 10 Customer Retention Strategies to Up Your Retention Game . Source: SaaS Quick Ratio An underlying point you should consider is that this metric is best used to define revenue growth in the startup or early growth stages of a SaaS business. You'll understand why going further into the article. Also, the SaaS quick ratio is not to be confused with the identically-named finance concept - quick ratio, aka acid test ratio. The acid test ratio is an accounting principle that measures liquidity - a company's ability to pay off current liabilities at a given point in time. However, both metrics measure the same aspect - whether a business's revenue health is good or poor. How to Calculate SaaS Quick Ratio The formula is pretty straightforward: the measure of net monthly revenue inflow (MRR growth) by the revenue outflow (lost MRR). SaaS Quick Ratio = ( New MRR + Expansion MRR ) / (Churned MRR + Contraction MRR ) Monthly Recurring Revenue ( MRR ): The predictable recurring revenue earned from subscriptions in a particular month. (MRR * 12 = ARR ) New MRR : The revenue your business makes from all the new customers gained during a month. Expansion MRR : The additional MRR from all customers who have upgraded to a higher pricing plan from a lower-priced plan or purchased a recurring add-on, including MRR contribution from reactivation of a previously canceled subscription and free-to-paid conversions. Churned MRR (or Cancellation MRR): (A component of Contraction MRR) The MRR lost due to canceled or churned subscriptions. Contraction MRR : The MRR lost due to cancellations, downgrades to lower price plans, removal of recurring add-ons, or even because of availing discounts. Company A: $6000 (New + Expansion) / $1000 (Contraction + Churn) = Quick Ratio 6 Company B: $7500 / $2500 = Quick Ratio 3 Company C: $10000 / $5000 = Quick Ratio 2 Company D: $25000 / $20000 = Quick Ratio 1.25 The Net New MRR is $5000 (new+expansion - contraction+churn) in all scenarios in the above examples. Yet, Company A fairs better than the rest since it makes that revenue with much less effort than the other companies. (To further explain: Company A makes $6 for every $1 lost whereas Company D makes $1.25 for every $1 lost, which is only a $0.25 gain. When the contraction is almost the same as expansion, it takes more effort to improve revenue health). Hence, the higher the quick ratio is, the better. The Quick Ratio Benchmark (?) When venture capitalist Mamoon Hamid , partner and co-founder of Social+Capital, coined the metric, he also came up with the hypothesis that a quick ratio of 4 and above was a company worth investing in. Given that VCs like Hamid were using the quick ratio to aid their investment decisions (Hamid funded companies like Slack, Box, Yammer), it quickly became a benchmark. Many SaaS startups began using it as a pitch in their presentations. However, this ratio might be more appropriate for measuring revenue growth in early-stage companies vs. scaling or mature companies. Here is the reason why: A quick ratio of 4 means $4 of the revenue made for every $1 lost. This kind of exponential growth is seen in the early phases and cools down as a company grows. Moreover, the likelihood of also increases. This is not to say that scaling or mature businesses shouldn't measure the quick ratio. But the fact remains that the difficulty of gaining 4x revenue for every unit churn is exceptionally high and only keeps growing as the company does. Scaling or mature SaaS companies rarely manage that. Additionally, the difference between a quick ratio of 4 for early-stage companies and scaling or mature companies is that we are talking about phenomenal growth; in contrast, for the latter, the focus is on phenomenal-ly low churn rates. So, as per conventional standards, a quick ratio of 4 is considered healthy, and by all means, a high quick ratio is what you should be aiming for. But having a lower quick ratio doesn't necessarily scream danger; it is very subjective to the business's scale. The quick ratio by itself can't be the sole determinant of a company's growth efficiency. It should be looked at in conjunction with CAC ( customer acquisition cost ) and to get a more wholesome understanding. (To further explain: For some companies, CAC might be a lot more or a lot less than the industry average. In such cases, high MRRs might not look so great against an almost as high marketing spend. In-kind, some companies choose to pay more attention to LTV compared to one-time purchases. In such cases, a low quick ratio is not an issue since you are aware that it will take time to scale it up. With aspects like these in consideration, it isn’t enough to base growth efficiency on just one metric. Moreover, no SaaS metric exists in complete isolation. Metrics need to be looked at in conjunction to get a holistic view of your business. How do you fix a low SaaS Quick Ratio? For any business, the go-to strategy while starting is to acquire as many customers as possible. The focus, however, should switch over time from gaining new customers to your existing customers, retention, and more importantly - reducing churn; the mantra for any company aiming for high growth rates should be to aim for low churn rates. Additionally, your strategies should depend on what your quick ratio shows you. Is there a lot of churn? Focus on retention. Is there not much expansion? Focus on product stickiness and customer experience. Based on your understanding of the components that make your formula, you can pick and choose ways to improve your quick ratio. In Conclusion Among SaaS metrics, the quick ratio is quite insightful. As much as you love to see your company's growth rate go through the roof, you also want to know how it is happening - because of new revenue or low churn - and the quick ratio gives you a peek into this. Like we discussed above, there are several ways for you to leverage those insights to your benefit. Finally, regardless of the myriad of opinions on an 'ideal' quick ratio, on any day - the higher the ratio, the better. Hence, the aim should be to improve it continually. Source: Value Added Tax How does Value Added Tax work? In contrast to Sales Tax, where an end customer pays a tax during the purchase of a product, Value Added Tax is collected at every stage of production. 166 countries around the world use a Value-Added taxation system, as it is easy to track the exact tax imposed during each stage. There is no risk of a double-taxation if VAT is followed. Take the example of an Oak company that sells raw Oak to a furniture maker for €100 + a VAT rate of 5%. It will charge the maker €105 and pay the tax amount of €5 to the government. The furniture maker will sell the furniture to a store for €300 + a VAT rate of 5%. It will charge the store €315 and pay €15 - €5 = €10 to the government. Finally, the store will sell the finished furniture to its customer for €500 + a VAT rate of 5%. It will charge the customer €525 and pay €25 - €15 = €10 to the government. Does VAT affect your SaaS business? Businesses that want to sell their SaaS products in a region where VAT is employed, must first register for VAT and obtain a VAT number. The VAT number is an identifier that is used to verify if you are a business or an end customer. Filing VAT invoices and returns is also mandatory for your business. They report the amount you are due to pay, and also the amount you can reclaim. All SaaS businesses selling in a region where the VAT system is followed must comply with the VAT rules. Choosing not to comply could result in paying back-taxes and penalties. To see if your SaaS product is qualified as VATable, you can address the following criteria: It is not a physical, tangible good. It’s essentially based on IT. The offering could not exist without technology. It’s provided via the Internet or an electronic network. It’s fully automated or involves minimal human intervention. Additional Reads More reads about Value Added Tax, and how Chargebee can help your business make them less taxing: Understand everything about EU VAT and learn how Chargebee can help you handle EU VAT at ease for your subscription business - The EU-What? Guide See how - Italy-based Voverc conquered VAT compliance, with Chargebee’s compliant Credit Notes that saved them from messy tax complexities. How does Chargebee accurately calculate taxes for your company? Tax invoices for SaaS and Subscription Commerce Businesses. Source: Gross MRR Churn Rate How is Gross MRR Churn Rate calculated? Gross MRR Churn Rate = [( Downgrade MRR + Cancellation MRR) / (Total MRR at the beginning of the period)] * 100 How should your business interpret Gross MRR Churn? The overall contraction in the MRR can be due to downgrades or cancellations. If this is high, a business should try to understand the reason for the cancellations taking place. It could be voluntary churn wherein dissatisfied customers cancel their subscription due to lack of perceived value, or, it could be involuntary churn wherein the customer's credit card expires and hence the subscription gets canceled. To handle involuntary churn it’s good hygiene to track credit card expiry dates and notify customers ahead of time. Good billing management systems offer this capability out of the box. Another way to battle involuntary churn is by setting up an effective dunning process - gentle, timely reminders for payment. Churn can be good sometimes— A drop in the Monthly recurring revenue coming from customers moving to an annual plan shows higher value and retention. Source: Subscription Churn How to calculate churn? Churn can be indicated as a ratio, a revenue figure, and also as a number indicating how many customers in total have stopped paying for your product/service. A basic formula for measuring churn is: Churn Rate = (Number of cancellations in a period / Total number of subscriptions in that period) X 100 Churn can also be demonstrated in other ways based on how it makes sense for a business. Here are a few: Customer Churn: off-the-shelf software solution that can’t be altered Customer Churn Rate: Percentage of customers lost MRR Churn: Value of MRR lost due to churn MRR Churn Rate: Percentage of MRR lost due to churn How can you reduce churn? Churn rate is one of the fundamental metrics that indicate a company’s business health. When you notice your subscription churn going up, the first thing to do is to understand why. Start with analyzing how long these customers stay with you before canceling their subscription. If customers churn very early in their subscription cycle, there might be a gap between how you position the product and customers’ perceived value of your product. If it arises in the later part of their lifecycle, it might mean your product doesn't scale with your customers as well as they expected. There are also other useful lenses to look at churn through. You could break down and understand churn patterns by pricing plans - is there a specific product plan that you offer that sees a higher churn? How much of your customer churn happens from a freemium plan versus that from paid plans? Source: Checkout Checkout: The Most Critical Moment In Your Customer’s Journey Checkout is essential for all kinds of transactions. From purchasing a product once to buying it on a subscription basis, checkout is absolutely necessary. Checkout in SaaS is the equivalent of having a checkout counter in a departmental store - from filling the cart with products you wish to buy, then paying for them using your credit card, and finally receiving a bill from the store. Except in SaaS, the whole process is carried out online. SaaS businesses by nature need to automatically trigger transactions at the time of renewal. This requires a way to securely collect and store payment information, which will then be used to trigger charges depending on the renewal cycle - weekly, monthly or annual. Typically, in a SaaS checkout flow, card information of the customer is collected and stored in a secure vault during Checkout, and a ‘token’ is generated in exchange. During the time of renewal, your billing system will use this token to trigger the transaction and process it using the information stored in the vault. How does ‘Checkout’ affect conversions? A typical acquisition funnel has 4 stages - Awareness, Interest, Desire and Action. Even assuming a company makes sure that the first three stages are well taken care of, the slightest friction during Checkout will result in customers dropping-off from the funnel. This could be due to any of the following: A long checkout process with too many fields. Limited number of payment options. Hidden costs and additional charges. Friction kills conversions. By customizing the checkout page, businesses can minimize friction and thereby increase conversions. Some ways to achieve this is by offering free trials (with or without credit card info), minimizing form fields and using auto-fills, providing multiple payment options, multiple currencies, encrypting payment information and establishing secure connections. Additional Reads More reads about optimizing checkout for increasing conversions and enabling a better user experience: Wondering why people come by to check out your site, get all the way to your checkout cart, and then leave? There’s a black hole on your checkout page that you didn’t know about. What methods should you employ to improve your checkout conversions? Introducing Chargebee Moments: For the Ultimate Moment of Truth at Checkout SaaS is built for global growth. Step Up Your Global Game with Multi-Currency Support Source: Bookings in the world of SaaS Bookings do not have a standard definition in Generally Accepted Accounting Principles (GAAP). So this varies across companies. However, bookings are a forward-looking metric, that typically indicates the value of a contract signed with a prospective customer for a given period of time. Revenues, on the other hand, is a GAAP defined term. Revenues are inflows of assets or settlements of liabilities (or both) from activities of the entity's central operations. Simplified meanings… Let’s take this example - a cloud-based helpdesk SaaS solution called ‘Help!’ with customers that come in all shapes and sizes. Help! is offered in 4 different plans - Startup, Growth, Pro, and Enterprise, priced at $200, $500, $1000, and $2000 respectively. Help! signed up an enterprise customer ‘A’ recently, under the Enterprise plan on 1st January 2016, with a contract in effect for 2 years. Bookings: The contract between ‘Help!’ and Customer A, that commits a service from the provider’s end, as well as a payment from the customer’s end during the 24 months of engagement, is Booking. So, Booking = $24000. It is the total value of all the contracts signed. Revenues: When ‘Help!’ has rendered the service to the extent that there is a reasonable guarantee of receiving payments for the service, then that revenue can be recognized. For instance, if the customer had signed up in January 2017 and ‘Help!’ has billed the customer at the beginning of January, then as at the end of January 2017, the Revenue = $1000. And as at the end of June 2017, the revenue recognized would be $6000, and so on. Breaking down Bookings and its types Bookings are a visual representation of the money committed to flow into the business. It is a great indicator of a product’s demand and a market’s response to the product, as a result of which they are willing to commit to the product or the service. While it is recorded as an annual number, bookings can extend to more than a year or less. In case of bookings, it is possible to collect the payments either at the beginning of the contract, in which case, it becomes a liability and is called deferred revenue , as the company is obligated to offer the services. Alternatively, the revenue can be recognized over the term of the relationship, when the revenues can be recognized. Types of Bookings Bookings can be classified under three types - New Bookings, Renewal Bookings, and Upgraded Bookings. New Bookings This portion of bookings includes new customers who have just signed up for the product or service. For instance, Customer A has been a customer of Help! Since 2014. However, if Customer A has introduced a new product and signs a new agreement with Help!, this will qualify under new bookings. Expansion/Upgraded Bookings Upgrades and expansion from up-selling usually fall under New Bookings. So, if Customer A wants to upgrade from Growth Plan at $500 to Enterprise Plan at $2000, a new contract needs to be signed with Help!, where Customer A commits an annualized value of $24000. Renewal Bookings This portion of bookings includes existing customers whose contracts are up for renewal. The Renewal Bookings can be calculated either at the time of the effective renewal date or when the renewal request is received on another date as opposed to the end of the contract. Apart from these, there are more distinct types of bookings that are usually ignored in terms of nuance and Santi Subotovsky points out those minor details in his post. Annual Contract Value (ACV) Bookings In the case of multi-year contracts, bookings that have at least one year’s committed revenue is considered as ACV bookings. For instance, if Customer A signs a contract with Help! for a three years contract under the Enterprise Plan of $2000, then the ACV Bookings will be $24000. Total Contract Value (TCV) Bookings Just like ACV Bookings, this involves multi-year contracts. However, TCV Bookings is calculated taking into consideration the complete duration of the contract. So, if Customer A signs a contract with Help! for a three years contract under the Enterprise Plan of $2000, then the TCV Bookings will be $72000. Non-Recurring Bookings While the recurring bookings are a standard practice that includes a defined set of offerings every month, quarter, or year on a recurring basis, some of the charges include non-recurring aspects such as set-up fees, training fees, discounts, etc., that don’t get included under recurring bookings. Typically, these are not included under SaaS Bookings by some businesses and investors. However, since bookings, in essence, denotes the value that you are able to predict upfront, all components which are ideally expected to pay, should be baked into bookings. These include non-recurring bookings. What do you include in Bookings: - New Contract - Renewals - Planned Upgrades - Planned Downgrades - Non-recurring bookings such as set-up or implementation fees, one-time charges, discounts Components of Bookings in a SaaS Financial Sheet: Average Deal Size - Average size of the deal for full duration Average Contract Length - Average duration of contract signed by the new customers Average Months Paid Upfront - Average number of months paid upfront by new customers Average MRR for new customers = Average Revenue Per Account (ARPA) - Average MRR across the new customers ARPA (Across the installed base) - Average MRR per customer across the existing customer What do Bookings mean for your business? Bookings help at various stages of growth. Many early-stage businesses that don’t entirely follow accounting best practices, treat bookings as the source of truth, in terms of revenues that can potentially be generated for their business. It also helps in understanding the market demand and the product-market fit for the solution they are building. For sales and marketing teams, bookings help in deciphering revenue flow. The teams can improve on their customer acquisition strategy by drawing insights from which prospects signed up for what plans, converting prospects into paid users, which salesperson was responsible for winning the customer, etc. Based on these inputs, you can tighten the process of customer acquisition, retention, and a possible upgrade. Who should care about Booking? Bookings are an indicator of sales growth - so the sales team’s primary metric is bookings. While the sales team also looks at metrics such as MRR and churn, to understand if they are targeting the right kind and quality of customers, Bookings is one of the better metrics to evaluate sales success, as it estimates the revenues that are won by sales, including non-recurring bookings. This is particularly necessary as MRR does not count in revenues from non-recurring charges. For instance, in the case of new bookings, attributes such as downgrades, or contract cancellations, etc. should be taken into consideration for evaluating compensation. Similarly, for renewal bookings, it is worth considering upgrades or downgrades during renewals to evaluate compensation. The idea is to bridge the gap in expectations raised during a sale versus expectations during continuous service delivery. That leads us to convert the bookings into recognizing the revenue. That is, if the bookings are high and the revenues recognized are low, there is a clear gap in the sales process and product delivery. How are Bookings perceived by different roles? Apart from sales, Bookings is an important metric for CFO’s and finance teams as well, to help in planning cash outflows and inflows. In effect, it helps finance teams to report bookings as committed money, without recording them as revenues, and thus falsely calculating MRR/ ARR . It is also a must for Product teams to refer to Bookings in order to deliver the product experience that customers have committed to pay for. How do you calculate and optimize Bookings for your SaaS business? Fred Wilson in his blog says, “When a customer commits to spend money, that is a booking”. With this in mind, we had earlier mentioned that bookings include recurring, non-recurring subscription charges along with one-time charges for professional services such as implementation, set-up, etc. Customer A signed up with Help! in Jan 2017, for a 24-months contract at $2000 per month, paid half-yearly. Customer A also committed to a one-time implementation fee of $3000. Customer B signed up with Help! around the same time, for a 12-months contract at $1000 per month, paid in advance. Customer B committed to pay one-time concierge support at $2000. Customer C committed to a 6 monthly contract at $1000 per month paid quarterly. Customer D upgrades to a monthly plan of $100 on a month-on-month basis The Bookings, in this case, will be $48000. We need to be careful about the multi-year subscription contract and take into consideration only the ACV booking. The subsequent year will be considered as a renewal booking, even if it was committed in advance. You will see that we have calculated and recorded bookings for different scenarios including bookings for multi-year subscription contracts, annualized bookings, bookings within the year, recording bookings for mid-term upgrades, and one-time charges. However, David Skok in his incredibly exhaustive post points out, “Since the bookings number might have a mix of different durations (e.g. month-to-month; 6 months; 12 months) this number is not very helpful for understanding the business.” He goes on to add that, you should look at the following components, to make more sensible decisions What happens with new customers: New MRR / ACV from new customer contracts What happens in your existing customers: Renewals Churned MRR /ACV Expansion bookings The sum of all of the above: Net New MRR/ACV Simply, Bookings don’t directly impact financial reports and income statements. Encouraging sales to enable prospects to pay upfront is another great way to improve bookings and increase cash flow. Needless to say, that should also mean delivering an experience that justifies the payment. Source: New MRR Why is New MRR important? New MRR is one of the most critical SaaS metrics to watch out for as it shows the new customers added month on month and indicates the general health of the subscription business. How to calculate New MRR? New MRR = Sum of MRR contributed by fresh subscriptions added during the month or New MRR = New customers * MRR per customer Let’s take a simple example. If you added 5 new subscriptions this month giving you revenues of $100, $200, $300, $400, and $500 respectively, your New MRR for the month would be $1500, the reasoning being, 100+200+300+400+500 = $1500 Note that we don’t focus on MRR gathered from the current customer base or lost MRR (churned MRR). Another thing to notice is how this calculation does not take into account the setup fees or additional one time cost that makes up the total contract value (TCV) . Also, do not take into account one-time payments or expected subscription revenue from trail customers. New MRR only aims to focus on  MRR  coming from new customers. How can businesses benefit from New MRR? New MRR is an important metric that can be monitored to help you deep-dive into what is causing your recurring revenue to increase or decrease on a month-on-month basis. Some of the benefits of New MRR are, Control over Customer Acquisition Cost (CAC) If your CAC is higher than your New MRR, it is an indication for your marketing budgets to be tweaked so it doesn’t eat into your overall profitability. Track these figures on a monthly basis to ensure that the New MRR figures are higher than the cost of acquiring new business. This way, you can deep dive into the  lifetime value  (LTV) of the customer as well. Insight for Teams New MRR in one way directly correlates to the marketing and sales team’s efforts. Making these figures visible to them and monitoring it regularly will give them a picture of the impact of their actions. This could give them more insights to better their KPIs. What next? To figure out if you actually made money at the end of the month, apart from calculating new MRR coming from new customers, you’d also have to take into account the number of customers you are losing per month. Churn  a crucial role in deciding the health of a business and an understanding of the Net New MRR is important. Net New MRR uses different types of MRR which are, New MRR - The MRR contributed by new customers from last month to the next month Expansion MRR  - The additional MRR that comes from existing customers due to upsells, reactivation, or movement across plans Churn MRR  - This is the erosion of your MRR ( Monthly recurring revenue ) due to downgrades or cancellations. Which would help you determine whether you lost more revenue than you gained within a given period of time. Check out  Net New MRR here . Source: Reactivation MRR Note: This does not include subscription plans that were upgraded from a free trial to a paid plan (or from a basic plan to a premium plan). That's called upgrade MRR .  How is reactivation MRR calculated? Reactivation MRR is a key metric for subscription businesses and should be reviewed on a monthly basis, if possible. This will give you valuable insights into how your customers see your product, which can inform future marketing and sales campaigns.  Thankfully, this only requires a simple revenue calculation: Reactivation MRR = Sum of MRR from customers that previously churned For instance, if a canceled subscription is reactivated in a pricing plan of MRR $150 then the reactivation MRR would be $150. What does reactivation MRR mean for your business? Reactivation MRR can indicate that your customers felt their needs were better met by a competitor, but for various reasons, decide to come back. Or, it can mean they no longer had the need for your product or service but saw it resurface again. Every reactivation is a case study opportunity. You should try to proactively control this by asking customers why they cancel when they do. It will show you an angle of your product or service's value you probably missed. If you observe your reactivation MRR rising, you may want to look into marketing or customer success campaigns targeted at bringing dead customers back to life. While this may be a good thing, it's worth looking into the cost of reactivation as well. Throwing in hefty discounts to get back individuals who aren't a product-market-fit could be a drain on your resources in the short run. It could also raise your customer churn rate in the long run. Source: Revenue Churn Revenue Churn Formula Revenue Churn is derived as the ratio of revenue lost through cancellations during a given period versus the revenue available at the beginning of that period. It’s usually expressed as a percentage. Revenue Churn = (Churned MRR)/(MRR at the beginning of the period) Customer Churn VS Revenue Churn How should a business interpret Revenue Churn? Churn is mostly inevitable and is caused by a variety of reasons such as cancelled subscriptions due to lack of perceived value and credit card expiry, categorized as  voluntary and involuntary churn . But, you can gain key insights from revenue churn, if you tailor the formula to find  Gross MRR Churn  or  Net MRR Churn . Gross MRR Churn Gross Monthly Recurring Revenue Churn attempts to show how much revenue is being lost, irrespective of how much you may be expanding within the existing customer base via expansion and upgrades. In this way, Gross MRR churn helps focus on how much revenue leakage is happening. Gross MRR Churn Rate = [( Downgrade MRR + Cancellation MRR) / (Total MRR at the beginning of the period)] * 100 Net MRR Churn Net Monthly Recurring Revenue Churn, on the other hand, attempts to paint a picture of the final reality after taking into account what’s lost (via cancellations, downgrades) and what’s gained (via expansion, reactivation and upgrades). Net MRR Churn Rate = [(MRR beginning of the month - MRR end of the month) - (Expansion MRR)] / [(MRR ( Monthly recurring revenue ) beginning of the month)] * 100 Net MRR Churn can be a negative churn. That’s to say the business is making more money out of a cohort of customers than it’s losing from the same cohort, in that period of time. MRR Retention Cohort Also, to stay on top of churn,  you need to analyze your SaaS  metrics. MRR Retention Cohort would be one of the charts you need to analyze. This chart will show you churn behavior based on both: when you acquired the customer and what happened in a particular month. Moving from left to right, you get an indication of change in MRR . And moving down rows, shows you how much new revenue you could acquire month on month. In the cohort above, you can see an adverse impact on revenue growth across customers in April. Source: Net MRR Churn Rate It takes into account the MRR gained from expansions and upgrades from your remaining customers. It gives you a clear indication of how much increase or decrease in revenue can be expected from your existing customers. The difference between Net MRR Churn Rate and Gross MRR Churn Rate is that the latter doesn’t take into account expansion revenue from the existing customer base. How is it calculated? Net MRR Churn Rate = [( Contraction MRR - Expansion MRR during a period) / (MRR at the beginning of the period)]*100. How should businesses interpret it? Net MRR Churn rate is the true indicator of how your business is faring. It tells you whether your business is sustainable or not. A net negative churn rate is great, indicating growth contributed by the existing subscription base. If this number is positive it means your business revenue contribution from existing customers, is shrinking faster than it is expanding. Source: Customer Retention Why is Customer Retention important? Customer retention is a crucial factor for any subscription business. Let's face it; your business is built on recurring revenue and repeat customers. So, if you have your customer base canceling their subscriptions, pretty soon, your business will be on shaky ground. No, pouring in more money into customer acquisition is not a healthy sign for a subscription business as you'll be spending five times more to acquire more customers that will eventually leave like those before them! Which is sure to take a toll on your bottom line. Plus, an investor will look more kindly on higher customer retention rate versus a higher spend on customer acquisition. SaaS businesses needs to keep a close watch on this metric, as it is an excellent proxy for customer satisfaction. If there's a constant dip in your customer retention rates, you can be sure there's an underlying problem in the product or service. Benefits of Customer Retention Additional Revenue: The probability of converting a prospect into a customer is only about 5-20%, while the likelihood of getting additional revenue through an existing customer ( expansion MRR ) is about 60-70%. Brand Ambassadors: Customer retention not only increases the customers’ lifetime value , but loyal customers often turn into your brand ambassadors who recommend your product or services to their friends, colleagues, and other prospective customers. This allows your brand to gain new customers for free over an extended period of time. Customer Upgrades: Around 50% of your loyal customers are likely to snap your new product up when it releases. It is invaluable to have good customer loyalty so you can trust a certain group to not only purchase, but advocate, for any new products. How to calculate Customer Retention rate? Before calculating CRR for a particular period of time, a business must first gather the total number of current customers at the end of the period, the number of new customers acquired during this period, and total customers at the start of the period. Once you have an understanding of your total customer base for a given period, you can calculate the rate at which you keep those customers. Customer Retention rate formula Customer Retention rate = [(number of customers at the end of the period - number of new customers during this period) / Total customers at the start of the period] x 100 Let's use an example. Say you had 100 customers at the start of 2020, and through 2020, you added 20 more customers, but you also lost 10. You have the original 100 customers, plus 10 (20-10), equalling 110. Your customer retention rate for 2020 is, (110-20)/100 = 0.9 or 90% Customer Retention strategies that make loyal customers Here are some retention tactics you could use to increase customer lifetime value, boost customer loyalty, and establish better customer expectations. Better onboarding experience: If you have an incredible new product that provides value to your customers, but an onboarding process that doesn't point out these values, it will likely result in the customer leaving the platform. Hubspot’s 'Aha moment' is when new customers use five key features within the first 30 days of onboarding. So the lesson is, prioritize the entire customer journey. Metrics can help you retain customers: We're living in the age of data and automation. These numbers can tell you a story before it's too late for your business to react. Investing in a subscription analytics platform will help you keep a close watch on your key metrics. Having accurate and real time tracking for your key metrics is like having radar that'll keep you course-corrected and help avoid icebergs. With real time metrics and access to 100% accurate data, ScreenCloud was able to reduce their customer churn with the help of RevenueStory . Talk to your customers: Customer experience is a no-brainer. The only way you'll have loyal customers is to offer customer support that accommodates customer feedback and allows the business to better understand and meet customer expectations. It is always best to keep engaging with your customers as opposed to waiting for them to come to you after there is already an issue. There will always be problems to solve, so be proactive and set up outreach and follow up processes. This will also help spread word-of-mouth about your service. Source: Cart Abandonment Losing Customers to Cart Abandonments One of the biggest headaches faced by merchants selling online is Cart Abandonment. Cart Abandonment is a situation whereby a customer that had put some products in the shopping cart fails to go through the entire checkout process or cancels the order during the checkout process. The global average rate of cart abandonment for 2019 is 75.6%. The cart abandonment rate shows how many of the items that are added to the shopping cart are abandoned. It is calculated by dividing the total number of completed transactions by the total number of transactions that were initiated. What makes Cart Abandonment Rate an important metric for online commerce sites is the fact that a high abandonment rate could signal a poor user experience or a friction-filled checkout experience. Top 4 Reasons Users Abandon Their Carts The following are the top cited on every survey that outlines the reasons why customers abandon a cart: Being forced to create an account. Struggling with complicated checkout processes. Unexpected delivery costs. Concerns over security. This shows that shoppers consider full transparency of the costs, guest checkout, coupon codes, security in transactions, variety in shipping options and a clear and short checkout process as prerequisites for online stores and necessities to make a purchase. To keep abandoned cart rates down, it’s always a simple matter of design and making the checkout process easier and more straightforward. Here are a few ways that you can reduce Cart Abandonment and help more buyers make it through the checkout process successfully. Understand intent. Shorten and simplify your checkout. Offer guest checkout. Consider accepting additional forms of payment. Implement an abandoned cart email strategy. While window shoppers on your site can’t be helped, there are ways to reduce carts that are abandoned for other reasons. That is why it’s important to use cart abandonment as an opportunity to gauge your visitors’ intent and help them in their purchasing journey. Additional Reads More reads on Cart Abandonment, and understanding how they affect the acquisition in SaaS businesses: Wondering why people come by to check out your site, get all the way to your checkout cart, and then leave? There’s a black hole on your checkout page that you didn’t know about. Using abandoned cart emails to plug holes in the revenue recovery pipeline. Improve Sales Conversions Against Checkout Drops With Chargebee’s Cart Abandonment Reporting   What methods should you employ to improve your checkout conversions? Introducing Chargebee Moments: For the Ultimate Moment of Truth at Checkout Source: operating expenses Understanding operating expenses Operating expenses are the capital costs incurred by a business in its day-to-day operations. These costs are important in measuring a company’s performance, making them important for management and financial analysts. Operating expenses include inventory expenses, rent, marketing activities, insurance expenses, payroll expenses, and research and development investments. These are necessary for the continued operation and profitability of the company. Operating expenses are carefully recorded on the income statement, clearly separate from the cost of goods sold (COGS). This separation is important for financial transparency. Additionally, the operating expense ratio (OER) is an important metric. It measures the efficiency of a company’s cost structure by comparing total operating expenses to total revenue. This ratio is calculated by dividing total operating expenses by total revenue. Understanding and effectively managing operating costs is important for maintaining day-to-day operations and long-term financial sustainability. Companies aiming to improve efficiencies must closely target these costs to achieve strategic profitability and growth. Operating vs. non-operating expenses Operating fees are vital fees related to a business's core functions, including salaries, rent, utilities, and advertising and marketing. These charges are critical for daily operations and are usually certain beneath the cost of goods offered (COGS) on the earnings statement. Understanding operating charges is important for assessing an agency's operational performance and monetary health. In evaluation, non-working expenses are charges that don't pertain at once to the primary commercial enterprise activities. These may include finance charges like interest, inventory clearance expenses, and prison fees, which can be recorded one at a time at the earnings announcement. Unlike operating costs, non-operating prices are subtracted from the running profit to decide the income earlier than tax. These charges can be either one-time or ordinary and frequently get up from non-recurring or peripheral enterprise sports, such as felony settlements, restructuring, or changes in accounting practices. Distinguishing among working and non-operating charges is vital for companies as it complements economic reporting accuracy and helps greater knowledgeable selection-making. This readability allows stakeholders to understand the proper monetary overall performance of an agency and guides strategic planning and budgeting efforts. OpEx vs. CapEx Capital costs (CapEx) and operating prices (OpEx) represent fundamental financial classes that each enterprise encounters. CapEx entails the purchase of assets that provide long-term prices to the business enterprise, like assets, flora, or equipment. These purchases are capitalized on the stability sheet and steadily depreciated over their useful life, reflecting their intake and fee loss over the years. Conversely, working charges relate to the costs required for the day-by-day functioning of a commercial enterprise, consisting of salaries, hires, utilities, and habitual protection. These fees are without delay recorded on the earnings assertion as they occur and are generally everyday and habitual. Understanding the nuances between CapEx and OpEx is vital for any commercial enterprise because it directly influences how economic activities are suggested and analyzed. This difference plays a vital role in strategic planning, budgeting, and average financial management, assisting corporations in allocating resources effectively and planning for a sustainable boom. Capital expenses vs. operating expenses Capital expenditures (CapEx) and running charges (OpEx) are two wonderful sorts of costs incurred by organizations. Capital expenses encompass important purchases such as new devices, facility creation, or technological improvements that can be expected to benefit the enterprise in the end. These expenses are recorded as assets on the balance sheet and are reduced over the years.  On the other hand, running prices are ongoing charges that assist the daily operations of the power, including lease, utilities, coverage, and payroll expenses. These prices are recorded in profits as a consequence and regularly recur. Understanding the distinction between CapEx and OpEx is critical for businesses because it impacts financial reporting, budgeting, and strategic planning. Importance of operating expenses Operating costs are integral to a company's day-to-day operations, affecting everything from payroll to marketing. The business's immediate operations affect these costs, as do its decisions regarding fund placement, pricing, and distribution. By carefully and diligently managing these debts, companies do more than protect their financial health; They actively increase operational efficiency and adaptability. This ongoing optimism helps identify areas where costs can be cut or processes streamlined, creating a culture of excellence that supports long-term and sustainable success. In a continuous business world at this pace, not only profits are focused on operating costs; thus, it is important for competitiveness and prosperity. How to calculate operating expenses To calculate operating expenses, you need to identify the various costs that a business incurs to maintain its day-to-day operations. These costs include: Salaries and Wages: Payroll for administrative staff, excluding labor for manufacturing. Insurance: Insurance premiums for employees, property, and equipment. Rent and Utilities: Rent for office space and utilities such as electricity, water, and gas. Research and Development: Expenses for research and development projects. Marketing and Advertising: Costs for advertising and promotional activities, including social media campaigns. Office Supplies: Expenses for office supplies, stationery, and other miscellaneous items. Travel and Vehicle Expenses: Expenses for business travel, vehicle maintenance, and fuel. Property Taxes: Taxes on real estate and property. Accounting Fees: Fees for accounting services, including bookkeeping and auditing. Legal and Professional Fees: Fees for legal and professional services, such as consulting and auditing. To calculate operating expenses, you can use the following formula: Operating Expenses = Salaries + Insurance + Rent + Utilities + Research and Development + Marketing and Advertising + Office Supplies + Travel and Vehicle Expenses + Property Taxes + Accounting Fees + Legal and Professional Fees Examples of operating expenses, let's say a company has the following expenses: Salaries: $1,000,000 Insurance: $200,000 Rent: $150,000 Utilities: $50,000 Research and Development: $100,000 Marketing and Advertising: $300,000 Office Supplies: $20,000 Travel and Vehicle Expenses: $30,000 Property Taxes: $50,000 Accounting Fees: $10,000 Legal and Professional Fees: $20,000 The total operating expenses would be: Operating Expenses = $1,000,000 + $200,000 + $150,000 + $50,000 + $100,000 + $300,000 + $20,000 + $30,000 + $50,000 + $10,000 + $20,000 = $2,020,000 This is the total operating expense for the company. How to cut operating costs In today's business climate, trimming operating costs isn't just a financial strategy—it's a necessity for staying competitive and sustainable. Here's how to approach it thoughtfully: Streamline Expenses: Assess and eliminate non-essential subscriptions or memberships. Simplifying your cost structure can clarify your operational focus. Leverage Technology: Use automation to reduce labor costs and improve efficiency. Eliminating mundane tasks saves money and enriches your team's work. Renegotiate Terms: Build stronger relationships with suppliers through honest negotiations to secure better prices without compromising quality. Implement Energy-Efficient Practices: Embrace sustainability to reduce energy costs, benefiting both your budget and the environment. Utilize Outsourcing: Employ freelancers and contractors to handle non-core tasks. This flexible approach adjusts to workload changes without the overhead of full-time salaries. Regularly Review Costs: Monitor your expenses regularly to identify and address inefficiencies, keeping your operations lean and effective. By embracing these strategies, you enhance your company's efficiency and financial health, paving the way for sustainable growth. Treating operating expenses in your books Operating Expenses, also known as OpEx, are not related to the production of a product (Ex: Cost of goods sold). These expenses affect the income and the cash flow of a business. So, operating expenses are recorded in the Income Statement and the Cash Flow Statement of a business. Income Statement - Also known as Profit & loss statement, this financial statement focuses on the revenues (operating and non-operating), expenses (primary and secondary activity), gains, and losses. Operating expenses along with expenses incurred from the production of the product are recorded under primary activity expenses. Cash flow statement - A cash flow statement reports a company’s flexibility, liquidity, and overall financial performance. It is segmented into 3 parts: Operating, Investing, and Financial cash flows. Operating expenses along with expenses incurred from production of the product are recorded under Cash flows from operating activities. Fun facts about operating expenses Salary/wages paid to full-time staff are considered operating expenses. Whereas, the cost of hiring labor, and outside wage payments for producing a product is calculated under Cost of Goods Sold. Regular business expenses like rent, utilities, etc. that are incurred while securing new business aren’t considered operating expenses. For MNCs and businesses of massive scale, it’s impractical and nearly impossible to calculate the actual operating expenses. It is usually shown as a projection when doing budgets for the next fiscal year. How Chargebee helps calculate operating expenses? Chargebee is an invaluable tool for businesses aiming to streamline their financial processes, particularly when it comes to managing operating expenses (OpEx). The platform offers a suite of features designed to automate and enhance the accuracy of financial tracking and reporting, making it easier for companies to stay on top of their day-to-day expenses without getting bogged down in spreadsheets.  Key features of Chargebee for operating expenses: Automated expense tracking: Chargebee automates the recording of fees as they arise, ensuring that all economic facts are appropriately captured without manual intervention. This helps lessen errors and save time. Customizable reporting: The platform permits groups to generate customized reports that provide insights into their running costs. This enables them to examine traits, identify areas where costs can be cut, and make informed monetary selections. Integration capabilities: Chargebee seamlessly integrates with different economic equipment and accounting software. This guarantees that every one statistic related to working prices is centralized, making it easier to manipulate and evaluate. Real-time data access: Chargebee gives real-time get right of entry to financial information, allowing businesses to display their working prices on the fly. This immediate get entry is vital for dynamic and fast-paced enterprise environments. Scalability: Whether you are a small startup or a huge agency, Chargebee scales to fulfill your enterprise needs. It helps a wide variety of business sizes and types adapt as their enterprises grow. Why it matters Accurately calculating and managing operating expenses is vital for maintaining financial stability and profitability. Chargebee's tools help ensure that your financial records reflect the true state of your business, enabling better strategic planning and resource allocation. Get started with Chargebee Interested in optimizing your business's financial management? Schedule a demo call with Chargebee today to see how we can assist you in effectively managing your operating expenses. By understanding and controlling these costs, you can drive your business towards greater profitability and success. Dive deeper with Chargebee Academy Want to expand your financial management skills further? Subscribe to Chargebee Academy today and gain access to a wealth of resources and courses designed to help you master the art of managing business finances. Source: Negative Churn What Causes Negative Churn? Net churn is calculated as: Net Churn = [Cancellation MRR + Downgrade MRR ] - [ Reactivation MRR + Upgrade MRR ]/[ MRR at Beginning] Imagine a business that closes a month with 10 customers paying $100 each. Let’s imagine one customer churns the next month, but the remaining 9 customers upgrade to $120 each. Net Churn = [1*100] - [9*20] / [10*100] = -8% How To Influence and Interpret Negative Churn Needless to say, negative churn is an aspirational state for any subscription business. It means the business is able to more than compensate for its revenue churn from within the existing customer base. Many factors go into achieving negative churn, not the least of which is minimizing revenue churn. On the other end, expansion revenue (upgrades) can be influenced via a strong and proactive customer success program. That said, the kind of value metric that your pricing is based on and the pricing structure itself is just as important to effect expansion. The right value-metric (like the number of seats for a helpdesk software) is almost certain to help with expansion revenue over time as the customer's business grows. Additional Reads From Unit Economics to Negative Churn: Hitchhiking to SaaS Growth The Craft and Craftiness of Interpreting Churn Source: Payment Methods In a store, perhaps you use cash, credit cards, or mobile payment options like Apple Pay. When online, you may want to make a direct bank transfer for local payments or go with PayPal for global transactions. For services like Uber, you probably have an online wallet linked to your credit card. And under each method (say, credit cards), you have a host of options (Visa, Mastercard, and American Express, to name a few). In fact, there are more than 200 alternative payment methods worldwide. So how many payment options should you give your customers when they come to your checkout page? Things to Consider While Shortlisting Payment Methods In general, having multiple payment options is obviously good for your customers. For instance, a 2014 study by the PPRO Group found that 68% of UK consumers abandoned an online retail site due to the payment process. 57% of them left because the process was too complicated, while 46% did not complete the transaction because they weren’t offered their payment method of choice. So fewer payment methods lead to higher bounce rates. But give buyers a ton of options and they’ll drop off just the same. As always, there’s a UX cost associated with having too many choices. So there’s a happy medium to be struck, like the children’s fairy tale where Goldilocks tries different chairs, bowls of porridge, and beds in the unsuspecting bears’ house until she finds one that’s ‘just right’. This golden mean for payment methods depends on factors like: Location - Find out which methods complement both your company’s country of incorporation and your customer base location. You may need to change payment methods for customers in different countries too. For instance, in Germany direct debit through SEPA, Giropay and open invoices are all more popular than credit card payments, a residual effect from World War II, when financial systems were failing. Purchase mode - Do customers use your services online or offline? Choosing the most-used mix of omnichannel payment options in the customer location may be the best option if they do both. If they primarily checkout online, you can safely omit offline options like cash on delivery and focus on picking online payment methods for your demographic. Business model - Do you have a recurring billing model or predominantly process one-time payments? Factor in an added layer of complexity if you have subscription customers. The bottom line? Shortlisting payment methods that satisfy these basic parameters is the first step. Your next step should be to look up cost and risk assessment processes associated with these options. For instance, PayPal is incredibly simple to sign up for and makes international transactions easy, but once you do their aggressive risk prevention processes may lead to payment holds with little explanation. If you’re laying the ground for internationalization, it’s also important to note that not all payment methods support multiple currencies. And it’s always best to keep an eye on outliers—options that may not be popular widely but are used heavily within your customer base—to ensure minimum churn during checkout. Multiple Payment Methods in Recurring Billing Recurring billing uses the same payment methods as one-time transactions, ie., credit cards, direct debits processed with ACH (US), Bacs (UK) or SEPA (Eurozone), PayPal, Amazon payments, etc. The difference is that when you use a billing system for recurring billing you can configure two kinds of payments - Automatic and Manual With automatic payment collection, your customers can choose a payment method that will be auto-charged on renewal of the billing cycle. With manual payments, you collect dues yourself and record them. In automatic payment collection, some billing solutions go one step further by allowing your customer to choose and set up multiple payment methods at once. This provides revenue assurance in the event of failure of the primary payment method. The billing solution can then automatically try the backup payment options without customer intervention and further delays. Ultimately, picking an optimal set of payment methods will ensure that your customers can pay you in a way that’s easiest for them and have more flexibility to do it on time. Pro Tip: You’ve set up an automatic payment collection with primary & backup payment methods for your subscription customers. But what happens if both fail? Sometimes, customers forget to update their credit card information and may not have opted in for you to collect updated data directly through the account updater. Or their backup payment methods could have been improperly set up to begin with. Whatever the case, Chargebee makes sure that the dunning process kicks in if all payment methods fail after repeated retries, so you don’t have to manually deal with involuntary churn. Additional Reads Looking for a place to start before you set up different payment methods? Here are a few basic articles which lay out the basics of why this is important for your customers and your business: Explore over 20 ways to handle failed payments. Failed Payments and Involuntary Churn — A Definitive Guide Credit card processing is one of those tricky places in online business where a blind spot can cost you. Online Credit Card Processing Can’t Be A Blind Spot Source: Renewal Rate This simple definition makes renewal rate look like a straightforward concept. If you take a closer look, though, you'll see that opportunities for analysis are endless.  Renewal rate vs. Retention rate Renewal rate and retention rate are often used interchangeably. However, there are some key differences — primarily in the customer intent. Renewal rate is the measure of customers who actively choose contract renewal.  Retention rate, on the other hand, refers to customers who had chosen not to cancel their subscription even when they had the chance to. This could either be an automatic decision or an active decision on their part to renew the contract. The renewal metric tells you how many customers choose to renew their contract at a given time. Retention metrics tell you how many customers you have been able to retain over a time period.  How to calculate renewal rates There are two methods for calculating rate of renewal, and both will give you actionable insights into customer health. 1. Count/Customer Renewal Rate The number of renewed items against the number of renewable items gives the count or customer renewal rate. The formula is as follows: No. of customers who renewed their contract / No. of customers who had a chance to renew their contracts Here are a few examples: Here's a quick example: 100 customers have subscribed to your product at the beginning of this month. At the end of the month, 90 renew their subscription. The renewal rate for your product (this month) is 90%. The customer count renewal rate can be a maximum of 100% and is best used with a homogenous customer base — similar types of customers, contract terms and conditions, price range, and the like. 2. Dollar/Revenue Renewal Rate Unlike the count formula, the revenue/dollar renewal rate considers the contracts’ dollar value renewed. The formula is as follows: Value of contracts that are renewed / Value of contracts that have a chance to be renewed Here's an example:  Customer X has a $100 subscription. Customer Y has a $1000 subscription. Customer X cancels, and Customer Y renews. The renewal rate is 91%. Additionally, let’s assume Customer Y renewed with a 10% price upgrade. Now, the revenue renewal rate is 100%. Here's another example to understand Monthly Recurring Revenue ( MRR ) Renewal Rate and Annual Recurring Revenue ( ARR ): Total number of customers: 100 Deal value: $12,000 for a 12 month contract ($1,000 MRR) Number of contracts up for renewal: 10 Contracts lost in churn: 2 The renewal rate is 80% ($8,000 MRR / $10,000 MRR) Additionally, assume you managed to up-sell to one of them from $1,000 to $5,000. Now, the MRR renewal rate is 120% ($12,000 / $10,000). To sum it up, MRR takes into account: the MRR at the beginning of the month, the MRR gained from new customers , expansion revenue ( MRR change gained from upgrading customers ), shrunk revenue ( MRR change lost from downgrading customers ), and the MRR churn. Once you know MRR, ARR = MRR * 12. Revenue renewal rate can be more than 100% and is best used when your customer base is heterogenous and you have to process data across various demographics. Hence, high renewal rates are something companies should aim for. Factors that affect renewal rate metrics Renewal rate is more complicated than it appears on the surface.  Companies need to factor in many different data points based on different customer cohorts.  Here are just a few examples of questions that businesses should ask themselves when calculating subscription renewal rates:  How many customers are renewing their contract for your lowest-priced product or plan? What about the higher-priced tier? How many renew after their subscription has lapsed? Has the renewed contract value expanded or shrunk? What is the length of the renewed contract? Was the renewal for the given period or prepaid for a longer duration? If so, is there a discount? Once these questions are factored into the calculation, it looks somewhat like this: Customer Y buys 100 seats of product A at $1300 per seat per year on January 2, 2020. The terms of the contract state that the price cannot increase by more than 5% a year. The same customer then renews his contract on January 1, 2021. This time he buys 120 seats at $1300 per seat per year. He makes a prepaid commitment for 5 years which allows him a 16% discount. Not so straightforward anymore, is it? This is what real-world renewal rate calculations look like in SaaS companies. Additionally, different customer success teams have different ways of processing the same data. Even though these questions make the analysis somewhat complicated, the results are rewarding. Let’s dive into the how.  How renewal rates impact customer success It costs five times more to acquire new customers (that's the CAC - customer acquisition cost ) than to retain an existing customer. As a CSM (customer success manager), customer retention should be one of your primary focus areas. Moreover, we know that renewal rates prove useful in revealing purchase patterns. Since renewal rates catch trends, they help improve retention, lead to better customer success outcomes, and even predict revenue growth. For instance, you may notice that one customer segment is renewing more than another. In reaction, you might optimize their response by upselling or cross-selling. Similarly, you may choose to revisit your product pricing, packaging, and value proposition for the customers you think are not renewing as much. Given what you discover, you can take measures to make the best of the situation, leading to better customer success outcomes for your company. Renewal rate is also closely linked to customer churn : Renewal Rate = 1 - Churn Rate . Focusing closely on churn and renewal rates ultimately allows you to improve your customer retention. 5 ways to improve your renewal rate Improving renewal rates doesn't happen overnight. The journey has to start somewhere, and the obvious secret is happy customers. Thankfully, there are many ways to achieve this goal.  1. Focus on product stickiness Look for gaps and build efficiency, so you can deliver the best customer-centric platform possible. As a result, you can improve product adoption. 2. Know when, and whom, to roll offers out to You do not want to offer heavy discounts to a customer who will likely pay the entire renewal amount. 3. Identify the customers most likely to churn By engaging them with attractive offers, you can help increase renewal or even increase new revenue. 4. Promote your product Just because you have a set of loyal customers doesn’t mean you shouldn’t talk to them about your product anymore. You can use social media and email campaigns to offer discounts and convey important information about your product. Not only will this help with renewal (and retention), but also in upselling and cross-selling. 5. Engage and nurture your customers Understand their needs, and work toward a mutually beneficial alliance. Remember – your success is your customers’ success. It's time to focus on retention There's much more to renewal rates than meets the eye. By looking closer, you can find big-picture insights that will lead to higher retention, a better customer experience, and ultimately, more renewal revenue.  Source: Accrued Revenue Accrued revenue is a part of  accrual accounting . As specified by  Generally Accepted Accounting Principles (GAAP) , accrued revenue is recognized when a performance obligation is satisfied by the performing party. For example, revenue is recognized when the customer takes possession of a good or when a service is provided, regardless of whether cash was paid at that time. Accrual Accounting mainly consists of two principles: Revenue recognition principle: The revenue should be recognized in the accounting period when it is realized and is earned. Revenue is earned only after delivering the product or service. Matching principle: Expenses should be recorded in the same accounting period as revenue that they helped generate. Simply put, expenses are 'matched' with revenue. When does Accrued Revenue Occur? Accrued revenue must be booked when there is a mismatch between the time of payment and delivery related goods/services. This can happen in cases such as: Loans: When a company loans money to other businesses or individuals; Long-term Projects: When in long-term projects revenue is booked based on 'percentage of completion' method; Milestones: When there is a large order and revenue is booked based on milestones met. Accrued Revenue for SaaS Accounting From the lens of SaaS, revenue is often accrued in cases of: Upgrades or downgrades Add-on purchases in the subscription period One-time charges like migration fees/setup fees For example, ABC marketing agency signs up for a marketing automation software, 'Yoohoo', that's billed quarterly at $600 for a three-user package. Twenty days into the subscription period, the agency realizes that they need two more users to access the software. Furthermore, the agency also requested Yoohoo to provide an exclusive training session. The cost of adding two more users and a training session is not billed immediately to the ABC agency but is marked as Yoohoo's accrued revenue for that month. This revenue will be converted to accounts receivable during the renewal in the next quarter. Accrued Revenue vs Deferred Revenue When a company receives upfront payment from a customer before the product/service has been delivered; it is considered as deferred revenue . In short, Deferred revenue is recognized after cash is received. Accrued Revenue, on the other hand, is recognized before cash is received. Let's look at the key differences between Accrued Revenue and Deferred Revenue: The entry of accrued revenue entry happens for all the revenue at once. Deferred Revenue is when the revenue is spread over time. Accrued revenue entry leads to cash receipts. Deferred revenue is the recognition of receipts and payments after the actual cash transaction. Deferred revenue is unearned revenue and hence is treated as a liability. Accrued revenue is treated as an asset in the form of Accounts Receivables. How is Accrued Revenue Recorded in Journal Entries? On the financial statements, accrued revenue is reported as an adjusting journal entry under current assets on the balance sheet and as earned revenue on the income statement of a company. When the payment is made, it is recorded as an adjusting entry to the asset account for accrued revenue. This only affects the balance sheet and not the income statement. Let’s understand this with an example. Pied Piper IT Services agrees to build a flight navigation software for XYZ airlines in 12 months for a sum of $120,000. According to the contract, Pied Piper is expected to deliver the first milestone of the software in 6 months which is valued at $60,000. A second milestone will be delivered at the end of another 6 months, indicating the end of the contract. The contract is such that it only allows for billing at the end of the project for $120,000. Hence Pied Piper must create the accrued revenue journal entry to record reaching the first milestone (6th month): After Pied Piper completes the second milestone and bills the client for $120,000, Pied Piper must record the following journal entry to reverse the initial accrual, and thereafter the second entry for the $120,000 invoice. Debit balances related to accrued revenue are recorded on the balance sheet, while the revenue change appears in the income statement. Is Accrued Revenue an Asset? Once a company bills the customer for the goods provided or service rendered, Accrued Revenue is treated as an Account Receivable until the customer pays the bill. Hence it is a current asset on the balance sheet. However, a high Accrued Revenue signifies that the business is not getting payments for its services and can be alarming from a cash-flow perspective. Why is Accrued Revenue Important? Recording accrued revenue as a part of accrual accounting can help a business be agile by anticipating expenses and revenues in real-time. It can also help monitor the profitability of the business and identify potential problems well in advance. SaaS businesses sell pre-paid subscriptions with services that are rendered over time and hence require the use of the accrual basis of accounting. Revenue recognition in SaaS is done when the service is rendered and the revenue is ‘earned’. Not using accrued revenue in SaaS would lead to revenue recognition at longer intervals, since revenues would only be recognized when invoices are issued. This would not capture the true health of the business. Accrued revenue serves to demonstrate how the business is doing in the long run. It also helps in understanding how sales are contributing to profitability and long-term growth. Additional Reads More reads about the best practices of SaaS Accounting and Revenue Recognition: Definition and examples of how to recognize revenue for SaaS businesses. What is revenue recognition? Demystifying SaaS Accounting SaaS Accounting 101 Source: SaaS Churn Rate SaaS Churn Rate Formula To calculate your  SaaS churn rate , you need to figure out what you’re looking to track. You could either track the revenue you’re losing or your customers. Here are a few churn numbers: Annual Revenue Churn Monthly Revenue Churn Subscriber Churn ARR churn and MRR churn would calculate the revenue lost. Whereas the Subscriber/ Customer churn rate  will calculate the rate at which you’re losing your customers. For most businesses, ARR churn isn’t a key indicator––since the measurement intervals are too far apart (yearly), you can’t make any active changes. Subscriber churn Subscriber churn is calculated as the ratio of the number of customers lost during a period (typically a month or a year) and the number of customers present at the beginning of that period. Subscriber Churn = ([Customer at the beginning of a given period] - [Customers at the end of that time period]) / [Customers at the beginning of that period] If the number of customers at the beginning of the year 2019 is 100 and through 2019 five of those customers canceled their subscriptions, subscriber churn is 5/100 or 5% MRR Churn Monthly Recurring Revenue Churn  is calculated as the ratio of  MRR  lost during that month minus new upgrades/subscription revenue and divided by total MRR at the beginning of the month MRR Churn = ([MRR beginning of the month - MRR end of the month] - [New subscription revenue or upgrades]) / [MRR beginning of the month] If a company had $300,000 MRR at the beginning of the month, $250,000 MRR at the end of that month, and $70,000 MRR in new subscription revenue from existing customers, the Monthly churn rate would be -6.6%. A negative churn rate means that the new revenues added during the period were greater than those that canceled. The annual churn rate ( ARR ) churn can also be calculated by the same formula by adjusting the periods. Net MRR churn rate gives a more accurate representation of the health of your business because it takes into account your revenue expansion from upsells and cross-sells as well. What is an acceptable SaaS Churn Rate? SaaS churn rate benchmarks can vary from industry to industry. It can also vary based on the stage of growth of a company. Here’s a  survey conducted by Totango  that shows the churn rate across different growth rates: A 3% churn rate is usually seen as a great rate. But, the typical benchmark for the average churn rate is 5-7%. Anything above this could be considered a higher churn rate. Why is SaaS churn rate a key SaaS metric? Churn has profound implications on the health of a SaaS business. For example, A monthly subscriber churn of 5% translates to approximately 46% annual churn. That is, a business with 5% monthly subscriber churn will end the year with half the customers it had at the beginning of the year. In other words, it will have to add 50% more customers during the year just to break even with the customer base it had at the beginning of the year. How do you reduce churn? Churn is inevitable; businesses will always have subscription cancellations. But if you find yourself dealing with a high churn rate, here are a few tactics you could employ for customer retention. Offer an annual pricing plan Compared to an across the board SaaS churn rate of 5-7%, monthly contracts have churn rates as high as  14% . Offering an annual contract as a churn reduction method can convert  6.5%  of the time, resulting in revenue lifts of around 4%. Implement a smart Dunning Management System A tenth of your recurring may be at risk, due to failed transactions. Many of these are due to expired credit cards, network outages, or insufficient funds on the card. By implementing a  payment retry and dunning management system , businesses can lower churn rates and increase your MRR by as much as  35% . Did you know that you can look at the churn in 20+ ways with RevenueStory? RevenueStory is a subscription reporting and analytics tool built on top of your billing system at Chargebee. You can try it out  here Source: Annual Recurring Revenue Why annual recurring revenue is important for your subscription business Understanding ARR is crucial for making informed decisions about future plans and investments. It shows what customers are willing to pay on an ongoing basis and serves as an indicator of the company's long-term growth potential. In essence, ARR provides a clear picture of how much revenue your business might earn in any given year through recurring subscriptions or services offered. Understanding your Annual Recurring Revenue (ARR) is crucial for several reasons: 1. Investor appeal Companies with a recurring revenue model are more attractive to investors due to predictability and reliability. This predictability can increase a company's valuation by up to 8 times. Investors appreciate the reliable revenue stream enabled by the subscription business model . SaaS companies on a growth trajectory with a strong ARR are more likely to attract investors and keep board members content. 2. Financial forecast predictability ARR provides a more accurate way to forecast future revenue, enabling better financial planning and resource allocation. 3. Stability Using ARR as a key performance indicator, you can manage expenses more accurately, ensuring a steady cash flow. 4. Scalability  A recurring revenue model allows you to scale and grow more effectively, as predictable cash flow enables reinvestment and sustainable growth. 5. Customer retention The recurring revenue model fosters long-term customer relationships as customers continue to pay for services over time, reducing customer churn and increasing. Nearly 50% of subscription professionals said that customer retention was a top priority in 2024 so having a recurring revenue model helps keep customers engaged. 6. Business value Companies with are more valuable than those without, as they can demonstrate reliable revenue streams, which are more appealing to buyers. How to calculate annual recurring revenue Calculating Annual Recurring Revenue (ARR) is straightforward. By accurately determining ARR, you can gain deep insights into your predictable revenue streams, empowering you to make informed decisions about investments, budget allocations, and growth strategies.  This section explains, in simple terms the essential formulas and calculations necessary to calculate ARR. The ARR formula Here's the formula and everything you need to know about it. You can calculate ARR as follows: ARR = Sum (Yearly Recurring Charge of all paying customers) If you bill your customers monthly, you can calculate ARR as: ARR = (Contract Value) x (12/ Duration of contract in months) For example, if a customer signs a 3-year contract (36 months) for $60,000, which is billed monthly, your ARR calculation is: ARR= $60,000 x (12/36) = $20,000. If you bill your customers annually, you can calculate ARR as: ARR = (Contract Value) / (Duration of contract in years) For example, if a customer signs an annual contract for two years at $40,000, your ARR calculation is: ARR= $40,000/2 = $20,000. While this seems relatively straightforward, it is important to know whether all the charges included in the contract value are 'recurring'. ARR adds context to other metrics If you have a churn rate of 4%, should you be concerned? Or is it within acceptable limits? By considering churn within the broader context alongside ARR, you can determine its significance. Elements to include and exclude in ARR calculation Include: Recurring invoices: All recurring subscription revenue, including per-user or seat charges. Upgrade revenue : When customers move to higher-value plans. Downgrade revenue: When customers move to lower-value plans, resulting in MRR churn. Exclude: One-time fees Set-up fees Non-recurring add-ons Credit adjustments ARR vs. MRR Understanding the difference between Annual Recurring Revenue (ARR) and Monthly Recurring Revenue (MRR) is key to grasping your subscription business's financial health. ARR is an annual metric that gives you a big-picture view of your company's recurring income over a year. This helps in long-term planning and strategic decision-making. For businesses with yearly subscription models, ARR aligns perfectly with billing cycles and shows how well you're doing on an annual basis. MRR, on the other hand, is calculated monthly and provides a more immediate look at your revenue. It includes different types, such as new MRR , upgrade MRR , expansion MRR , and contraction MRR . This detailed breakdown offers insights into your revenue trends and allows for quick adjustments to keep your business on track. Both metrics are vital: ARR helps you see the long-term trajectory of your business, making it easier to plan for growth and sustainability. MRR gives you a month-by-month snapshot, letting you react swiftly to changes and seize opportunities. By using both ARR and MRR, you get a complete understanding of your revenue streams. This dual approach helps predict growth accurately and supports making informed financial decisions. In a world where efficient expansion is crucial, mastering both ARR and MRR can set your business up for success. For instance, seeing your MRR double is a clear sign of rising success and helps pinpoint which services are performing well. Investors and stakeholders love this kind of clarity. In short, balancing ARR and MRR gives you the best of both worlds—strategic long-term vision and agile short-term management. This powerful combination ensures you’re on a solid path to achieving your financial goals and scaling your business effectively. Impact of customer acquisition, retention, and expansionary revenue on ARR 1. What are the implications of reducing customer acquisition costs on ARR? Reducing Customer Acquisition Costs (CAC) allows a business to allocate resources more efficiently, which may not directly increase MRR/ARR but enhances overall operational efficiency. This strategic cost management supports sustained growth by freeing up capital that can be invested back into other areas like product development or marketing, indirectly benefiting ARR. 2. How does improving customer retention directly influence ARR? Improving retention aligns the product closer to the customers' needs, which increases customer satisfaction and loyalty. This alignment helps expand the customer base and extends the duration of customer subscriptions, both of which are crucial for boosting Lifetime Value and, consequently, ARR. 3. What strategies can be employed to increase expansionary revenue from existing customers? To increase expansionary revenue, businesses can incentivize existing customers to opt for upgraded services that align with critical value metrics. This approach not only enhances the perceived value of the product but also encourages customers to expand their engagement, directly impacting ARR growth. 4. How can increasing net customer acquisition impact ARR? Boosting net customer acquisition effectively increases your Monthly and Annual Recurring Revenue by bringing more qualified leads into the sales funnel. Improving the efficiency of the acquisition process and lowering the costs associated with acquiring new customers enhances the LTV/CAC ratio, which directly contributes to higher ARR. Common pitfalls to avoid when interpreting ARR 1. Mistaking ARR for cash ARR is not the same as cash. Let's understand with the same example as we used above. A customer signs an annual contract for two years at $40,000. In this scenario, the ARR is $20,000.  But, assuming an upfront payment, cash is $40,000. Mistaking ARR for cash can create a falsified image of how much money a business has. 2. Looking backward, not forward There’s a reason your rearview mirror on your car is small, and your windshield is large. You need to focus on looking forward more than looking back. A common mistake is when businesses calculate ARR by adding up the total revenue for the last 12 months. But in reality, ARR is a forward-looking metric that takes into account how much revenue you can expect in the future, not how much you generated last year. 3. Not accounting for discounts If you have given your customers discounts or coupons , that means they aren’t paying the full price of the subscription. It’s essential to account for discounts when calculating ARR. For example, if the annual subscription value is $10,000 with a 20% discount, the customer is only paying $8000, and only that amount should be considered for ARR calculation. 4. Not including late payments Every business has delinquent customers. Implementing a dunning mechanism can keep late payments under control, but when the amounts come rolling in, remember to include them in your ARR calculations. Grow your annual recurring revenue  MRR and ARR provide the clearest insight into your subscription business's revenue growth and momentum. Generating higher levels of recurring revenue enables sustained growth and expansion of your strategic initiatives. Essentially, MRR and ARR are the lifeblood of your subscription business, propelling it forward. Below, we outline four practical strategies to boost the MRR and ARR of your business: 1. Improve customer retention Reduce churn by focusing on customer satisfaction, addressing their needs, and offering personalized customer experiences. 2. Upselling and cross-selling Offer additional products or services to existing customers to increase their lifetime value and ARR. 3. Optimize pricing Regularly review and adjust your pricing strategy to ensure it remains competitive and maximizes revenue. 4. Leverage data and analytics Analyze key metrics such as customer acquisition cost, customer lifetime value, and churn rate to identify areas for improvement and make data-driven decisions. Conclusion A robust ARR figure not only reflects the health of your business but also enables the development of superior products and the assembly of a more skilled team. It acts as a compounding indicator of your company's potential for growth and sustainability. With ARR as your guide, the path to scaling operations, improving customer satisfaction, and ultimately boosting profitability becomes clearer and more attainable. In conclusion, the strategic tracking of ARR is indispensable for subscription-based businesses aiming to thrive in competitive markets. It not only provides a snapshot of current financial health but also offers a forecast for future growth, ensuring that your business decisions are both proactive and informed Ready to rev your ARR engine?  Request a demo of Chargebee, the leading Revenue Growth Management (RGM) platform for subscription businesses.  Our mission is to help businesses of all sizes grow their revenue by providing a comprehensive suite of solutions, including subscription management and recurring billing, pricing and payment optimization, revenue recognition, collections, and customer retention. Understanding ARR in business metrics: Common FAQs 1. What is ARR and why is it important? Annual Recurring Revenue (ARR) is a key performance indicator (KPI) used in businesses with subscription-based models, such as Netflix. It measures the predictable and recurring revenue generated by customers over a year. ARR is critical for assessing the financial health and stability of a business, as it provides insight into future revenue streams. 2. How is ARR calculated? Let's consider a simple example involving a Netflix subscription: For example, a customer subscribes to a plan at $8.99 per month and later upgrades to $15.99 per month. Total ARR from this customer: $53.94 + $95.94 = $149.88. 3. How do customer choices impact ARR? Customer upgrades, downgrades, or cancellations directly affect ARR. More upgrades increase ARR, while cancellations decrease it. 4. What is the importance of tracking ARR? Tracking ARR helps businesses: Predict revenue more accurately. Make informed financial planning decisions. Evaluate customer loyalty and product value effectiveness. 5. How does ARR reflect pricing strategies? Pricing strategies are pivotal in influencing ARR. Strategic adjustments like setting attractive prices for upgrades or introducing new premium features can encourage customers to spend more, thereby enhancing the ARR. In summary, understanding ARR is crucial for businesses to forecast revenue, plan strategically, and make data-driven decisions. Each customer's journey—from the initial subscription to any subsequent upgrades or cancellations—shapes the company's financial trajectory in terms of recurring revenue. Source: Volume Discounting What are the benefits of using volume discount pricing? Volume discounts are offered for a variety of reasons. It’s useful for many B2B companies to buy software licenses in large numbers, for example.  Volume discounting incentives are especially high for SaaS businesses because there are fewer costs that are involved when allowing another customer to access your product. Here are some of  benefits of implementing volume discounting to your SaaS pricing model . 1. Helps you compete in the market Businesses function dynamically according to  the ever-changing needs of the customer and competition. To successfully thrive and compete in the market, it is very important to have a well-planned pricing strategy that will be attractive and valuable to your customers. Providing a quantity discount to your customers every now and then helps you add value to your brand and market share at the same time. Plus, providing volume discounting only as and when needed to keep your customer engaged with the product will help you increase the perceived value of the product in your customers eyes. 2. Attracts a larger  customer base In your pricing strategy and promotions, volume discounting is a key concept. Leveraging it and offering your prospective customers quantity discounts along with a good package plan that suits their needs will definitely create affinity towards your brand and product. 3. Encourages your customers to buy more When volume discounts are offered it usually encourages your customers to buy a bulk quantity  of your product. Sometimes they might choose plans which they might need in the future because it’s affordable and will be useful as they scale. This, in turn, helps you generate more cash flow Understanding the psychology behind volume discounting B2B companies usually offer quantity-based discounts to show appreciation and loyalty to their customers. As long as the idea is sparsely leveraged it sits well, but when offered frequently, it lowers your product’s perceived value from the eyes of your customers.  For B2B software businesses , your perceived value is an important parameter that sits on a pedestal as the value cannot be linked to a physical product. When offering bulk discounts, businesses lower their perceived value thereby sabotaging their image.  Disadvantages of volume discounting Let’s review some of the common problems faced by businesses when offering volume discounts: 1. Lowered price value: Once you lower your price to satisfy your customer, the lowered price of your product sets the new standard for your product price. Things might not go well with your customers if you suddenly need to increase your prices in the future to suit the ever-evolving business needs. 2. Profit loss: By offering volume discounting frequently you put your business at a loss. For every 5% reduction in price you need to sell 38% more to ensure that your profitability doesn’t tank. 3. Product devaluation: Every time you offer a reduced price, you risk reducing the perceived value of your product. They might think that the discounts are offered as the quality of the product is poor and diminishes your brand value in their eyes. It is crucial to ensure that your customer associates quality with your product and brand. Types of volume discounting There are three types of volume discounting strategies: Tiered model All units (or) Volume model Package model What is the difference between tiered pricing and volume pricing? Tiered and volume pricing models are overlapping terms that are often used interchangeably. That said, the fundamental difference between a tiered pricing model and a volume pricing model is the way in which the pricing structure is interpreted upon calculation.  Even though both seem to be the same in hindsight, the accumulated costs in the end are where the difference lies. To sum it up:  Tiered model : The price per unit you’re selling is within a particular price range. Once you fill up one tier you move to the next. Volume model: The price of all the units you’re selling is within the set price range. Now, let’s see how these calculations work. Tiered vs. volume pricing structure  Suppose you’re a business who is selling widgets. Here is how your prices would vary if you either opt for a tiered pricing model or a volume pricing model. How do you calculate pricing for Tiered model? You’ve sold 60 widgets to your customer. In a tiered pricing model, you calculate your total like this [($20x10) + ($10x20) + ($5 x 30)] = $550. You move to the next tier only when one tier is completely filled. How do you calculate it for a volume pricing model? Whereas, in a volume pricing model, the total is calculated as ($5x60) according to the total number of widgets bought which falls under the 30-100 widgets price range. Let’s now see some real world examples to show you how these pricing models are implemented. Examples of volume discounts 1. Tiered pricing: Confluence is a content collaboration tool that helps teams to work together. Look how they’ve implemented the tiered discount structure for their product. They charge $5 for the first 100 users and from the 101th user they charge $4 and so on. 2. Volume pricing: Sketch is a design toolkit that helps you create your work from start to finish. They use a volume pricing model to price their product, so the more devices you want to buy the license for, the less you pay. 3. Package pricing model: Package pricing is similar to that of tiered pricing model,but the difference between the two is that businesses offer a discount for specified number of units. The discounted price usually increases with the volume bought. This is how the product is priced and discounts are offered. If you buy in larger quantities the prices are discounted. Suppose in a packaged pricing model you need to buy 6 widgets, you would pay the cost for 5 widgets and the full price for the other 1 widget. Therefore, your total price is calculated like: For the first five widgets, your cost is $900 and for the other one widget your cost is $200, thereby your total cost being $1100 ($900+$200). Moving Forward A volume discounting strategy is beneficial when done rarely. If offered frequently it can sabotage the brand and product value. Hence, it is necessary to carefully evaluate your pricing plans and product offerings before offering discount prices.  If carefully planned and executed, volume discounting can help you reap many benefits and beat the competition. Source: SaaS Income Statement Over the past decade, tech companies have realized the advantages of using a SaaS model over the traditional software sales model. Rather than selling a single license for a lifetime of access, the SaaS model views the software as an ongoing service—and allows companies to charge a monthly or yearly fee for that service.  But, while this model does have its advantages, providing a service in the form of software also comes with increased operating costs, as businesses focus on providing improved customer experience throughout the customer relationship.  Because of the unique qualities of the SaaS model, a SaaS income statement has become a vital document for evaluating the financial performance of your company. It helps business leaders and investors determine whether a company is heading toward profitability. But what is a SaaS income statement and what should it look like? How do you factor in revenue recognition, so you can show profits and losses accurately? In this article, we’ll explain what a SaaS income statement is and what it should include. We’ll also look at how you can prepare one in accordance with the revenue recognition principle. Table of Contents What is a SaaS Income Statement? SaaS Income Statement Example Accrual or Cash Basis: Which is Right for SaaS? How To Structure Your SaaS Income Statement Best Practices For SaaS Income Statements Automate Revenue Recognition With Chargebee RevRec What Is a SaaS Income Statement? A SaaS income statement is a financial document that shows your company’s revenue and expenses over a given period (monthly, quarterly, or yearly). It’s also known as a profit and loss (P&L) statement. An income statement paired with a balance sheet and other cash flow statements can give a good estimation of your company’s financial health. Importantly, it shows your company’s ability to earn profits over time — all of which are key to making informed business decisions. SaaS Income Statement Example Here’s an example of an income statement from HubSpot from 2009 to 2019.  ( Image Source ) Above, we can see that HubSpot had a gross margin of 43% — not terrible, but not that great either. However, the company greatly improved their profit margin over the years. By the end of 2019, their gross profit margin rose to 82%, which was significantly higher than the industry average of 59% for software. Before we look at how you can create a SaaS income statement, there are two accounting methods that you’ll need to know about: accrual and cash basis accounting.  Accrual or Cash Basis: Which Is Right for SaaS? The key difference between accrual basis and cash basis accounting is when your revenue and expenses are recorded. Here’s an overview of both accounting methods. We’ll also look at which one you should choose for your SaaS company. Accrual Basis Accrual basis accounting is when a business records revenue when it’s earned, and records expenses when they’re incurred.  For example, if you sent an invoice to a customer for $100, you'd still record the revenue in the current month, even if you don’t expect to receive payment until the following month. The same applies to expenses. If you purchase office equipment on credit, you’ll still record the expense even if you pay the full balance later. The accrual method includes receivables and payables, which provides a more accurate view of a company’s financial health. However, accrual accounting is more complex. It requires double-entry bookkeeping where each transaction is recorded in two accounts. Cash Basis Cash basis accounting is when a business recognizes revenue and expenses only when money changes hands. For example, if a customer signs an annual contract and pays up $1,000 front in January, you’ll record all of the revenue in that same month. Expenses work the same way. If you have a monthly contract with a vendor, you’ll only record those expenses when you pay. Cash-based accounting is common for small businesses. However, it doesn’t consider liabilities and receivables, which makes it difficult to assess a company’s financial health. So, which accounting method should you use for your SaaS business? It’s best to use accrual-based accounting for SaaS companies because it gives a more accurate picture of a company’s financial performance. It reflects earned revenue and incurred expenses at any given time.  Accrual basis accounting also follows the Generally Accepted Accounting Principle (GAAP) — a set of accounting rules and procedures issued by the Financial Accounting Standards Board (FASB). With that said, let’s look at how you can structure your SaaS income statement. How To Structure Your SaaS Income Statement Here’s a list of the different components of a SaaS income statement. We’ll explain what they are, why they’re important, and how you can calculate them. 1. Bookings Bookings are when customers commit to buying your products or services (or a subscription in this case). Tracking this metric helps you forecast future revenue growth. If a customer signs up for a paid plan, it’s considered a booking. As you enter bookings in your income statement, you’ll estimate the Total Contract Value (TCV). Here’s the formula: TCV = Monthly Recurring Revenue (MRR) x Contract Length + One-Time Fees For example, let’s say a customer signs up for a 2-year plan that costs $150 a month. However, they also pay data migration fees which are $5,000. The TCV for this booking is $8,600. Note that you can divide bookings into three categories: New bookings: Bookings from new customers. Renewal bookings: Bookings from existing customers. Upgraded bookings: Bookings from existing customers who upgraded their accounts. Segmenting and analyzing your bookings can help you understand how effective your sales team is at converting new customers. If a customer pays their balance upfront, the revenue you collect becomes deferred revenue , in which case it’s listed as a liability on your balance sheet. 2. Revenue Based on the accrual basis accounting method, you’ll record revenue when it’s earned — even when cash hasn’t changed hands yet. Per GAAP rules, a business can only recognize revenue when it‌ delivers services to its customers. This is known as accrued revenue . For example, if a customer signs up for a 1-year contract valued at $5,000 and agrees to pay monthly, you can’t recognize the full amount because you haven’t delivered a year of service. Instead, you'd recognize $416 of revenue (5,000 / 12) for each month you provide a service. This follows the five-step process for recognizing revenue using ASC 606 . ( Image Source ) Check out our white paper on ASC 606 revenue recognition and implementation for details. 3. Cost of Goods Sold (COGS) Cost of goods sold (COGS) is the cost that your company incurs to deliver and maintain your software product. For a SaaS company, COGS typically includes: Hosting and server costs like Amazon Web Services (AWS) Licenses for third-party apps that support your product Software subscriptions to develop your product Salaries for customer success and DevOps teams Customer onboarding and training costs In general, you'd include an expense in your COGS if you need it to maintain and deliver your software to your customers. That means you won’t include overhead costs, sales and marketing expenses, or other administrative costs. 4. Gross Profit Gross profit tells you how much your company made after accounting for direct costs. It appears under revenue and COGS in an income statement. Here’s the formula to calculate gross profit: Gross Profit = Revenue - COGS Companies can also calculate their gross margin, which measures gross profits as a percentage of revenue. This metric helps you measure how efficient your company is at earning profits.  Here’s the formula to calculate gross margin: Gross Margin = ( Revenue - COGS / Revenue )  x 100 A high gross margin means you have more profits left over to grow the business. 5. Operating Expenses Operating expenses are the costs that a company incurs to keep the business running. Some examples include: Rent Utilities Salaries and wages Supplies and equipment Marketing and advertising Maintenance and repairs You’ll record operating expenses in your income statement as they’re incurred. Let’s say your company orders supplies for $5,000 in August and the vendor offers net 30 terms. You'd record $5,000 as an operating expense in August even if you paid the invoice in September. 6. Non-Operating Expenses Non-operating expenses are expenses that aren’t related to your day-to-day activities. Some examples include: Interest payments on loans Obsolete inventory charges Lawsuit settlements Losses from investments Restructuring costs These types of expenses tend to be one-off payments. They also typically appear below operating expenses on an income statement as separate lines.  Here’s an example of non-operating expenses highlighted in red: ( Image Source ) While these costs are unrelated to your normal operations, separating them from operating expenses gives you a better idea of how well your company is performing. 7. Non-Cash Expenses Non-cash expenses don’t involve an actual cash transaction, but they’re still recorded in an income statement per GAAP standards. One common example is depreciation, in which you spread the cost of a tangible asset over its useful life. For example, let’s say you purchase a computer for $5,000 and estimate that it has a useful life of five years. You'd add a depreciation expense of $1,000 for the next five years.  Other examples of non-cash expenses include: Amortization Unrealized gains and losses Stock-based compensation Deferred income taxes Provisions for future losses By recording your non-cash expenses, you can reduce your taxable income . However, keep in mind that these types of expenses are based on estimates. Incorrect estimates can skew your financial statements. 8. Earnings Before Interest and Taxes (EBIT) Earnings before interest and taxes (EBIT) is an indicator of a company’s profitability. It’s also referred to as “operating profit” or “operating earnings” on an income statement. Here’s the formula to calculate EBIT: EBIT = Revenue - COGS - Operating Expenses EBIT is a useful metric because it measures your company’s operating efficiency by ignoring variables like taxes and capital structure. However, EBIT excludes depreciation and amortization of fixed assets. 9. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) Earnings before interest, taxes, depreciation, and amortization (EBITDA) is another indicator of your company’s profitability. By excluding variables like interest payments, taxes, and non-cash expenses, you can assess your company’s operational performance.  Here’s the formula to calculate EBITDA: EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization Let’s say a company has the following lines on its income statement: Net income: $10,000,000 Interest: $500,000 Taxes: $3,000,000 Depreciation + Amortization: $2,000,000 The company’s EBITDA is $15,500,000. By excluding depreciation and amortization, you can get a more accurate view of your operating profits. This is important, especially if your company has a lot of fixed assets. 10. Net Income Net income is often the last item on an income statement — this is where the term “bottom line” comes from. It represents your company’s profits (or losses) over a given period.  Here’s the formula to calculate net income: Net Income = Total Revenue - Total Expenses Total revenue is the net total of income earned. Total expenses include the operating and non-operating expenses that your company incurred. Once you’ve calculated your numbers, you can put your income statement together. Use our SaaS financial model template instead of creating one from scratch. Here’s a snapshot of what the SaaS income statement template looks like ( Image Source ) Edit and customize the template to fit your needs. You can also calculate and track other key SaaS metrics like churn, annual recurring revenue ( ARR ), and more. Download the free SaaS financial model template here . Best Practices For SaaS Income Statements Follow these best practices as you prepare your income statement: Choose a reporting period: Businesses typically report their income statement on a monthly, quarterly, or annual basis. Monthly statements can help you spot trends in your financial data over time.  Categorize your revenue into two subcategories: Separate recurring revenue from existing subscriptions and non-recurring revenue from one-off payments like setup fees. This will enable you to accurately track metrics like monthly recurring revenue ( MRR ).   Subtract bad debts from your revenue: You recognize revenue when you raise an invoice, but what if a customer can’t pay? This can inflate your revenue. Deduct the “bad debt” from your recognized revenue for a more accurate view of your financial health. ( Image Source ) Deduct discounts from gross revenue: Offering discounts is a great way to attract new customers. But make sure to deduct the discount from your gross revenue to avoid skewing your numbers. Follow disclosure requirements: Disclosures provide stakeholders with information about your company’s financial health. Every company has different requirements, so seek legal counsel when preparing your income statement. Automate Revenue Recognition With Chargebee RevRec Income statements provide valuable insights into your company’s performance. However, revenue recognition isn’t easy for SaaS companies. Any missteps could affect the integrity of your statements and misrepresent your financial situation to stakeholders. Chargebee RevRec is a powerful revenue recognition software that automates revenue recognition in accordance with ASC 606/IFRS standards. It also integrates with accounting tools like Xero and QuickBooks Online, so you can streamline the accounting process. Schedule a demo today to see how Chargebee RevRec can help simplify revenue recognition for your growing SaaS business. Source: Proration Proration Isn’t Rocket Science, Just Smart Billing Proration can be boiled down to a simple use case: "If a group of customers use Plan A for 20 days and switch to Plan B for the next 10 days (assuming that a billing cycle lasts 30 days), they should be charged Plan A prices for two-thirds of the month and Plan B prices for the other one-third." As you can see, it’s a way to ensure that they are charged accurately for the portion of the services they’ve used, taking into account their actions (upgrades /downgrades) to change the quantity/subscription terms of these services before a billing cycle ends. Now consider two simple sub-use cases: Proration with Upgrades When a subscription is upgraded, calculate the amount for the remaining period of the new plan and add that as a line item to the invoice generated during the plan change. Current Plan: $100 / month New plan: $150 / month Proration logic: $100 paid at the beginning of the billing cycle. Assume, changes are made exactly in the middle of the billing cycle. Prorated “consumed” charge $50. Prorated credit remaining is $50. Additional charge on new plan for the remaining period: $75 Net additional charges after adjusting credits: $25 Proration with Downgrades When a subscription is downgraded, the customer is more likely to have paid more than the expected usage in the middle of the billing cycle. There will be a net credit to the customer. This needs to reflect unambiguously in the invoice line items, with appropriate charges. Current Plan: $150 / month New Plan: $100 / month Proration Logic: $150 paid at the beginning of the billing cycle Assume, changes are made exactly in the middle of the billing cycle. Prorated “consumed” charge $75 Prorated credit remaining is $75 The charge on the new plan for the remaining period: $50 Net additional credits after adjusting credits: $25. Here is what the next bill would look like: Chargebee takes one more important factor into account when it prorates charges: the state of the invoice (paid or unpaid). The more factors that go into your logic, the more complex prorating gets. But good proration intelligence provides options for as many relevant factors as possible. Is Proration Necessary? If you’re just starting out, it may seem like too much effort to set up proration. Why not just remove the option to switch plans mid-cycle and set up non-prorated billing? Several businesses do choose to go with this. But while it seems deceptively simple and hassle-free in the beginning, you’ll quickly realize that it’s ill-equipped to deal with some basic challenges like: Mismatched Invoicing & Billing Cycles - Businesses who are your customers may want to be billed on a specific date because your invoicing cycle doesn’t sync with their billing cycle. For instance, Neil Patel says it’s good to let customers pick their own date and even suggests adding a line somewhere in the checkout process that reads "Need a different billing date? Send us an email, and we’ll see what we can do!" Proration helps you send clear, unambiguous invoices when you go the extra mile to provide billing flexibility for your customers. Fair Usage-Based Charges - Without proration, you have to charge more than a customer consumes if they want to downgrade or keep them stuck on an old plan if they want to upgrade, until the next billing cycle. In the first case, the customer will feel like they’re being overcharged unfairly without options for a refund, and in the second, you’re losing out on revenue. Neither is good for you or your customers. To sum it up, proration is the smartest way to balance clean & clear bookkeeping on your end and provide convenient billing options on the customer end. And while you can leave it out of the mix if you want, you’re really going to miss it when your customer base grows. Pro Tip: How can you refund customers who are downgrading their plans mid-cycle? You can simply refund the outstanding amount in the next invoice. But this doesn’t let you calculate the reduction in your tax liability or document the downgrade for reference. And what do you do when the invoice hasn’t been paid yet? You can’t return the money you never received. Instead, efficient billing systems use something akin to credit notes (you may be familiar with the term if you’ve used accounting software). A credit note is an invoice-like document that either assigns refundable credits for the equivalent of the money owed to the customer or directly adjusts the invoice amount to reflect the downgrade. It’s neat, unambiguous, and effective. Additional Reads Explore the different facets of billing proration through a perspective-widening selection of intriguing Q&As and articles: Read about our new design overhaul to make this essential featureless fuzzy and more customer-friendly. Proration – A dose of intelligence Learn more about Proration and how you can handle it for your SaaS with the help of our blog. How does Proration work & why is it important in SaaS? Wish your prorated subscriptions were simpler to manage? Chargebee's got it covered. Handle prorated subscriptions with ease Source: Customer Attrition Subscription-based businesses are often laser-focused on finding new customers. While customer acquisition is essential, you should also be worried about how to retain your existing customers.  You can see the impact customer attrition can have on a business in the graph below. A 5% difference in attrition between two companies with the same acquisition rate can result in a 500% difference in the total number of customers in two years. In other words, measuring your customer attrition metric, identifying why customers leave , and employing proactive strategies to reduce churn are vital.  Several factors can cause customer attrition — we'll discuss them in more detail below. For now, know that customers can leave of their own accord because of poor customer service or unaffordable prices (voluntary customer attrition), or they can inadvertently stop using your service because of payment failure ( involuntary customer attrition ).  What Causes Customer Attrition? “Why are customers leaving?” is the first question marketers tasked with reducing churn tend to ask. And it’s an important one because you can’t develop an effective retention strategy if you don’t know what causes customer attrition.  Thankfully, most customers don’t cancel their subscriptions on a whim. Likely, they do so for one of the following reasons.  1. Poor Customer Support Customers want to feel understood and valued by businesses. Almost 90% say customer experience is as important as a company’s products or services. If you aren’t meeting these customer satisfaction expectations, they may be more likely to churn. When customer service is poor, attrition increases. In fact, over three-quarters of customers will go out of their way to use a company with better customer service.  2. A Lack of ROI Few businesses will persist with a tool that fails to deliver a return on their investment. If your tool costs businesses more money than they generate from using it, a cancellation is inevitable.  This is why customers often list price as one of their reasons when cancelling a membership. The price is too high for them to see a return. And, as budgets tighten, this reason will only get more common.  Having a competitive pricing structure isn't enough, however. Companies must prove their product or service can deliver a return for businesses. 3. Payment Failures Involuntary customer attrition can cause churn just as much as voluntary customer attrition. One example of this is payment failure . We estimate that up to 10% of your revenue may be at risk of a payment failure.  Payments can fail for several reasons, including:  An expired card Network downtime Insufficient funds Your job is to make sure that one payment failure doesn’t automatically result in churn. Bad Onboarding 4. Bad Onboarding Do you find that customers cancel their subscriptions after only a couple of months? A bad onboarding experience could be the reason. When you don’t create an in-depth onboarding strategy — whether it’s an automated workflow or led by a member of your customer success team — you leave it to customers to get set up and extract the most from your product. That’s not a great start to the customer journey.  Unfortunately, most customers will have better things to do than spend hours trying to get to grips with a new tool. This can result in a perceived lack of value and, ultimately, attrition.  5. Poor Product-Market Fit Poor product-market fit occurs when your product doesn’t meet customer expectations. They think it solves one pain point when your product actually solves something entirely different. When customers realize that, a contract cancellation can swiftly follow. This typically happens because of a lack of alignment between sales and customer support. How to Calculate Customer Attrition? Calculating customer attrition or customer churn is easy, but you’ll need a few pieces of information first: The period you want to calculate customer attrition over The number of customers you had at the beginning of that period The number of customers you had at the end of the period Next, enter that information into the following formula: Customer Attrition = [(Customers at the beginning of a period – Customers at the end of that period) / Total customers at the beginning of that period] x 100 That'll give you a customer attrition rate as a percentage. This is also known as customer churn rate.  For example, let’s say we want to calculate customer attrition over the first quarter of the year. At the start of that quarter, we had 1000 customers. We have 900 customers at the end of the quarter. Entering that information into the formula, we get: Customer Attrition = [(100-90)/100] x 100 Or 10% It’s important to note that customer attrition calculations can be influenced by the number of new users you bring on board. If you lose 100 customers, like in the example above, but bring on 50 new customers, then you’ve only really lost 50 customers, which equates to a 5% attrition rate. Not 10%. Bear this in mind when calculating your customer attrition rate. What is a Good Customer Attrition Rate? Unfortunately, there isn’t a straightforward answer to this question. Obviously, you want to have the lowest customer attrition rate possible. But how big that figure is will depend on a lot of factors.  The best way to benchmark your customer attrition success is to compare your rate to the industry benchmark. From the image above, customer attrition rates (and customer retention rates) vary significantly between different industries — and some are much higher than you might think. In other words, if your attrition rate is 10% or under, you’re doing great. 5 Proven Strategies to Reduce Customer Attrition You can use a combination of proactive and reactive strategies to reduce customer attrition. Try one or more of the following five methods.  1. Engage Customers Regularly Regular communication with your existing customer base is a great way to strengthen customer relationships and decrease attrition. You show customers you care about them and are committed to improving the customer experience.  A common strategy for SaaS businesses is to email customers major product updates. Highlighting new features can help keep customers engaged and give them a reason to keep using your product. It also shows your commitment to improving your tool.  You can also take a more targeted approach to customer interaction by identifying at-risk customers.  Have one of your customer success rep reach out to this segment with individual, personalized emails and ask how they are finding your product and whether they need help maximizing value.  This demonstrates you value their thoughts and are committed to helping them achieve ROI. It also gives existing customers a chance to raise issues that you might not have otherwise heard about. 2. Demonstrate and Improve ROI Customers want to know they are getting a good deal, so make sure to regularly remind them of the value your business generates.  This can happen within your tool, by including a dashboard that shows relevant KPIs such as time saved or revenue won.  Regular reminders are great, but demonstrating a customer’s ROI becomes really powerful when they are on the cusp of canceling. Businesses can use a platform like Chargebee Retention to create a popup during the cancellation process that showcases the customer’s activity levels and potential ROI. Coming face to face with a personalized reminder of what they stand to lose can be enough for customers to give you another chance. 3. Upgrade Customer Onboarding and Support A thorough, well-designed onboarding experience can be the difference between a customer falling in love with your product or getting so frustrated that they cancel their subscription after three months.  Customers can find it overwhelming when they first use your product. But both automated, in-app onboarding processes and personalized walkthroughs led by customer success teams are effective at easing the transition.  The important thing is to make sure new customers have everything they need to see a return on their investment as quickly as possible. The faster you get customers up and running with your product, the more value they'll derive.  Once customers have become regular users, make sure they continue to get value from your product through an exceptional customer service experience. Every customer is bound to run into a problem at some point during their relationship with your business. The difference between retention and attrition could come down to how well your customer support team helps them overcome their problem. Customers will forgive errors if they receive excellent customer service, while they won’t be so forgiving if your support team fails to deliver. 4. Improve Retention Strategies While it’s best not to leave efforts to reduce customer attrition to the last minute, a customer retention strategy that catches customers in the act of cancellation and convinces them to stay can work wonders.  If you’ve ever canceled a SaaS subscription, you’ve probably been given a personalized incentive that encourages you to continue paying. A free month’s subscription or an annual discount are common offers. They're easy to implement with a platform like Chargebee. As shown in the image below, you can set up a workflow whereby customers are served up personalized retention offers the moment they click cancel. 5. Analyze Churned Customers and Collect Feedback You can learn a lot from customers who have already left. By collecting customer feedback when customers cancel their subscriptions, you can conduct customer attrition analysis, identify the most common reasons for churn, and then set about fixing them. If a significant number of churned customers cite a lack of a particular feature as the reason they churned, for instance, your product team can add it to their development list.   Reduce Customer Attrition with Chargebee Some amount of churn is inevitable, but having a customer attrition rate that threatens your bottom line is when steps need to be taken. Start by calculating what your company’s attrition rate is, find out what’s causing the spike in attrition, and then implement one or more of the strategies we’ve discussed to reduce it.  It’s even easier when you use a customer retention platform like Chargebee. We make it easy to find out why customers are leaving, and then target them with personalized offers that keep cancellations to a minimum.   Explore Chargebee Retention today. Source: Value Based Pricing You’ve created a unique and valuable SaaS product that customers are sure to love.  But how do you know how to price it? There are a couple of standard methods. One is to determine your price point by calculating the cost of supplies and labor and adding an additional cost on top — what's known as cost-plus pricing. Another is to base your prices on competitor pricing.  These methods work perfectly for some types of products, but they're not ideal for SaaS. They don't accurately reflect the value that your product brings to your customers.  Luckily, there’s a way to give your customers what they want for the price they’re willing to pay: value-based pricing.  This article introduces value-based pricing and shows you how to create a value-based pricing strategy. What is Value-Based Pricing?  Value-based pricing , also known as value-added pricing or value pricing, is a method of setting prices based on your customers and how they perceive the value of your product . The more your audience thinks your product or service is worth, the more you can charge.  For example, a famous painting or a meal at a fine dining restaurant might come with a high price tag. This isn’t because the materials used to create the art or the food were costly — it’s because consumers believe the final product and experience attached to it to be worth a lot.  Value-based pricing is differentiated from other pricing strategies because it's exclusively focused on the benefits your product offers a customer. This sets it apart from cost-based pricing, which focuses on what your product costs to make, and competitor pricing, which focuses on the existing price points in the market. Value-Based Pricing vs. Cost-Based Pricing Cost-based pricing, also called cost-plus pricing, involves calculating the cost of producing a product and then setting the price of the product a bit higher than that.  Cost-based pricing has a few upsides. For one thing, it’s simple. It doesn’t involve as much research and analysis as value-based pricing — you just calculate your costs, tack on a “little extra” — typically at least 50% — and you’re good to go.  This method of pricing also guarantees, by definition, that you’re covering your cost and also adding a profit margin.  However, cost-based pricing has limitations, especially for SaaS companies.  The amount that customers are willing to pay has nothing to do with your cost of production. They’ll pay more for a product they value highly. That might be because it solves a certain problem in their business or a variety of other reasons.  Say it costs $20 to make a product. Using cost-based pricing, you mark that up to a price of $40 to cover some of your other operating costs as well. But what if customers think your product is worth $100? You’ll be losing money by choosing cost-plus.  Customers often value SaaS products well beyond what they cost to make. If an accounting SaaS app saves you $5,000 in payroll per month, you won’t scoff at a $300 monthly price point, even if the cost of running the app for you is only $20 or less. Cost-based pricing may be easier to implement than value-based pricing, but it’s usually not as profitable for SaaS companies. Value-Based Pricing vs. Competitor Pricing The competitor pricing or competitive pricing strategy means that you set your prices based on what your competitors are charging for similar products. You can choose to set a higher, lower, or equivalent price, but in all cases, you’re setting your prices based on the competition.  Like cost-based pricing, competitor pricing is straightforward and doesn’t require all the research involved with value-based pricing. And if you follow the lead of a successful competitor, you’re likely to end up in the ballpark of what customers are willing to pay.  But is your product exactly like your competitor’s?  SaaS businesses usually work to find their own niche. Competing products are similar, but don’t have the exact same audience or value proposition. If you use competitor pricing, you’re basing your prices on your competitor’s target market and niche, not yours.  It could be that your customers are willing to pay more for the features that make your product unique. What are the Advantages of Value-Based Pricing?  Value-based pricing is more complex than other options. So why should you bother with it. Here are a few reasons why a value-based system is worth the trouble.  1. You Build a Better Product With value-based pricing, your profits are higher when your customer values it more. That provides an incentive to build a quality product that provides more value to customers than your competitors do. In the end, everyone wins — customers get a better version of your product and you make more money.  2. Customer Service Improves Value doesn’t just come from product features. Customer service is a huge driver of perceived value. Value-based pricing compels you to have best-in-class customer service, which again is a win-win situation for you and your customers. 3. Value-Based Pricing Inspires Loyalty  Value-based pricing is the only pricing method that focuses on the customer experience and customer needs rather than internal or market factors.  Naturally, that’s a business strategy customers like.  They learn that they can count on you to develop the features that they value most. And they don’t feel like they’re overpaying, because your prices are based on what the customer sees as fitting.  When your customers know you care about their needs and their budgets, it improves brand loyalty and trust . A good example of this is Adobe Creative Cloud, with its $20.99 per month Photoshop plan.  Clocking in at over $200 per year, it’s much more expensive than many alternatives, but the perceived value of the product (that it’s just much better than everything else on the market) drives loyal customers regardless of the higher price tag. When you sell a better product at a higher price point, people have to justify to themselves why they’re choosing your brand, so they’re open to noticing all the little differences that sets your product apart.  Think of how an iPhone user talks about how “clunky” the Android interface is (barely different, objectively), or how Rolex owners swear by their “high-quality” watch, acting like it has nothing to do with status. Value-based pricing is a psychological tool you can use to build brand loyalty — but only if you have the product and service quality to back that price up. 4. You Make More Money Another advantage of value-based pricing is that you can charge more for an identical product. If the perceived value of your product is higher than your current price, your profits have room to soar.  And you have some control over that perceived value. By changing your marketing messaging, building awareness of your company, or positioning your brand differently, you can cause customers to consider your product more valuable than they did before.  Value-based pricing lets you set your prices at the highest amount your customers are willing to pay. Customers feel good about what they’re paying because they perceive the price to be reasonable for what they get.  5. It Teaches You About Your Audience Understanding your target market is valuable beyond creating your pricing model. It helps you learn which product features to develop to increase the value of your product.  The work you put into researching and analyzing your customers will also provide insights you can use for marketing, sales, customer support, and more. How to Create a Value-Based Pricing Strategy in 6 Steps  Value-based pricing sounds perfect for your SaaS business, and you’re ready to maximize profits and build customer loyalty. Now how do you actually implement it? The steps below take you through the process of setting value-based prices from start to finish.  1. Research and Analyze You can’t adopt value-based pricing if you don’t know what your customers value. Before you can set any prices, you have to learn about your audience.  The best way to find out what your customers want is to ask them. Send out surveys or conduct customer interviews. Ask questions like: What would you be willing to pay for this product? How much have you paid for similar products in the past? How much do you budget for this category of product? Which features would cause you to pay more for the product? What challenges does the product solve for you? How do you decide between competing products? Other research tactics include reading customer reviews and monitoring brand mentions on social media.  Although your primary focus is your customers, you can also look into competitor pricing and marketplace factors during the research phase. After all, these things can affect how your potential customers perceive you. 2. Build Customer Personas As you learn about your audience, you’ll probably notice some clear patterns.  For example, say you’ve created a productivity app. Maybe a large percentage of your audience is students, while another significant group is mid-career professionals. These groups both like your product, but they have different interests and needs.  In the B2B world, SaaS companies often target individual contributors, small businesses, and enterprise customers differently.  The next step is to create buyer personas for your main two to five audience segments. A buyer persona (or customer persona or audience persona) is a detailed description of a person who represents a segment of your customers. The persona usually has a name and includes information about the fictional person, including:  Age Location Job Interests Habits Pain points and challenges Budget 3. Create Packages Based on Customer Segments Look at the customer personas you’ve created. What does each of them want? What do they value? Maybe your student persona wants the core benefit of your product, but they value a low price tag over fancy features. Meanwhile, the professional persona is willing to pay more for integrations with Google Calendar and Salesforce.  To address the needs, you need to create multiple tiers of your product — put together a package of features for each persona. You’re not setting prices yet — just determining which features will be most valuable to each audience segment.  Think about the biggest selling points for each package. It will be important to communicate these with your audience segments when you roll out the new plan. 4. Set Your Price Points Now it’s time to set a price for each of the packages you’ve put together.  For example, let’s go back to our Slack example above. Slack probably researched the budgets and needs of businesses of different sizes. They found that small teams were willing to pay around $6 per month for a business communication platform with features like messaging and Office 36 integrations. But they didn’t need more than that and weren’t willing to pay more, so they set the pro tier to $6.67 per month.  Meanwhile, mid-sized businesses had larger budgets and also valued identity management features. So they offered a middle-tier plan offering identity management for $12.50 per month.  Value-based pricing isn’t an exact science. If you’ve done the research, you have the information you need to take a stab at choosing a price. But you may have to adjust later.  5. Communicate Your Plans to Customers If you’re a brand new business, launching your value-based pricing tier plans isn’t complicated. Just feature them clearly on your website and emphasize the selling points of each package.  But if you’ve used a different pricing plan before, you have to roll out your new pricing in a way that doesn’t upset customers.  The key is to communicate the value of your new pricing plan to each audience segment separately. For example, let your individual and small business users know that there’s a new package that will save them money on your product, and let your enterprise customers know about the helpful integrations they can get if they upgrade to a higher tier plan.  This is an opportunity to collect more data on customer perceptions, so tell people how they can give you customer feedback on the new product packages.  6. Keep Optimizing Unlike cost-based pricing, which is easy to calculate based on concrete factors like the costs of production, value-based pricing sometimes requires ongoing research.  After you’ve set your initial prices, continue to reach out to customers to get feedback. Find out whether they feel like they’re overpaying and which features they feel are missing.  Also, look for customers switching plans. If all of your enterprises are abandoning the higher tier package for the one you created for SMBs, that means your package isn’t providing enough value to that group.  As your business grows and the word spreads about your product, brand awareness and improved customer perception may allow you to raise your prices. You can also adjust your prices based on new features or add-ons you develop.  What Are the Challenges of Value-Based Pricing? Value-based pricing has clear benefits, but it’s not the easiest pricing approach to master. Here are a few challenges of value-based pricing.  1. It Requires a Deep Understanding of Your Target Audience With cost-based pricing, you only need to know how much your products cost to produce — information you already have. With competitor pricing, you just look up what your competitors charge.  But value-based pricing relies on understanding your potential customers’ values, thought processes, habits, and concerns. Gathering that data requires time and resources that not every company has, like having your support reps conduct customer interviews. 2. You Have to Target One Segment At a Time Another challenge of value-based pricing is that you can only target a limited audience segment with each price point.  Value-based prices aren’t one-size-fits-all — they’re calculated based on the perceptions of one particular group of people. If you target more than one group, you have to put in the work to determine the best price for each group separately.    3. It’s Volatile Finally, value-based pricing iseasily impacted by marketplace changes.People’s perception of the value of your product can change rapidly. When that happens, you need to update your prices to match the current customer sentiment. That can wreak havoc on your plans and projections.  Example of Value-Based Pricing  Value-based pricing lets companies price products at amounts beyond the sum of their parts. To understand what value-based pricing looks like in the SaaS world, let’s look at Slack.  Slack and value-based pricing Slack’s 169k+ paid users come from organizations ranging from tiny businesses to Fortune 100 companies, and Slack’s pricing is based on providing value to each.  For example, the Pro plan, which is aimed at small teams, provides features like voice calls and integration with Google Drive. These features are valuable to businesses of any size.  The more expensive Enterprise Grid plan offers HIPAA compliance support, encryption key management, and a designated account management team.  The reason Slack can charge enterprises a lot more isn’t because the enterprise version of Slack is that much more expensive to produce but because enterprise customers value those features highly. Small business customers don’t value those features enough to pay for them, but they value Slack’s basic features enough to pay for the cheaper plan.  When Should You Use Value-Based Pricing?  There are examples of value-based pricing in a variety of industries, but it works best in niches that meet at least one of the following criteria: You Have Limited Ongoing Production Costs Software as a service is the perfect example here. You don’t have materials and manufacturing costs to account for every new SaaS subscriber. That makes cost-plus pricing a bad fit.  Instead, you can base your prices on how valuable your customers think your product is for solving problems or improving their quality of life.  Your Product Is Niche If you and all of your competitors create very similar products, think toilet paper, they’re likely to have similar value to customers. In that case, it’s hard to avoid competitor-based pricing. But a unique product can be much more valuable to customers. If it’s the only product to solve a particular problem, value-based pricing is a good choice. Your product may not be more expensive to produce, but if it can fill a need that no other product fills, consumers will be willing to pay more for it.  You Plan to Create Add-Ons and Upgrades With a value-based pricing strategy, add-ons and new features are a great way to increase the perceived value of your product. When you learn what upgrades your customers want, you can create them and raise the price of your product accordingly. Value-Based Pricing and the SaaS Industry SaaS is particularly well-suited for value-based pricing, as your product often offers very concrete value (in the form of increased productivity or savings) to individuals or businesses. Plus, developing upgrades and add-ons is a big part of most SaaS businesses. These improvements generate value in the eyes of your users — even if the cost of developing the upgrades wasn’t significant. Consequently, if you use cost-plus pricing for your SaaS product, you could be undervaluing it. Plus, it can be hard to conceptualize what the costs are in providing the service to each customer in the first place with high up-front R&D costs. Creating new features and add-ons continually increases the perceived value of your product and, in turn, your profit margin.  Competitor pricing also isn’t the greatest fit for SaaS. SaaS products are often highly differentiated from their competitors — many companies appeal to a specific niche.  For example, LawRuler has a completely different target market from a more generic CRM like Salesforce, so it wouldn’t make sense to use the same pricing. Other SaaS products are brand new ideas and don’t have direct competitors.  When to Use Value-Based Pricing Value-based pricing is a great strategy for many businesses, including the majority of SaaS companies. You should consider making the switch to value-based pricing if you can say the following:  Your product fills a unique need or has an emotional appeal to customers You can continually add value to your product You have the capacity to research and analyze customer data You stand out from the competition Conclusion  Traditional pricing strategies like cost-plus and competitor pricing are a good choice for many industries, but for SaaS companies, they could be causing you to undervalue your products.  If you’ve been using cost-based or competitor-based pricing, consider running some experiments with value-based pricing to see how it works for your product. You may find that it allows you to build a better product for your customers and raise your profit margin in the process. Source: Recurring Billing Recurring Billing for your SaaS Recurring billing has been called the ‘new black’ in the digital economy and it’s probably no stranger to you. While you’ve definitely read the articles about why the world is catching the subscription bug, you still feel you can’t quite put your finger on a couple of things: what is recurring billing and how can it support your business? Take a common problem: If you have a SaaS business or you’re planning to start one, one of the most important and frustrating things you’ll bump against is the pricing strategy. But if your pricing is right and you provide value, your customer base is going to grow. If at this point, you don’t use a recurring billing solution to support your pricing model, it’s like putting jet fuel in a steam engine. Your billing efforts can’t keep up with your growth and you’ll be adding complexity unwittingly, where you actually think you’re simplifying. Recurring Billing is Your Jet Engine A bill is generally a simple object which shows details like money owed, discounts, taxes, and so on. But in a SaaS recurring revenue scenario, you’re dealing with much more: Invoices that need to take into account: Global taxes Proration Discounts & Coupons Localization for languages Payment methods, etc Post-invoicing necessities: Dunning Payment Failure Handling Targeted Transactions Customer Emails Issuing Refunds, Credits, Write-offs etc., Recurring Billing Works with Different Pricing Models There are several different kinds of SaaS pricing strategies you may be using based on your business model. Most commonly, we see a few kinds of billing models in the recurring revenue space: Usage-based billing: Charge customers based on their usage of your product or service. Here customers are billed post usage on a regular, pre-determined schedule. User-based billing: SaaS software that is typically employed by larger teams may use a user-based billing model, where recurring billing happens based on the number of ‘seats’ that are serviced. Tiered billing: Different products or services have different price points. When the customer chooses a different bundle of features or exceeds a particular volume of features, they need to upgrade to a higher pricing tier. If you follow any of the above, a recurring billing system should be able to facilitate it and remove unnecessary complexity from your plate. As Jason Fried says, ‘Complexity is like a leak in your roof. It starts small. But over time, it does real damage. And once that damage has begun, it's hard to stop. Best not to let it in in the first place. Pro Tip: What’s a better billing cycle for SaaS subscriptions: monthly or annual? Annual subscriptions improve your revenue, remove the need for monthly invoicing and basically puts more cash in the bank. However, monthly subscriptions are flexible and relatively risk-free, giving customers a low barrier to entry. In 2014, Price Intelligently created the ‘SaaS Pricing Page Blueprint’ which stated a fact: Only 1 in 5 of the 270 SaaS companies they studied offered both monthly and annual pricing. Whether you bill monthly, annually or provide both options should depend on which option gives your customers the highest value. Additional Reads A roundup of expert opinions, stories, and insights around recurring billing: A comprehensive guide that unravels the necessity for systems thinking, why recurring billing is not just a utility, and how to solve problems contextually with growth levers. Unhacking SaaS growth and rethinking recurring billing’s role in it Building a subscription billing system internally is like creating a product within your own product. What You Need to Know Before Building a Subscription Billing Software Get on the right billing launchpad with The definitive guide on choosing a Subscription Billing and Management software Source: GDPR What is GDPR? The GDPR applies to both organizations based in the European Union (EU) as well as those outside the EU but sell their goods/services to the EU, or process and/or hold personal information of EU citizens. This is a step forward for individuals towards achieving greater transparency and control over their personal data, and for businesses becoming more accountable. The GDPR law applies to ‘personal data’, any information that can be used directly or indirectly to identify the identity of a person. Examples of personal data range from name, location to even the identification number of the person. How can you become GDPR compliant? To make sure your organization is GDPR compliant, here are some steps you can look into: Evaluate various areas in your product and company to check for GDPR impact areas. Bring in changes to your privacy policy and communicate to users of changes made with respect to GDPR. Make sure enough awareness is created about GDPR in your organization, especially to key people in the decision-making process. Strengthen procedures in the event of a data breach and having a response plan in place. Ensure your technical security meets international standards of compliance. Maintain documentation of all the personal data you have access to, where it is gotten from and how it will be used. Sign DPAs with all the sub-processors used by your organization. Include a legal basis explaining the reason your company needs to process personal information in your privacy policy. Provide an outline of processes relating to personal data for the public to be able to access. Seek explicit consent and allow existing users to withdraw consent. Provide easy access to an individual’s personal information on request. Make sure customers can update their information easily. Implement Privacy by Design. Get procedures in place for data portability and management. Delete data that is not necessary for the company from customers that stopped using your services. International data transfer has to be on par with GDPR rules. Source: Credit Card Data Portability We frequently subscribe to services, however, we rarely notice when they’re renewed. For instance, you may have recently subscribed to an online SaaS product, additional storage on an email client, healthy work lunches. or even a curated wardrobe. But do you remember when you last gave any of these services your credit card details? Chances are, you did it once—when you signed up. When merchants switch payment gateways behind the scenes, it’s usually invisible to you as a customer. You’re never asked for your sensitive billing information again and it’s all thanks to credit card data portability. But this wasn’t always the norm (and still isn’t.) This is why it’s one of the most important questions to ask before you sign up with a payment provider if you do recurring billing for your customers. The Pre-2010 ‘Data Hostage’ Crisis To understand what credit card data portability is and why we need it, it’s vital to know the story behind its genesis. Before 2010, if you needed to collect credit card information from your customers for recurring billing your payment provider would store it for you. But perhaps you want to switch payment gateways when you discover a better provider? Tough luck, consider your customer data lost. In an era where data is the new oil that’s not just an inconvenience, it’s a horror story. Braintree was the first to champion credit card data portability because they saw this massive problem in the payments processing world. Most payment providers wouldn’t allow merchants to port credit card data stored with them on request, and they cited PCI compliance issues as the reason behind it. It’s true, the data exchange problem is essentially a security problem. But there was more to it that they weren’t revealing to hapless merchants: It’s a difficult process to port sensitive data securely and map it to another provider Payment providers wanted to retain customers, not make it easier for them to leave Businesses were left with the only thing to do if they wanted to switch: start afresh and ask customers to add their credit card information again. A nightmare because churn rates would go through the roof and revenues would take a massive hit. So data hostaging effectively prevented many businesses from switching to payment providers they preferred and this vendor lock-in crippled fair competition. 7 Essential Credit Card Data Portability Questions to Ask Your Payment Provider In 2010, Braintree created the much-needed credit card portability standard. They stated their objectives as: Eliminating vendor lock-in for merchants reliant upon a service provider storing their customers' credit card data Creating a secure, PCI Compliant, and standards-based process for data transfers Embracing free market principles and fair competition But while this standard has been in effect for many years and is slowly becoming the norm, some payment providers still don’t support it, most notably PayPal and Authorize.NET. And many merchants don’t find out until it’s too late because, quite simply, they don’t ask early enough. So we’ve put together a list of 7 questions to ask about credit card data portability before you decide to work with a payment provider: Can I retain my customer’s credit card data if I choose to switch providers? Are you PCI compliant? What’s required from me to initiate credit card data transfer to a new payment provider? How long will this process take? What happens to new sign ups on the old payment gateway while this process is underway? Is there an additional fee for you to port credit card information on my behalf? What are the terms and conditions I must satisfy before you can port my data securely? The data hostage crisis was a cautionary tale which prompted conscientious providers to volunteer this information to merchants. But as a business, it’s best to stay one step ahead by proactively asking for a solution. Pro Tip Your preferred payment gateway doesn’t support credit card data portability. Now what? As Douglas Adams famously wrote, don’t panic. Some recurring billing solutions that work on top of payment gateways may be able to solve this issue for you. At Chargebee, we work with a range of payment gateways, some support card data portability and some don’t. For the latter, we store customer credit card information away from the payment gateways in Spreedly’s PCI compliant card vault. You can rest assured that your data will never be lost in limbo and business will go on as usual, whenever you choose to switch providers. Additional Reads A roundup of practical, insightful reads about the challenges of credit card data portability and preventive measures to overcome them: A time machine to 2010: Braintree’s credit card data portability initiative. Still as important today as the day it was set up. PortabilityStandard.org An excellent article from Justin Benson at Spreedly about the difficulty of implementing card data portability and why merchants often turn a blind eye to the problem until it’s too late. Credit Card Data Portability – Does anyone really care? Watch a brief 4 minute 30 second whiteboard video from Chargebee’s CEO, Krish, walking you through the terrain of data portability with points to consider when you choose a SaaS vendor. Data portability – Whiteboard Monday “There are some well-known industry names that if you were to call and ask about the data migration process the reply would be a flat ‘We don’t do that’.” Agile Payments looks at card data portability from both the merchant and payment provider sides of the coin. What’s most interesting is their description of the real-world walls you’ll hit when trying to migrate sensitive information. Payment data portability or data hostage Source: Discounts and Coupons Using Discounts and Coupons in SaaS to grow your revenue Psychologically, the term ‘COUPON’ creates happiness. Customers find delight and joy in receiving an exclusive offer. They even spend multiple hours a week just looking for ways to save money. Discounts offered day after day are what keeps retail companies spinning, a lot of the time. But SaaS isn’t retail. In SaaS, the purpose of offering a discount is not just to offer a price slash to get a customer onboard but also to retain him for a greater LTV. A study by  Price Intelligently  found that SaaS discounting lowers long-term value (LTV) by 30 percent, as well as producing a higher churn rate and lower willingness to pay higher prices. Thus, if discounts are not offered intelligently, they might not be a great idea. Effective discounts, promotions and coupons strategies: Discounts for beta users: If you’re working on a new product and have been in beta mode with live users testing your software but feel that you are finally ready to release the final product, one of the best promotional stunts you can pull is to give your loyal beta users a discount on the final product. Time-sensitive discounts: Discounts should always be time-sensitive. If you don’t put some bookends on the offer, it will look like you are just discounting your product for no reason. This can also devalue your product. A lot of companies use time-sensitive discounting as a way to instill a fear factor in potential customers. Referral discounts: If you run an affiliate program, reward the affiliate marketers who are really advertising your product with a tiered system of rewards and discounts. Does someone refer five of their friends? Start giving them a month free at that point, or even a heavily discounted rate on their next billing cycle. Seasonal promotional campaigns: Seasonal promotions are another popular way for companies to see a surge in business. Get creative with your discounts every year, especially around the end of the year when many businesses are looking for new services to work within the coming year. Loyalty discounts: Have a customer who has been around for five years? How about an entire decade? Instead of giving them a congratulatory email, you can send out promotional coupons to loyal customers. Such good PR can mean they make a shout about your business and their friends start using your service. Hence, discounts used at the right time can always nudge prospective customers in the right direction. Additional Reads More reads about SaaS businesses running promotional discounts and coupons to grow revenue: What are some great ways to use promotional coupons for your SaaS? 5 Ways to Use Promotional Coupons Ready to level up your coupon strategy? A collection of customer stories of how Chargebee has helped run effective coupon campaigns SaaS discounts are both awesome and awful. How-to Use SaaS Pricing Discounts to Grow Revenue