MRR Definition: SaaS Metrics What is MRR & how is it used in SaaS and Subscription Businesses?

SaaSOptics for Subscription Intelligence In a Flash

CLV

customer-lifetime-value-clv

MRR Momentum™

mrr_momentum_subscription_metrics

MRR Cohort

mrr_cohort_subscription_metrics

Churn & Renewals

churn_renewal_rates_subscription_metrics

Projections

project_subscription_cash_revenues

Customer Count

customer_count_subscription_metrics

Cancellations

subscription_cancellation_stats

Bookings

subscription_bookings_metrics

Understanding MRR


This page includes detailed answers, explanations, and examples including in-depth discussion for the following questions:
  • What is MRR and how to you measure it?
  • How is MRR different from GAAP Revenue?
  • How to you calculate and measure MRR?
  • How is MRR used to manage your subscription business?
  • Special issues and thoughts for MRR used in Sales Compensation
  • The impact of adjustments and credits in MRR calculations
  • How to report on MRR in a spreadsheet

What is MRR?


MRR is an acronym for Monthly Recurring Revenue, which can be contracted, committed, or a predictable revenue stream. A primary purpose of MRR is to permit performance reporting across dissimilar subscriptions terms. The reporting challenge is easily illustrated in the following scenario.

  • Customer A subscribes to a one-year term with a $1200 total contract value.
  • Customer B subscribes to a two-year term with a $2400 total contract value.
  • Customer C upgrades mid term, adding $845 in contract value to what was previously a $1200 contract and now a $2045 contract value.
  • Customer D downgrades mid term, reducing $562 in contract value to what was previously a $1200 contract and now is with $638.
  • Customer E has a $1200 annual contract, but updates AND extends the contract at the same time, establishing a new end date.
  • Customer F fails to renew a three-year contract with a total contract value of $3600.

Using the tradition method of bookings, it is difficult to get a clear sense of performance. Real growth rates and real churn rates and difficult to measure without a form of contract revenue normalization. MRR provides such normalization.

MRR-vs-GAAP-revenue
There are no set rules for the calculation of MRR, but MRR is NOT reportable GAAP Revenue. MRR is a normalized measurement of recurring revenue, most frequently measured with a constant value in each month of the subscription period. GAAP revenue is typically computed using a daily recognition model, which is to say the revenue is recognized pro rata each day between the start and end date of the subscription.

The distinction between MRR and GAAP revenue is best understood when viewing a subscription's MRR and GAAP revenues side-by-side. The table to the right shows the MRR and GAAP reportable revenue for a $1200 annual subscription that begins on Feb 13, 2013 and ends on Feb 12, 2014. The GAAP revenue recognition is a daily computation, the universally preferred (and least error prone) method for recognizing revenue.

As a normalized measurement, one primary purpose of MRR is to remove the noise or jitter associated with real GAAP revenue when reporting on subscription growth and business momentum. If you were to use the GAAP revenue number, your momentum reporting would show significant fluctuations month-to-month. The change from February to March would indicate growth of 100%, and March to April would indicate roughly a 3% contraction, when in fact this customer represents no subscription change at all - neither incremental growth nor incremental contraction - subsequent to the subscription start date. Click on images below to see how the different numbers result in very different MRR reporting.

Noise & Jitter when using "GAAP Revenue"

using-GAAP-for-momentum

Clean numbers when using "MRR"

mrr-momentum-no-jitter

While MRR is an approximation of reportable revenue, the difference is most clearly visible in the simple math of addition. An annual subscription that starts on any day other than the first of the month will span 13 months. And as is the common practice, the MRR is included in each month. The aggregate of MRR over the annual term is roughly 8% more than the GAAP revenue in this scenario - $1,300 vs. $1,200. If the transaction were to start on the first day of a month and end on the last day of the month, and therefor espan only 12 months, then the MRR aggregate would be equal to the GAAP revenue over the term.

monthly GAAP revenue schedule
Note that the difference between GAAP revenue and MRR also exists for a monthly subscription model, that is a subscription with a one-month term or no term (monthly service paid in advance). While common practice to recognize revenues for monthly subscriptions on the date of invoicing or billing, proper GAAP accounting would still result in recognition of the revenue over the subscription period, in this case a single month. A $100 one-month subscription that starts on Feb 13, 2013 and ends on March 12, 2014 would still have prorated GAAP revenue of $57.14 in February and $42.86 in March.

Importance of Revenue Definition Clarity


The examples above clearly demonstrate that MRR is not GAAP revenue, and indirectly highlight a subtlety that frequently causes significant confusion for many organization and finance professionals.

In the subscription world, the word "revenue" is an imprecise term subject to interpretation.

For most efficient business discussions, consider adopting the term "GAAP Revenue" for discussions relating to accounting and income performance, and "MRR" for subscription metrics and analytics. For maximum communication efficiency, ensure each party who consumes the numbers has a clear understanding of the terminology as well as the rules for the generation of the underlying numbers.

Finance professionals, specifically accountants, rarely need education on GAAP Revenue, but many times are new to the subscription model and do need to understand how MRR is different from GAAP revenue. Line managers in sales, marketing and product functions frequently need education on both topics.

How is MRR Used?


In the finance function, MRR is used in or to:
  • Report on growth from new contracts, including those with different term lengths
  • Report on net gross expansion and contraction from existing customers
  • Assess trends in ASP (average selling price)
  • Calculate Customer Lifetime Value
  • Report on MRR Cohorts (typically by customer start month, quarter or year)
  • Estimate or project future GAAP revenue

MRR In Sales Performance and Compensation


Given the importance of MRR growth in the subscription business model, MRR is more and more a consideration in sales compensation plans. However, measurement of MRR for sales compensation often requires a set of "exception" rules that are more complicated than those for a MRR measurement performed for the purpose of assessing strategic business performance.

The primary issues typically involve the inclusion or exclusion of subscription records, the value of MRR, and the timing of transactions.

Top-level MRR performance is no less likely to include ALL MRR transactions than financial statements would all transactions that impact revenue and the balance sheet. Bad AR, write-offs, refunds, and credits are always accounted for in revenue reporting and balance sheets, as they should be in some way in board-level MRR reporting.

However, the sales team is often not accountable for many post-sale financial or contractual changes, including early cancellations, collection issues, bankruptcies, concessions, and settlements. Therefore, changes in MRR performance due to issues such as these are often excepted out of the MRR performance reporting for the sales team.

In addition to complicated "sales exception rules" that factor in or out certain transactions, significant complication can also be introduced based on significant differences in the interpretation of timing of transactions. For instance, a gap in a subscription terms (time between the end of one term and the start of another) would be addressed by finance in revenue reporting, but not likely addressed in a reduction of the renewal booking value within the sales function. And such a situation would likely lead to a difference in reporting.

For example, a customer's subscription is expired and the sales team works for over a month to secure the renewal. Eventually, the renewal comes in. The sales concession to the customer is to start the new term as of the date business terms were agreed upon, in the example below March 28, 2013. However, the customer had access to the service during the gap so the finance team adjusts the records accordingly, recording the subscription and GAAP revenue start date as Feb 12, 2013 and the end date as March 27, 2014. MRR is adjusted down as the $1200 is actually over a term of 13 months (and a few days).

The view of the information from the sale and finance perspectives are thus very different, leading to significant potential complications in measurement and tracking of MRR performance.

Sales Team's View

Original Transaction
Start Date: Feb 12, 2012
End Date: Feb 11, 2013
Amount: $1200
MRR: $100

Renewal Transaction
Start Date: March 28, 2013
End Date: March 27, 2014
Amount: $1200
MRR: $100

Net MRR Change = $0

Financial View

Original Transaction
Start Date: Feb 12, 2012
End Date: Feb 11, 2013
Amount: $1200
MRR: $100

Renewal Transaction
Start Date: Feb 12, 2013
End Date: March 27, 2014
Amount: $1200
MRR: $89.96

Net MRR Change = $-1.04

Invoice and Other Adjustments in MRR Calculations


Noting again that there are no objective rules regarding the computation of MRR, you are left to decide if it is appropriate to include or not include adjustments in your MRR calculations. Given the complexity of many financial adjustment transactions, it is often the practice that they are simply not included. On the other hand, inaccurate or incomplete bookkeeping practices frequently make it very difficult if not impossible to include adjusting transactions in MRR computations if desired.

At SaaSOptics, we work with many early stage and emerging businesses and we see very common patterns. In the early days of the business where the focus is on cash flow and simple viability, bookkeeping practices are erratic, inconsistent, and often inaccurate. An invoice might be associated with one income account and a credit memo for the invoice associated with a completely different income account (typically based on the use of different sales items in the invoice and credit memo). Broad stroke journal adjustments and use of a generalized non-product specific "credit" sales item are also common.

Recording of financial records in this manner makes it difficult to even have the option to include such transactions in MRR calculations.

Inclusion of Variable, Usage, or Consumption fees in MRR Calculations


Variable, usage, or consumption fees are sometimes included, but only when you can make a strong contractual argument or statistical argument that the revenue stream is predictable or consistent. This is most often the case with "capacity" based subscription pricing models common in telecom and telecom-like subscriptions, where the subscription includes X units/instances/actions per month, term or billing period.

MRR Reporting in a Spreadsheet


You will be hard pressed to find a MRR data field or function in any GL or finance system. Certain billing platform providers such as Zuora do include MRR calculations, but not for all transaction types (e.g. usage fees do not include MRR). And, unless your finance system has a rev rec module, it will not have a Contract Object, and therefor will not likely track subscription start and end dates, which means "cancellation" actions and churn are not easily reportable.

With the absence of MRR numbers and cancellation data, the common approach has been to turn to a spreadsheet to track and measure MRR and MRR Churn. In fact, SaaSOptics is an application that evolved (conceptually not technically) from such a MRR spreadsheet. While SaaSOptics now has significantly evolved methods for calculating and reporting on MRR, we understand the xls concepts and organizational maturation process well.

To perform core MRR calculations of MRR Churn and total MRR, it is easiest to start with a simple "status" or state spreadsheet. Your xls will include basic information needed to report on the present state of each contract or subscription. This approach works well for a few dozen customers, but its value quickly evaporates a company grows. Ultimately, this approach does not provide information to report on changes, and what is fundamentally interesting about a subscription company is the change or rate of change.

In short order, most organizations move to a transaction or subscription ledger approach, one that mimics a simple database that captures each subscription action (new booking, upgrade, renewal) as a record in the spreadsheet. To calculate MRR Churn, you need to report on cancellations. A cancellation is the equivalent of the absence of a Renewal. However, measuring a cancellation using an "absence of data" is extremely difficult, especially in a spreadsheet. In other words, you need some form of a cancellation data element that you can clearly record and measure. Therefor, you either tag transactions to indicate the transaction did not renew, or you add a Cancellation transaction with a value (for bookings loss) and a MRR value.

The best-practice approach to creating cancellation records is to record the cancellation in the same period as you would record it as if it were a renewal. Doing so enables you to consistently measure renewals and churn, a mathematical must since churn is simply 1 minus Renewal Rate.

By way of illustration, a subscription ends on July 31. If it renews, the start date of the new term is August 1, and therefore the renewal date for MRR calculations is August 1. If it doesn't renew, i.e. it cancels, there is a tendency to report the Cancellation (especially within the Sales function) as of the end date. However, in doing so, you are reporting the cancellation in a different period. The Cancellation should be recorded on Aug 1, which is the same date and therefore in the same period as the renewal had it renewed.

The typical MRR report performance report includes MRR totals broken out by the following classes: New, Renewal, Expansion/Upgrade, Contraction/Downgrade, and Lost as shown in this SaaSOptics MRR Momentum Report.

mrr_momentum_report2

While the data management and xls formulas become increasingly complicated as your business and reporting needs grow, calculation of New and Lost are typically the easiest and can usually be calculated using a data field or flag to indicate the class of a record. In early stage subscription businesses, you can also use data fields/flags to indicate the class of a transaction. However, as the volume of data grows and the complexity of transactions increases, this becomes increasing complicated. Mid-term subscription changes for quantity, products, value, and term end dates all create immediate havoc with the formulas used to calculate Expansion, Contraction and Renewals.