What is ARPU( Average Revenue Per user)+ how to calculate it ?
ARPU is an acronym that stands for Average Revenue Per User or Average Revenue Per Unit depending on what type of business you run. For a SaaS business, it is the average revenue extracted per user and for any eCommerce or any other product business, it is the unit.
According to the definition, Average revenue per user is nothing but simply the revenue or the money that a business is able to extract from an individual customer over a period of time(usually calculated for a month).
ARPU is a very useful metric for the analysis of a company’s overall revenue generation and growth at a per-unit level. That also helps in classifying high and low revenue products.
Note that this is an average number and shouldn’t be used to evaluate individual transactions. Instead, it should be used to understand your business’s health over time.
Thus it is advised to measure ARPA for new and existing customers separately if there has been a significant change in pricing. It helps to understand the evolution of ARPA by providing a more accurate average revenue per account.
Read more on — What is customer success and 7 metrics to help you do it right in your business
How do we calculate ARPU?
ARPU is simply calculated by dividing the total revenue generated by your business for a given period of time by the total number of customers you have.
ARPA (per month) = Monthly recurring revenue (MRR) / Total Number of Customers
Note that the total number of customers should involve only the paying customers. Inactive or free users should not be a part of ARPU calculation. Where the total revenue generated should be calculated keeping in mind the given parameters like,
- New acquisition: The revenue generated by acquiring a new customer with an upfront fee.
- MRR or ARR: All the Recurring revenue generated through account renewals or subscriptions over a month or a year.
- Upsells: Revenue generated by plan upgrades, or product upgrades from the existing customers
- Cross-sells: Total Revenue generated from customers buying other products from you.
A lot of times businesses also include revenue churn or account downgrades for calculating ARPU. This is done by simply subtracting the churn rate from the total revenue, but this may not help you fetch the right figure of ARPU. As it is a non-performing asset for your financial calculation, thus you can just ignore involving churn rate into ARPU calculation to avoid getting a wrong calculation.
Why is ARPU an essential SaaS growth metric?
If you can’t measure it, you can not improve it.
Lord Kelvin
I think there is no dropping off the ball to this statement when it comes to running a SaaS Business.ARPU is such a metric that helps you understand where your company revenue is going on a unit basis. Given that information, you are able to plan acquisition strategies and other initiatives.
Now to keep a SaaS Business sustainable, you need to focus equally on growth and profitability. For a profitable SaaS business, the Customer Lifetime Value(CLC) and the Customer Acquisition Cost ratio(CAC) have to be anywhere greater than 3. This means for a SaaS business to be profitable and acquire growth at the same time, the Customer lifetime value should be 3 times greater than the money spent on acquiring a new Customer.
How do CAC (Customer Acquisition Cost) and LTV(Customer Lifetime Value) share direct relation with ARPU?
What is the correlation between these three metrics? To answer this let us first understand — How much is an average new Customer worth to your Business?
Customer Lifetime Value (LTV) to Calculated as the Average Revenue Per User( ARPU) multiplied by the number of months an average customer remains a customer.
Customer Lifetime Value = Average Revenue Per User (ARPU) X Number of Months an Average Customer remain
ARPU helps you understand whether your customers are becoming more valuable over time. The higher your ARPU the more money you have to reinvest in your business.
Other key SaaS metrics that share relation with ARPU?
ARPU has a direct correlation with the total revenue of your business. But more than that, it is also an essential indicator for you to decide upon the strategies and investments you must make to grow your organization. Let’s look at them individually.
1. MRR (Monthly Retention Rate)
MRR or Monthly Retention Rate is an available indicator used to measure the amount of additional recurring revenue obtained from existing customers through add-ons, upselling, and/or cross-selling. It indicates that the customers are receiving more value and the product’s usage is increasing.
The higher your SaaS ARPU, the higher the MRR (in the short-term) and LTV (in the long-term). To increase your MRR or LTV you have to work towards your ARPU growth at a granular level.
Expansion MRR generation is valuable for long-term profits and growth as it costs less than acquiring new customers. Calculating MRR expansion involves adding up all additional revenue from current customers that occurred within the month.
Read here to know about -How to achieve 130% MRR Retention?
2. Churn Rate
One of the most important or standard metrics, it’s the ratio of the number of customers who canceled their subscription / did not renew it to the total number of customers you had. It defines or limits the largest size the business can achieve.
3. Customer Lifetime Value (LTV)
LTV (Lifetime Value) is an estimation of the average gross margin contribution of a customer over the life of the customer.
Let’s face it. Acquiring new customers is far more difficult and expensive compared to increasing the revenue expected over the lifetime of an existing customer. Also, it is a reliable way of growth because LTV, if managed well can account for the majority of revenue coming from repeat purchases.
LTV can be calculated using the formula:
LTV = (ARPA * Gross Margin %) / Revenue Churn Rate
(for differing ARPA across the customer base)
As we take into account the negative churn or other parameters, the formula for LTV gets more complicated.
4. Customer Size Base
The amount of ARPU decides the number of customers you need to meet your business goals. For low ARPU, you naturally need more customers to meet your targets. Inversely, your business targets can be met with a smaller number of customers with high ARPU.
5. Customer Success Liability
The primary goal of customer success practice is to retain the customers and help them grow. Hence, your ARPU must increase over time if your customer success team is working at its best. Your ARPU should grow exponentially when compared to the customer success cost for them to justify their role in your organization.
Suggested Reads:-
1. Is it fair to treat customers differently based on ARPA?
Originally published at https://customersuccessbox.com on July 15, 2021.
