revenue

How to Calculate ARPU for SaaS Companies

Steve Eveleigh

In this article

In the age of big data, keeping a close eye on the right metrics and KPIs can help businesses plot a clear path to success. But in the increasingly competitive world of B2B SaaS, you’ll need to look at very specific metrics to gain that all-important edge. Of course, you’ll likely be aware of the usual suspects like Monthly Recurring Revenue (MRR), churn rate, customer acquisition costs and the like. However, here we’re going to look at a seemingly humble metric that can unlock a veritable wealth of insight as well as encapsulating the metrics mentioned above.

That’s your business’ ARPU.

 

Section 1:

What is ARPU?

ARPU stands for Average Revenue Per User. It’s used interchangeably throughout the industry with similar terms like Average Revenue Per Account (ARPA) or Average Revenue Per Customer (ARPC) but the principle remains the same. Although this variable will depend upon your pricing and business model.

You may wonder at the value in finding out the average revenue per user when you could be looking at the revenue generated by specific customers or groups of users. After all, wouldn’t that allow you to better focus your efforts on the accounts that generate the most revenue?

Nonetheless, ARPU can be an extremely useful metric to track at every stage of the customer journey, offering insights into everything from how you’re doing in comparison to other SaaS businesses to which acquisition channels are the most effective. 

ARPPU - No, it’s not a typo!

Just to muddy the waters a little bit, it’s important to differentiate between ARPU and ARPPU. While they are functionally the same, ARPPU stands for Average Revenue Per Paying User. Businesses that use a “Freemium” service model or have a free tier will find that incorporating non-paying users into their calculations will significantly drive down their ARPU.

So it’s a good idea to focus solely on the paying users who are driving the profitability of your business.  

 

Section 2:

Is ARPU the same as LTV?

At first glance, ARPU may seem very similar to your user LTV (LifeTime Value). However, they are different in a fundamental way, meaning that they generate different insights.

Your LTV is a measure of how much money the user/customer makes for you before churning (cancelling or suspending their subscription). In other words, it measures how well you’re doing at retaining customers and providing the value and trust that they need to stick around. It’s a metric that has implications on how well you’re marketing to your existing customers, how well your product is meeting their needs and how cared for your customers feel.

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ARPU, on the other hand, generates a snapshot of how well you’re doing at a given stage of the customer journey rather than across their lifetime. As such, it’s more useful for evaluating the effectiveness of your communications channels, how well your messaging resonates with customers and how appealing your price point is within your target market.

 

Section 3:

How do I calculate ARPU?

In its simplest terms, calculating your ARPU is really straightforward. Simply calculate the number of users, or paying users in a given time period (b) and divide your total revenue for that period (a) by this number. 

a / b = ARPU

Since most SaaS companies use a monthly subscription model, most will find that a month is the best period within which to measure ARPU, but things get a little more complicated if you offer annual or quarterly subscriptions.  Likewise if you use feature-based pricing this may further complicate matters.

It’s up to you to determine whether a monthly, quarterly or even annual measure of ARPU will yield the most useful insights.

The components of your ARPU

Now that we know the basic formula for calculating ARPU it’s useful to take a look at what goes into the ARPU calculation. 

ARPU is composed of several key elements- your  Monthly Recurring Revenue (MRR) and your total number of paying users. But within this first metric, there are a lot of different components that go beyond what your users are spending on their subscriptions.

Your MRR consists of a number of important elements that will all have subtly different implications for your ARPU.

These include:

 

  • Recurring Revenue from subscriptions- This includes customers both new and old who are either paying for their first month’s subscription or who are letting their subscriptions roll over.
  • Upgrades- Your upgrades (upsell and bolt-on) are those customers who have “levelled up” to a higher pricing tier, purchased extra features or have added another supplemental subscription on top of their main plan.
  • Downgrades- Within your MRR you will also have customers who have dropped down to a lower pricing tier or jettisoned some additional services. You’re still making money from them, but it’s possible that they perceive less value in your offering.
  • Churned accounts- These are customers who have cancelled their subscription at some point during the month / time period.

MRR is a broad church and each of these components within it can have a slightly different effect on your ARPU. An effective strategy makes provisions to improve all of these areas of revenue to improve the value of your ARPU overall. 

 

Section 4:

What strategic insights does ARPU afford?

Broadly speaking ARPU is a metric that measures not just how much money you’re making but the quality of the revenue you’re generating. It can help you to identify positive trends not just in subscription rates but in the adoption of extras and add-ons. When you’re dealing with investors, ARPU can help them to see in no uncertain terms that you’re generating a healthy return for them.

It gives a great snapshot of how you’re doing generally while also helping you with strategic decision making when it comes to;

Forecasting revenue

This month’s average sales you generate can give you a rough idea of what kind of revenue you can expect to generate next month.

Let’s say you brought in 500 customers who between them generate £100 per month in ARPU in the first half of the year. While you can expect some of those to churn, their lost revenue will be (roughly) balanced out by new acquisitions in the remaining months of the year. So you can expect to bring in about as much in the second half of the year, bringing your MRR to £10,000 per month. 

Competitor analysis

ARPU also gives you a reliable indicator of how you stack up against your competitors. Of course, your ARPU will vary wildly depending on if you’re trying to catch a handful of whales or a whole lot of minnows. Still, if your competitors have a similar market strategy to yours, comparing ARPUs can help you better understand how you measure up. 

Improving customer segmentation

While ARPU gives you an overview, it can also be reverse engineered to help you to segment your market and get a better understanding of each segment within it.

It can help you to identify factors that drive conversions from unpaid to paid services or motivate higher paying customers to drop to a lower tier. It can help you to improve your value prospect for higher paying customers while also ensuring that your pricing is competitive enough to encourage conversions from lower paying or non-paying users.

Evaluating your acquisition channels  

Cross-reference your ARPU with the marketing channels that generate customer acquisitions and you’ll be able to identify which channels draw in higher paying customers. This can help you to squeeze every penny out of your marketing budget and prevent you from wasting money on channels with low ROI.

As you can see, ARPU is an extremely useful metric which impinges on pretty much every KPI worth watching. When you know how to calculate your ARPU, it can unlock a wealth of useful insights that can inform your strategy and drive sustainable growth. 

Interview with a founder of a SaaS company

Originally published on 18/02/20 10:14

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