Demystifying NRR: Clearing up Confusion Around SaaS Revenue Retention Metrics

TL;DR

• SaaS companies frequently employ a wide range of terms to describe Net Revenue Retention, leading to widespread confusion.
• The inclusion of ‘dollar-based’ or ‘revenue’ in NRR metrics clarifies a focus on financial changes rather than just customer counts.
• Terms like ‘subscription’ or ‘cloud’ often specify that the NRR calculation applies only to a subset of their revenue streams.
• NRR is a critical metric that evaluates a SaaS company’s dual capacity to both retain existing customer revenue and expand it over time.
• For a metric to truly represent ‘net’ retention, it must account for customer expansion, revenue contraction, and churn.

1. The Labyrinth of NRR Terminology

Ordway’s recent analysis of over 150 publicly traded companies revealed a surprising diversity in how Net Revenue Retention is reported.

• Many businesses craft unique names, making direct comparisons challenging.
  
• This variability underscores the importance of delving into each company’s specific definition rather than relying solely on the title.
  
• Understanding this landscape is the first step toward accurate financial interpretation.

2. NRR’s Dual Power: Retention and Expansion

At its heart, NRR is a powerful indicator because it captures two vital aspects of customer value:

• Customer Retention: It first assesses a company’s ability to keep its existing customers and their associated revenue streams.
  
• Revenue Expansion: Crucially, NRR also measures the growth in revenue from these retained customers through upsells, cross-sells, and price increases.
  
• Holistic Growth View: This dual perspective offers a holistic view, demonstrating not just customer loyalty but also the product’s ability to drive increased value over time.

3. The True Definition of ‘Net’ Retention

For a metric to genuinely qualify as ‘net’ retention, it must encompass all changes in existing customer revenue:

• Expansion: Increases in spending from existing customers.
  
• Contraction: Decreases in spending due to downgrades or reduced usage.
  
• Churn: Complete loss of revenue from customers who cancel their services.
  
• Comprehensive Snapshot: Excluding any of these components would provide an incomplete or misleading picture of a company’s true revenue retention performance from its established customer base.

4. Why Investors Obsess Over NRR

High NRR signals robust product-market fit and significant value realization, making it a favorite among investors:

• Efficient Growth: It demonstrates a company’s capacity to grow revenue from its current customer base without incurring new customer acquisition costs.
  
• Predictive Power: A consistently strong NRR often indicates a sticky product and effective customer success strategies, hinting at future stability and growth.
  
• Valuation Driver: For many enterprise SaaS companies, NRR benchmarks (often 110-130%+) are key drivers in their valuation models, reflecting the potential for compounding revenue growth.

5. Decoding ‘Dollar-Based’ and ‘Revenue’ in NRR

When you encounter ‘dollar-based’ or ‘revenue’ within an NRR metric, it signals a crucial distinction:

• Focus on Financial Value: These terms indicate that the calculation measures changes in the actual recurring revenue generated by customers.
  
• Not Just Customer Count: This is distinct from metrics that simply track the number of customers. A company could lose customers but still show strong ‘dollar-based’ retention if the remaining customers significantly increase their spending.
  
• Investor Clarity: Using these descriptive words helps communicate to investors that the metric reflects the financial impact of customer relationships, not merely their quantity.

6. Why ‘Subscription’ or ‘Cloud’ Matters

Some NRR metrics include qualifiers like ‘subscription’ or ‘cloud’ for a specific reason:

• Targeted Revenue Streams: These terms are typically used by companies with diverse revenue portfolios, aiming to isolate the performance of their core recurring services.
  
• Excluding Legacy Offerings: Older software companies, for instance, might have perpetual licenses or discontinued products with planned revenue declines. Including these would skew the NRR downwards, misrepresenting the health of their go-forward, cloud-based offerings.
  
• Clearer Performance Picture: By specifying ‘subscription’ or ‘cloud,’ companies provide a clearer, more focused view of their growth from contemporary business models.

7. Most Prevalent NRR Terminology

Despite the wide array of terms, some have emerged as more common among publicly traded SaaS firms:

• Dollar-Based Net Retention Rate (DBNRR): This term leads the pack, used by approximately 30% of companies studied.
  
• Net Dollar Expansion Rate (NDER): Accounted for roughly 17% of usage.
  
• Net Revenue Retention Rate (NRRR): Followed closely at about 16%.
  Net Dollar Retention Rate (NDRR): Represented around 13% of the observed terms.
• These commonalities offer some anchor points amidst the diverse naming conventions.